Ameriprise Financial, Inc. : The Psychology of this Market – 4

11/19/2013David Joy

We are at a point in this market cycle where stock prices continue to climb alongside a rising chorus of cautionary notes. It is impossible to avoid media reports speculating about asset bubbles or impending corrections, and yet stock prices keep on climbing.

Last week was no exception. The SP 500 rose another 1.6 percent, its sixth straight week of gains, pushing its price-only return on the year to 26 percent. At the same time, the contrarian antennae is up, pointing to excessive investor optimism, accompanied by the recent shift into domestic equity mutual funds by individual investors, elevated valuations, the extended length of the current rally in calendar terms, the eventuality of Fed tapering, and so on.

And it seems there is little middle ground. Both the bullish and bearish camps are convinced of the soundness of their position. Everyone agrees that a correction is coming sooner or later. How close to an eventual top is it possible to get before taking some exposure off the table is the nagging question being asked by investors who desire to lock in at least some of their profits.

But, is that the right question? After all, stocks are up 170 percent from their 2009 low. Even secular bull markets experience corrections and bear markets along the way, and divining their onset has proven problematic over time.

Investors who have a need to rebalance after this year's gains should begin to think about doing so, especially if year-end is typically the time assigned for this task. At the same time, those who desire to get into equities after being overweight in bonds should do so slowly. And equity investors whose investment time horizon is longer than the next few months or quarters should probably stay the course, while not overlooking their own need to rebalance.

Midwest Farmland

One asset category that has long been feared to be exhibiting bubble-like characteristics has been Midwest farmland. According to the Chicago Federal Reserve, farmland values in the Seventh Federal Reserve District have risen every year since 1987, during which prices climbed seven fold. Driving these gains was a combination of falling interest rates, government ethanol fuel mandates, rising global demand, and more recently, drought.

Last August, however, the Chicago Fed reported that although Seventh District farmland values rose in the second quarter by 17 percent year-over-year, they saw no gain during the quarter itself. It was the first time that there had been no gain since the third quarter of 2013. Last week, the Chicago Fed reported that in the third quarter, farmland values rose 14 percent year-over-year, but just 1 percent during the quarter itself. The Fed also reported that prices were expected to decline in the fourth quarter, according to the overall sentiment of the 195 agricultural bankers participating in the Fed's survey.

An expected record corn harvest is mostly to blame, especially coming after last year's drought-induced production decline. During the third quarter, the price of a bushel of corn fell from $6.79 to $4.41. Prices have since fallen further to $4.12. From its March 2013 high of $7.41, prices have fallen an extraordinary 44 percent.

Also last week, for the first time the Environmental Protection Agency proposed a reduction in the ethanol fuel mandate. There is a 60-day comment period on the proposal which would reduce the biofuel mandate for 2014 by 16 percent.

Further contributing to the flattening of farmland values is the recent rise in interest rates, although so far the increase has been modest. But if real rates continue to rise as expected, the attraction of farmland as an investment diminishes, especially if crop prices reduce the income-producing potential of the land. Farmland prices might normally be expected to absorb the cyclical pressures of record production, falling mandates and rising interest rates. But after 25 years of uninterrupted price gains, that may be harder to achieve. And in the Tenth Federal Reserve District, the Kansas City Fed notes a continued rise in farmland values, but warns that the current non-irrigated cropland value-to-rent ratio of 27x is extended compared to a normal historical valuation of less than 20x, and also when compared to the analogous price to earnings ratio of the SP 500, currently at 18x (their number).

On this week's economic calendar are reports on retail sales, consumer and producer prices, pending and existing home sales, initial jobless claims, and the Markit PMI. Perhaps of greatest interest will be the Fed October meeting minutes which are released on Wednesday.

Important Disclosures:

The views expressed are as of the date given, may change as market or other conditions change, and may differ from views expressed by other Ameriprise Financial associates or affiliates. Actual investments or investment decisions made by Ameriprise Financial and its affiliates, whether for its own account or on behalf of clients, will not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not account for individual investor circumstances. Investment decisions should always be made based on an investor's specific financial needs, objectives, goals, time horizon, and risk tolerance.

The SP 500 is an index containing the stocks of 500 large-cap corporations, most of which are American. The index is the most notable of the many indices owned and maintained by Standard Poor's, a division of McGraw-Hill.

Investment products are not federally or FDIC-insured, are not deposits or obligations of, or guaranteed by any financial institution and involve investment risks including possible loss of principal and fluctuation in value.

Brokerage, investment and financial advisory services are made available through Ameriprise Financial Services, Inc. Member FINRA and SIPC.

© 2013 Ameriprise Financial, Inc. All rights reserved.


The Psychology of this Market

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