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They Say The Sky Is Clear, We Say Take Cover

Bubbles are the only things that matter. The rest of it is boring. You show up for work, markets are at normal levels, and there's not much you can do. It's all trivial. But in a great bubble you can get your clients' arses out of the way, and the money you can save can be quite legendary." - Jeremy Grantham

The financial services industry generally frowns upon market prognosticators. "Stay the course," they say. This is especially true in recent years since passive investments have outperformed active ones. Admittedly, peering into one's financial crystal ball and voicing an opinion can be a risky endeavor. Besides the obvious risk of being wrong, another risk is being labeled a perma-bull or perma-bear. In article after article that I read, the media loves to turn to its favorite go-to bulls and go-to bears for an appropriate quote. Unfortunately, few individuals are permitted to change their minds and even fewer do it well.

At Runnymede, we do a lot of research, and our view is dynamic, not fixed. Ultimately, our market outlook is reflected in the positioning of our clients' portfolios. Contrary to our views expressed in July 2015 (Financial weather: Central bankers creating clear skies), our outlook has changed markedly. Here's a quick recap.

Valuation

On August 12, 2015, Runnymede sounded off the first alarm for the possibility of a major financial hurricane.

We wrote:

“When looking at the financial weather, Runnymede uses a multi-factor model to track where we are in the market cycle. One of the key components is valuation. Two of the most famous valuation models are Warren Buffett's total market capitalization to GDP and Nobel laureate Robert Shiller's CAPE (cyclically adjusted PE) ratio. If you look at either of these measures, the market is overvalued.”

“Looking at these two valuation models together, the market certainly looks overvalued in relation to history. The next 10 years will likely be a challenging environment for investors and it isn't going to be an easy road to navigate. It most certainly won't be a good environment for those who choose to set it and forget it. There are times to be aggressive and times to be defensive. Simply using valuation metrics, this is a time to be defensive.”

Recession Is Coming

A stock market top usually takes time to happen reflecting investors' inability to anticipate negative fundamental change and most financial advisors' reluctance to take action. A month later on September 2, 2015, we sounded off our second alarm:

“What is the cause of the problem? The zero interest rate policy (ZIRP) is a major factor in that it penalizes savers who cannot earn a risk-free return on their deposits - in essence a heavy tax burden on all citizens and institutions. The longer this policy persists, the longer the nation’s economic growth will be subpar and possibly worsen. Additionally, the US’s trade policy seems to distance the US from the BRIC countries, the growth engine of the world’s economy over the past decade. Since BRICs account for half of the world’s population, it is difficult to understand the rationale behind a trade policy that discourages doing business with a major part of the world. This is a negative for the BRICs as well as the US.”

“Since economists are usually late officially announcing the recession, we are sounding the alarm and anticipate negative surprises from the energy and commodity related industries. We believe the recent decline in stocks could be a harbinger of the coming recession and remain concerned that risks could be compounded if the Fed has run out of options to stimulate.”

Watching the Fed

Many investment firms, banks and insurance companies give plenty of excuses why there will be no bear market or recession. This gives Runnymede the opportunity to sound off a third alarm on January 6, 2016:

“Given the increasingly pessimistic economic data published by the Federal Reserve‘s own regional banks in Chicago, Atlanta, and Philadelphia, we wonder why San Francisco Fed President John Williams told CNBC that the U.S. economy is “in very good shape.” The good news is that Williams is not a voting member of the Fed’s policy committee this year. The bad news is that his views remain important because he is widely seen as a key ally of Fed Chairwoman Janet Yellen, having served as one of her top advisers. We are genuinely and increasingly concerned that the people at the Fed are clueless as to what is going on in the economy.”

When the Fed makes big policy mistakes, the stock market can react violently. Today, we believe that market risks outweigh reward. Be safe out there. They say the sky is clear. We say take cover.

Are you worried about the stock market in 2016? Where do you think the market will finish by year end? Please share your comments.

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photo credit: Blowing in the Wind via photopin (license)

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About the Author: Andrew Wang

Andrew Wang

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Please remember that past performance may not be indicative of future results.  Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Runnymede Capital Management, Inc.-"Runnymede"), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful.  Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions.  Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from Runnymede.  Please remember that if you are a Runnymede client, it remains your responsibility to advise Runnymede, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. Runnymede is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice. A copy of the Runnymede's current written disclosure Brochure discussing our advisory services and fees is available for review upon request. Please Note: Runnymede does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to Runnymede's web site or blog or incorporated herein, and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly.