By Doug Kass at Real Clear Markets
“Can I get an amen?“
— Reverend LeRoy, The Church of What’s Happening Now, The Flip Wilson Show
As I’ve previously noted, I believe a broadening and important market top is in place, and that a relatively meaningful portion of stocks’ daily moves are exaggerated by gamma hedging, risk parity and other quant strategies.
If I’m correct, buying on strength in an attempt to sell on more strength isn’t advisable — and it’s certainly not the route that I’m taking in today’s market. Let’s look at why:
I remain cautious on a market that’s characterized by:
* Wobbly fundamentals (tepid top line growth and an accelerating rate of downward earnings revisions);
* Elevated profit margins that are beginning to regress to a mean;
* A dependence on low interest rates and central-bank largesse that’s losing its potency;
* High valuations relative to historic standards;
Political and geopolitical uncertainties;
* A general global economic vulnerability to exogenous and “black swans.”
We live in a flat, interconnected and networked world, so the notion of the United States as an “oasis of prosperity” has lost its credibility. Instead, the BRIC countries (Brazil, Russia, India and China) have “exported” lower economic activity, disappointing sales and profit growth, and they continue to weigh on the world’s economies. Deflation is also still very much a problem, as seen in the negative interest rates that are prevalent among non-U.S. sovereign bonds.
Malinvestment — the byproduct of 0% interest rates and the “search for yield” — has produced a series of valuation and fundamental potholes for both credit markets and stocks’ overpriced “unicorns.” These will weigh on the markets for some time to come.
And as I mentioned in my Move over ‘Peak Autos’; Here Comes ‘Peak Housing’ missiveyesterday, such malinvestment can even damage U.S. economic growth’s core foundations.
The technicals have been eroding since late November 2014 — and from a supply-and-demand standpoint, the only buyer keeping the market alive seems to be corporations that are doing stock buybacks.
But buyback strategies have historically backfired and generally had poor timing. Just askCaterpillar (CAT). Meanwhile, the retail investor continues to withdraw from the market at a record pace, in part because the “Screwflation of the Middle Class” has left many people with little to invest after paying their living costs.
On The Flip Wilson Show, parishioners going to Rev. LeRoy’s Church of What’s Happening Now were justifiably wary that he was a con artist. Similarly, the market’s almost religious obsession with price “action” and technical trends might be somewhat misplaced in a market dominated by machines and algorithms.
Loss of Confidence in Central Bankers
With economists cutting global growth forecasts for a fourth year in a row, investors are losing confidence in central bankers’ ability to catalyze expansion. And with governments around the world unwilling or too partisan to provide a fiscal blueprint for growth, I believe the “Ah-Ha Moment” lies ahead.
Seven years of 0% or near 0% U.S. interest rates have pulled forward economic activity and profits for some time. (Think “Peak Housing” and “Peak Autos.”) Combined with structural headwinds, this raises the likelihood of more downward adjustments to consensus economic forecasts over the next three to five years.
I believe rallies from market corrections are losing their force and will continue to become more and more feeble over the next year. As the global economy ebbs, investors will become ever more unresponsive to central bankers’ attempts to take on market risk.
The Bottom Line
“Price is what you pay, value is what you get.“
— Warren Buffett
These days, there are more possible economic and profit outcomes (many of them adverse) than I can remember seeing at any other time in my decades of investing.
As a result, buying high and selling higher — the advice from business-TV “storytellers” who always seem to shift their market views with stock-price changes — might be an unsuitable strategy for 2016.
Instead, I’d recommend heeding Warren Buffett’s recommendation above. Beware of storytellers who were bearish two weeks ago but are now bullish after the S&P 500’s 200-handle advance.
TV pundits often change with the winds of stock prices, but quants who are agnostic to private-market values, income statements and balance sheets could be artificially influencing those prices. These traders could also be ruining some portion of the charts that technical analysts have historically relied on.
Personally, my S&P 500 fair-market value remains at 1,860 — about 8% lower than Monday’s close. And I calculate that America faces a 35% chance of a “garden-variety” recession in 2016-17, as well as about a 15% chance of a “deeper recession.” As such, I remain “all-in short.” (Click here to see my top 10 reasons to sell now.)
My advice: Don’t worship at The Church of What’s Happening Now. Rather, intelligently examine risk vs. reward and recognize that the higher stock prices rise, the less attractive the market’s opportunities become.
In other words, buy low and sell high!