Open Sesame is, of course, the phrase used by Ali Baba to open the 40 thieves’ cave and plunder their riches in the Arabian Nights tale. It would seem an apt phrase to describe the frenzy surrounding the IPO of Alibaba, the Chinese internet commerce firm that floated shares in the US last week. Certainly early investors in Alibaba reaped a significant windfall on the IPO with a first day market cap of roughly $230 billion. Those who bought in the aftermarket will have to wait to see if they too have opened a cave of riches or whether they will end up like Ali Baba’s brother, whose greed provides the story with its main moral message.

I do wonder whether most of the people who scrambled to buy Alibaba stock last week even have an inkling what they’ve bought. If they think they’ve bought stock in a Chinese company they might be disappointed to discover that they own no such thing. In fact, what they own is shares of a Cayman Island company entitled, assuming the Chinese government continues to allow it, to the earnings of the mainland Chinese company. The assets of the company are owned by Jack Ma and the legality of shifting those profits to the Caribbean is dependent on the whims of the Chinese judicial system. In other words, the Chinese government which, as we all know, is known for its commitment to justice. On a side note, my daughter is in Beijing right now and visited Tiananmen Square last week.

Even assuming that the earnings continue to flow to the Cayman Islands, there is no guarantee they will be sufficient to justify the current price although I don’t imagine that will be a concern for stockholders anytime soon. The company is still growing rapidly and that will likely overshadow any negatives such as the fact that margins have been falling for 6 consecutive quarters, competition is nipping at the company’s 80% market share and the Chinese economy isn’t exactly hitting on all cylinders right now. None of that seems likely to matter when even at 32 times next year’s earnings estimate the stock looks cheap compared to some of the social media companies trading in the public and private market. Of course, to me, “it’s cheaper than Twitter” or “it’s cheaper than Facebook” is not exactly a ringing endorsement but it is apparently good enough for a lot of people.

The frenzy surrounding the Alibaba IPO is just another sign of the exuberance, irrational or not, that has infected markets once again. It is far from the only sign that speculation is alive and thriving in world markets. London real estate is trading at multiples of income that makes Tokyo real estate prices in the late 80s look reasonable. Junk bonds and leverage loans are trading as if default is a word that will soon be excised from Webster’s. The stock market, by some measures, is about as expensive as it has ever been and yet prices keep rising. None of that matters I guess when the market moves on grammar. Stocks were up last week, if one believes the headlines, because the Fed decided to retain the phrase “considerable period” in the statement that followed the FOMC meeting. In other words, Yellen isn’t stealing the punch bowl just yet so party on.

I do think it will be a considerable period before the Fed raises interest rates but that may not be the good news the bulls believe it to be. The bond market is still pricing in a much slower pace of rate hikes than the Fed’s forecasters and given the Fed’s track record of unalloyed and so far unrewarded economic optimism, I’d have to say the bond market is probably the better bet. In fact, it seems to me that even if the Fed takes a more aggressive path to higher rates the bond market will ultimately be proven correct. Contrary to popular belief the world has not used the recent expansion to reduce debt outside of some pockets that have been more than offset by others. The global economy will not take kindly to higher rates, something I think is being reflected in the yield curve even now. Even as the risk of rate hikes has been priced into the shorter end of the curve, the longer end has moved much less. In addition to the lower growth signals the bond market was sending earlier this year, the rising dollar is now pushing down inflation expectations as well. Considerable period? How about never or at least a very long time.

If the Fed does push rate hikes too soon the damage will not be confined to the US. Corporate debt has been rising pretty relentlessly and not just in the US and not just for buybacks and dividends. Emerging market companies, mostly in Asia, have borrowed an additional $2 trillion since 2009 with roughly 2/3 of that in dollars. The Fed’s stimulus did have an effect, just not in the US. The recent return of a rising dollar, while a long term positive for the US and the global economy, is not likely good news for emerging market economies with dollar debts and a dangerous dependence on waning Chinese growth. The Asia ex-Japan debt to GDP ratio is now well over 200% and still rising. Including Japan would not make the picture more appealing. As for China, it appears to me that growth is still falling and while the government there did inject $80 billion into the banking system recently, that would appear to be more to paper over previous mistakes rather than to fund new ones.

As for Europe, while most everyone believes that Mario Draghi will soon undertake full blown QE – despite its apparent failure in Japan and the US – the first round of the ECB’s new T-LTRO program saw tenders of just a bit over 80 billion Euro last week, half – at best – of what was expected, bringing to mind the old saying about horses and water. The ECB can’t even get QE Lite to work and the Germans seem unlikely to back the full monty in any case. I would not bet on more monetary stimulus any time soon in Europe. In the meantime the falling Euro – which all the powers that be seem to want – would not seem an ideal way to attract capital to a continent that needs more of it.

Meanwhile, in the US stock market we are starting to see some cracks in the bullish case. While the Dow and S&P were indeed higher last week, setting new records, the rest of the market had a heavier feel to it. The NASDAQ, despite or maybe because of the Alibaba IPO, was flat while small company stocks were down on the week. The rally is narrowing with fewer and fewer stocks participating in the records. Less than half the stocks in the NASDAQ are trading above their 200 day moving average and a comparable number have already fallen over 20% from their peaks. For those of you who have forgotten the definition, that would be a bear market. Of course, a bifurcated market of a few winners and many losers can go on for quite a while as it did in the late 90s so maybe this doesn’t mean the bull market is over but it surely isn’t a good sign.

By the way, another area that is not liking the higher dollar is the oil sector. A higher dollar generally means lower oil prices and oil stocks are one of the worst performing sectors recently. The average energy stock in the S&P 1500 (that’s the S&P 500, 400 and 600 together) is already down 20% and the small cap energy stocks most vulnerable to lower oil prices are down a whopping 30% already. I’ve warned about the dangers of lower oil prices to the fracking economy recently and if prices keep falling – and with a higher dollar and global growth facing difficulties that seems more likely by the day – we will soon find out whether these companies can cope with their high debt loads and falling prices for their product. I don’t know if a higher dollar and lower oil prices will be enough to push the US into recession but it is certainly worth keeping an eye on.

The tale of Ali Baba and the 40 Thieves is one that warns of the dangers and consequences of greed. That’s a lesson that a lot of investors would be wise to heed but in an era of magical economic thinking it is not surprising that most opted for the IPO rather than the book. If you didn’t buy the stock you might want to check out these Aladdin genie lamps I found on Alibaba’s website. May all your wishes come true.

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For information on Alhambra Investment Partners’ money management services and global portfolio approach to capital preservation, Joe Calhoun can be reached at: jyc3@4kb.d43.myftpupload.com or   786-249-3773. You can also book an appointment using our contact form.