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Gad: Day of Reckoning Looms

Editor's Note: This article was originally published on Real Money at 12 p.m. EDT on May 13. To see latest Real Money commentary as it's published, sign up for a free trial of Real Money.

NEW YORK ( Real Money) -- How long will stocks keep climbing? Or, put another way, when will the party end? The elephant in the room is the Federal Reserve and when it will decide to stop injecting money into the system. When the Fed stops making asset purchases, it will be a move heard around the world.

Rest assured that by the time the Fed actually announces it is done buying, Mr. Market will probably have already started taking some chips off the table. We can focus on the Fed's meeting minutes for clues, but the only thing we know for sure is that each passing day brings us one day closer to that day of reckoning.

In the meantime, investors should take stock of the following useful market data:

  1. According to S&P Capital IQ, first-quarter corporate earnings grew by 5%, year-over-year. That's a respectable figure, but there is a bit more to it. Sales during the quarter grew by only 1%.
  2. Corporate compensation averaged 55% of sales, one of the lowest rates in decades.

These two points should not come as a complete shock, but they bear revisiting today. Companies are doing more with less. Profits are growing but not due to increased demand, but rather because of lean operations. That dynamic cannot continue. Demand will have to pick up and for that to happen, the economy has to continue improving. Employment needs to continue to growing, housing prices need to continue stabilizing, and, ultimately, the consumer needs to continue gaining confidence. To be sure, all these things are slowly happening.

Of course, not all companies are getting by on efficiency. Some businesses are experiencing quality top-line growth and increased profitability. But the key takeaway for investors today is that today's 0% real interest rates are having a skewed effect on the flow of capital that favors the stock market. Investors should remember this when they see stock prices going up in the absence of underlying fundamentals.

Stocks are not in bubble territory -- many big-cap names are producing tangible cash flows. Still, as the saying goes: It's good to be greedy when others are fearful and fearful when others are greedy. It seems to me that we are moving toward the greedy side; thus, caution today is more than warranted.

At the time of publication, Gad had no positions in stocks mentioned, although positions may change at any time.

Sham Gad is the managing partner of Gad Capital Management, a value-focused investment firm based in Athens, Ga. Gad has written extensively for The Motley Fool and was a securities analyst for UAS Asset Management, a small value investment fund in New York City, in 2007. From 2002-2005, Gad managed assets for the Gad Investment Group.

Additionally, Gad has just released a new book, The Business of Value Investing: Six Essential Elements to Buying Companies Like Warren Buffett. He earned his BBA and MBA at the University of Georgia. Gad appreciates your feedback; click here to send him an email.

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