“Happy” 2nd anniversary, Mr Bull Market!

Be afraid!, be very afraid!... , or so goes a cheesy tagline from a noted ‘80’s horror movie. Silly as it sounds, it may just be the right prescription for approaching financial markets today.

As I write these lines in mid march 2011, what seems like the whole world is engaged in collective celebration as we enter the 3^rd year of a remarkable, 24-month upward surge in the broad benchmark S&P 500, doubling its price level in this timeframe. As usual, financial journalists and all manner of market “savants” are joining the party and further exacerbating the trend.

Over the last few weeks, even as we witness both the turmoil in Libya, Yemen and Bahrain, and the tragic human consequences of a mammoth earthquake and tsunami in Japan, there’s no de-railing this euphoric sentiment. At least not yet…

Deeper, or in fact any analysis of the underlying health of the world’s largest economies depicts however a rather fragile state of affairs. First and perhaps most importantly, the current historically high level of corporate earnings can be, to a large extent, explained away by the abundance of cheap credit. Sound familiar? Yes, the same recipe for getting us to the 2007-2008 bust in the first place. This time also coupled with totally indiscriminate distribution.

Put another way, it’s not too difficult to report growing earnings when money is almost free and also ubiquitous!. Furthermore the distinction between sound businesses and run-of the mill enterprises is dangerously blurred as the tide of capital raises all boats.

Whether intentionally or as an act of suspensions of disbelief, investors seem willing to ignore the waning of an imminent end to the US Federal Reserve’s lax monetary policies, better know as quantitative easing. Is the picture becoming clearer now?

For those not yet convinced about the risks lurking behind the scenes today, here is some food for thought.

1. Unemployment is at nearing 10% in the US and above 15% in some of the PIIGS. Quite clearly, demand for corporations’ products and services cannot be expected to keep growing with decreased purchasing power from would-be consumers.

2. Low hiring rates across corporations (the flip-side of unemployment) reveal that much of today’s earnings are driven from inventory level reductions and increased productivity rather than the healthier top-line growth component.

3. With both sovereign-issued debt and corporate paper yielding negative returns after being adjusted for inflation, and real estate’s protracted secular decline still in progress, much of today’s inflated stock valuations reflect equities status as an investment of last resort (with the notable exception of gold, of course).

All in all, as we prepare to enter spring we should also brace ourselves for a potential number of lean years. Markets are priced for perfection and nothing else will do.

Negative earnings surprises, additional energy shocks or the eventual (but absolutely inevitable) rise in lending rates will turn the collective euphoria into a mad rush for the proverbial market exits. The fact that we have seen it all before, many times over, does not in any way make this prophecy less likely to occur.

However, not all is lost.

At least for disciplined value investors. To them I offer the following message: worry not for the “market” matters little when the search is aimed at individually compelling investment opportunities whilst the herd is busy in a frenzy of liquidity- seeking forced selling.

Such a time may come sooner than we think.