Kass: Turn, Turn, Turn
(The following article was originally posted on RealMoney Pro on June 11, 8:05 a.m ET.)
"To everything - turn, turn, turn
There is a season - turn, turn, turn
And a time to every purpose under heaven
A time to be born, a time to die
A time to plant, a time to reap
A time to kill, a time to heal
A time to laugh, a time to weep."
-- Pete Seeger: Turn, Turn, Turn
Over the last few weeks I have observed many money managers and strategist make several crucial points that serve as the fountain of their market optimism.
- There is no or limited complacency in the capital markets.
- Valuations are elevated, but remain reasonable.
- There appear to be few economic excesses and, as such, no boom from which to bust.
- There is no alternative to stocks.
- The U.S. economy is well positioned to return to average (to above-average) growth, with low-cost energy, manufacturing cost advantages and the wealth effect of higher home and stock prices.
The meme above is consistent and pervasive. After all, the crowd usually outsmarts the remnants (except, of course, at inflection points), so it rarely pays to be proactive. Play the trend, don't fight the tape or question the market's rise and, above all, stay fully invested (if not, you will face career risk).I would argue that :
- We are in a bull market in complacency. Complacency means, "self-satisfaction, especially when accompanied by unawareness of actual dangers or deficiencies." Bulls have rarely been more self confident in view (just watch the talking heads in the business media). But there are numerous dangers to the bull market in stocks that are being ignored by many, including subpar economic growth, which is still (five years after the Great Recession) dependent on exaggerated and extreme implementation of monetary policy, a growing schism between haves and have-nots (after the failure of QE), weak top-line sales growth, vulnerability to corporate profits (and profit margins), a consumer sector that is spent up, not pent up, etc.
- Arguably, valuations ARE stretched. I would repeat for emphasis that while price/earnings ratios (against stated or nominal profits) are only slightly above the historic average, normalized profits are well above the historic average, as profit margins are now exposed to a reversal of the factors (interest rates will rise, productivity will fall and reversals of bank industry loan loss provisions will moderate) that contributed to the 70%-above six-decade average and at a near-60-year high. Looking at nominal or stated profits (projected at S&P $117-120/share) rather than normalized earnings (to account for degradation in profit margins) could prove to be a fool's errand, just like the mistake that was made back at the Generational Bottom (when trailing earnings of only $45/share understated normalized corporate profitability). At that time in 2009, investors were as reluctant to buy as they are emboldened to buy in 2014.
- There are bubblicious pockets of extreme overvaluation. Above all, there is most definitely a bubble in the belief that central bankers can guide the economy higher and into a self-sustaining trajectory of growth absent fiscal and regulatory reform. (It's been five years and we are not yet there.) Importantly, bubbles are not the mandatory starting point to corrections, as stocks often fall from excessive valuation rather than bubbles.
- While equities are less frothy than fixed income. I don't feel stocks are inexpensive or compelling buys at the margin. I don't buy the either/or argument, as cash is an asset class. At numerous times in history, not losing money (and being in cash) is a reasonable alternative to being in risk assets.
- The domestic economy is unlikely to kick in and gain escape velocity in 2014's second half. Though it has maintained its second-half optimism recently, I expect that the Federal Reserve will end up lowering its official economic forecast. The recovery and wealth effect has been lopsided, favoring the wealthy. It is not broad based. This is clear in the U.S. housing market's pause since last summer. The consumer (the average Joe suffering from stagnating wages and higher costs of the necessities of life) remains the Achilles heel of U.S. economic growth. And the growing savings class is an important constituency that will continue to be penalized by zero-interest-rate policy. Most economists have predicted escape velocity for the U.S. economy since 2011. They have been wrong footed and might continue to be.
- Fear has been driven from Wall Street and there is no concern for downside risk.
- Global economic growth is falling short of earlier forecasts, while a number of regions are flirting with deflation.
- While the shoulders of economic growth have relied on central banker policy, in the absence of regulatory and fiscal reform, QE's impact is now materially moderating.
- S&P profits are estimated to have risen by only about 10% in 2013-14, against a 38% rise in the S&P Index. (The difference is the animal spirits' impact on rising multiples, something everyone now accepts, but none anticipated 18 months ago).
- Though fundamentals remain soft, (with sales and profit growth muted), bulls are self confident in view as share prices propel ever higher.
- Bullish sentiment (measured by Investors Intelligence bull/bear spreads, etc.) is at a historical extreme.
- Shorts are and out-of-favor, endangered (and ridiculed) species.
- There is less to valuations than meets the eye.
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