A Contrarian View - Raging Bull
TLDR - seen a lot of pessimism out of the major firms, it's starting to make me think it's too pessimistic, making me consider that we're on the cusp of a multi-year secular bull market, let's discuss
OK, I've been struggling with a couple of thoughts over the past few months and wanted to see what others thought (either your personal view or your firm's view). let's try to keep this based on the market, not turn it into politics, even though a bit of that will be inevitable. full disclosure, my personal money outside of emergency funds is ~100% invested, about 60/40 US/non US, with a bias towards quality/GARP/dividend growth in the US while I outsource the nonUS (for all of you Taleb fans you believe "don't tell me what you think, just tell me what's in your portfolio")
Over the past couple of years I've noticed a tremendously bearish tenor from many of the major firms. I'm just not seeing the optimism. everyone from people I hate (Hussman) to people I admire (Howard marks) seem to have a conservative tilt in their commentary. I wanted to explore this a bit more, because outside of permabulls like Jeremy Siegel, I'm not seeing the optimism and it makes me think we're on the cusp of a secular bull market. allow me to present some points and counterpoints, and then I'm curious to hear your take.
9.5 year economic recover
1. US is 9.5 years into this economic and market recovery, near the longest on record, trees don't grow to the sky, eventually, this will roll over and likely sooner rather than later
this recovery, while long in date, has been short in growth, one of the shallowest post-crisis recoveries of all time, GDP growth is below average, bucking the previous trends of sharp down followed by sharp up, markets don't wear a watch and the economy does not look particularly overheated**
2. Debt is an issue that will hamper growth, between student loans, inability to get a mortgage, and the federal gov't, how can the US feasibly continue to grow at any sort of rate? the crash is coming
Actually, the household debt service ratio is near the lowest it's been in over 35 years (was lower earlier this decade, but still it's low AF), consumer balance sheets are incredibly healthy, student loans have little effect on the economy unless there's a massive cascading default wave of gov't subsidized loans, and the gov't debt issue (while near & dear to my heart) only becomes anti-growth if you have the crowding out problem Japan had. so yes, it's a problem, but not for my portfolio at the moment**
3. Looking at CAPE and other longer-term valuation measures, stocks are projected to get dismal returns, equity risk premia are declining as stocks rise and rates rise, why would you invest in stocks when the potential returns are so low?
Actually, with earnings growth, valuations have been coming down, and while ERPs are skinnier, they're a notoriously terrible forecasting tool. while negative into the tech bubble, they were also negative in the 80s & early 90s (great returns) and positive leading into WW2 (negative returns). furthermore, show me an asset class with meaningfully higher potential returns than stocks for the next several years. in other words, yeah, stocks are probably due for a below average time period of returns, but that does NOT mean you shouldn't invest, it means you should alter your expectations. you think me, a 30-something guy is going to go into fixed income? unless munis start paying 8%, NOPE**
4. Ok bro, you mention earnings growth, but that's been accounting sleight of hand, with stock buybacks, laying off people, etc., and since we're operating at near peak profit margins, this earnings growth can't go on forever.
This one's actually kinda tough, because I don't know what peak profit margins are, we won't know until it's been years from now and we can look back. there's an argument to be made that since we're a more tech and outsource heavy economy, profit margins along with multiples may just be perennially higher. comparing an economy that's heavy in manufacturing compared with one that's more service and tech-oriented is just nonsense. I'm not saying "this time is different." what I am saying is the heuristics you use to draw market conclusions need to keep up with the times. finally, sales growth has been STRONG. the economy (credit trump or credit the cycle) is firing on most cylinders right now. earnings growth without sales growth? yeah I'd be worried, but we're not seeing that**
A few more random thoughts:
Yes they're an issue, but this only meaningfully affects indebted companies, if you keep quality high, I really wonder how much of an impact this has. there's actually some data out there that up until the US10 reaches 5%, stock prices rise along with rising rates. now, if Jay takes rates tremendously high, you likely have an overheating economy or he's been drinking jungle juice. neither of which seems plausible at the moment
Trump & trade:
Look, I worry about trade as well, tariffs if persistent can lead to runaway inflation, which is bad for everyone, and nobody wants a 1970s stock market again. I wonder if we're using the availability bias (can you tell I've been reading psychology?) where we all grew up in a period of globalization out of fear of another global war (the Euro, NATO, NAFTA, UN all came post WW2), maybe bilateral deals aren't a bad thing, maybe Trump acting like a jackass is just rubbing people the wrong way and the effect of all of this is completely moot. on other stuff he's doing, he's decidedly pro growth
This one I struggle a bit with, the % of the S&P tech makes up is near the highest of all time right before the worst 3 years in market history outside of the great depression. however, what's different is earnings. back then, before SOX, companies were actually making shit up in a big way and prices were far & away outpacing earnings growth. today, when I see MSFT crush it in cloud (70+% growth!) and the stock gets whipsawed, that doesn't scream euphoric to me.
Flows have been in a steady decline (across all products) for stocks whereas bond flows have been quite strong. the average investor tends to be dead wrong if you look at fund flow data & subsequent performance, this bodes well for stocks
I don't use them personally, but I hear the argument that people going passive will cause the next recession, I don't see it. an ETF is just a wrapper, that's all it is. furthermore, they still barely make up 20% of the overall equity universe and even less of the bond world, so to say they could cause a crash is just short-sighted and wrong.
Inverted yield curve:
It has a flawless track record, predicting every recession we've ever had, the thought process is if long credit pays less than short credit, that's indicative of an overheated economy and that we're on the cusp of a slow down. well, it's not yet inverted, and I'd like to throw one other thing out there. full disclosure: if the yield curve inverts, I'll probably take some risk off, this part is more of an intellectual exercise. has anyone ever actually thought that our sample size for recessions might be too small to draw conclusions? I mean think about it, we've had 18 technical NBER recessions in 118 years, out of which, the only really really bad ones were the tech bubble, GFC, Vietnam, WW2, great depression, and WW1 (early 90s was barely one, you actually had positive full-year market performance, similar for the 50's & 60's). maybe something that infrequent and over such a short time period (118yrs is nothing in the context of human history, much less natural history), maybe it's truly just coincidental, or like Soros believes, a reflexivity type reaction, where because everyone believes the economy will contract because of the inverted YC, they conduct their affairs as such, thus sending the economy into a recession.
Part of me wonders if because we had two of the worst market declines in modern history in the past 20 years has made people, in general, more skeptical and conservative. This is not normal, you don't normally see your assets get cut in half twice in two decades. Is this the new normal as PIMCO famously said (and subsequently backed off of)? Or, was that truly a blip and it's now off to the races?
Bottom line, I'm still undecided on this, but since I seem to be seeing no optimism, I want to know from WSO, am I totally off the reservation? what do you all think?
Tagging a bunch of CU's so we get some good discussion going
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