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