By Shah Gilani
Be careful out there.
The stock market rally that started in March 2009 – the one that’s taken us out of the Great Recession and to new highs, the one that’s driving sentiment indicators of people who benefit from rising financial assets directly, peripherally, or because they hope all boats rise with the market – that rally has never been loved.
The thing is, equity markets don’t need love go twice as high from here, or three times as high in the next 20 years. If they get what else they need, they’ll keep going higher.
We could be on the verge of a generational bull market. That’s if deficit-plagued, interconnected global sovereigns deleverage and, at the same time, re-capitalize middle and rising classes by making “recourse-sound” capital available and simultaneously reconstituting entirely the notion of taxation.
Too bad the likelihood of that happening is somewhere between slim and none.
That’s one reason why I’m an increasingly “reluctant” bull.
But there’s another reason too.
The other reason I’m increasingly reluctant is because governments have been running their printing presses non-stop. What will happen if they don’t stop? What will happen if they do stop?
Besides printing on account of deflationary fears, printing money globally to keep up with the Federal Reserve’s massive quantitative easing experiment has been necessary to offset the Fed’s intended consequences to depress the U.S. dollar.
Everyone wants to export their way out of slow growth. The U.S. is no exception.
But printing money, in an articulated policy, to pump up asset prices (which benefit from low interest rates), a depressed dollar that benefits exports, and positive overseas revenue translations, has been fuelling asset price inflation for five years. It’s also been leading a beggar-thy-neighbor campaign. Neither of those are sustainable.
When stimulus slows – or if it stops being effective – we’ll see whether there’s sufficient global growth and fiat trust to avoid deflation.
That’s what central banks worry about, a lot more than asset bubbles.
So, is deflation coming? Yes and no.
It’s not coming in the way most people think about it – at least not at first.
The deflation that’s coming first is coming to financial assets.
That’s what I worry about. I worry about asset bubble deflation.
I worry that we’re now 10% above where stocks (as measured by the Dow Industrials) were at their 2007 peak. That just means we’ve made back all those credit crisis and Great Recession losses (theoretically) and may have started a new bull market.
And a 10% up-leg doesn’t impress me when it’s built on leveraging a zero interest rate policy.
So we just had a better-than-expected jobs report where 204,000 people landed jobs instead of the 120,000 analysts expected? So what if the previous two months saw slight upward revisions?
The unemployment rate still went up. Not down.
The labor participation rate fell by 0.04% (to 62.8%) in October. That’s the lowest rate since March 1978. It means fewer people are looking for work. More people are disenfranchised.
Speaking of analysts’ revisions, so what if 70% of half the companies in the S&P who’ve reported earnings for the third quarter beat analysts’ expectations? They all lowered them after last quarter to make them easier to beat. And they’re lowering them again now because CEOs are guiding future expectations down again.
These days, revenues are rising a lot slower than earnings, it they’re rising at all. Which begs the question, if the rate of change of revenue growth slows and earnings growth from buybacks (which by some measures could have added 40% to rising prices), productivity gains, and cheap debt financing slows down, aren’t stocks fully priced? What’s left for them to feed on?
So what that consumer sentiment is rising with stock prices? It’s been rising because of rising home prices too. How many stocks and how many homes do most people own? Oh, that would be a lot fewer than before the housing bubble broke and stocks crashed.
So what if volatility is at historic lows and seemingly resting comfortably there? That goes hand in hand with margin debt being at record levels.
It’s all just one big party as long as there’s punch in the bowl and revenue to feed profits.
And that’s where we are. We’re at the intersection where asset price inflation (driven by stimulus) meets the real economy’s ability to produce goods and services to sell to people who can afford them, as opposed to being redistributed to them.
Tapering, when it comes, will be scary. Not that it’s coming soon. But it is coming.
That’s good news. Because there’s going to be plenty of time, maybe a few more quarters if we’re lucky, to get sufficiently defensive and put on strategic short positions. Do that now, just in case global growth isn’t there to augment the soon-to-be-diminishing returns of quack-itative easing.
The market has upward momentum. We’re going into the holiday season where spending picks up. There’s a better than even chance if the market moves higher a lot of institutional managers will buy up the winners to window-dress their fourth-quarter and full-year returns. It’s unlikely that Helicopter Ben will slow down QE right before he leaves office next year. He’ll let his successor make her own policy decisions. Why would Ben risk wrecking the rally that he engineered when he’s on his way out the door?
Over in my patch, we’re adding selectively to positions that pay nice dividends, and we’ll be happy to add more to those positions if the market falters. We’re playing in the hot technology patch, and we’re starting to put on some defensive positions.
You don’t have to love this market, but you do have to be in it. And you have to understand that, love it or hate it, the market can’t go up in a straight line forever.
Courtesy Shah Gilani at Wall Street Insights & Indictments (EconMatters author archive here)
The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.
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