Wednesday, February 19, 2020

This Week's Message: The Secret Sauce

No kidding, it absolutely makes some sense to us that amid what you already know about the coronavirus and its impact on the global economy, as well as the frightening data points charted for you below, that global stocks are holding near their all-time highs and may (as in maybe) very well continue right on through them in the weeks to come. 

I'll explain why after you scroll through a few not-so-rosy-looking graphs:

Click each insert below to enlarge (shaded areas highlight past recessions)...

US Job Openings:

% Of US Industries Experiencing Negative Jobs Growth (75%):

Institute for Supply Management Surveys:

Industrial Production:

Durable Goods Orders:

Commercial and Industrial Loans:

Heavy Truck Sales:

Cass Freight Index:

Factory Capacity Utilization:

Industrial Materials Prices:

Baltic Dry Index:

Leading Economic Indicator/Coincident Economic Indicator Ratio:

Auto Loan Delinquency Rates (90-day+):

I'm just gonna stop there. Trust me, my "Charts That Trouble Me" file is utterly bulging!

Now, you have to be wondering if I’m only showing the ugly stuff to make a point when, in reality, there's plenty of good economic data that I could be sharing as well. 

Well, that’s clearly what I’ve done to this point!

However, since I not only pride myself on being objective, I believe objectivity is a critical attribute of successful money managers, here's some good stuff for ya:

US Retail Sales:

Consumer Spending:

Housing Starts:

Housing Permits:

Consumer Confidence:

Home Builder Confidence:

Jobless Claims:

Unemployment Rate:

That, frankly, is about as good as it gets for now, in terms of the good data points. However, despite the fact that I couldn't match the number of negatives preceding them (and remember what I said about my "Charts That Trouble Me” file) given that the consumer accounts for 2/3rds of the U.S. economy, perhaps it doesn't matter so much that there's so much more in terms of negatives to illustrate. Right? 

Well, perhaps...

As for why it makes some sense that stocks remain strong amid such a, we'll call it mixed, picture, well, hang on a minute; first let's apply a few valuation metrics to the U.S. stock market.

S&P 500 Forward Price to Earnings Ratio:

S&P 500 Price to Book Ratio:

S&P 500 Price to Sales Ratio:

Total U.S. Stock Market Cap to GDP Ratio:

Note that the price-to-earnings and price-to-book ratios exceed 2007 peak levels, but remain below their peak 1999 levels while the price-to-sales ratio and the market-cap-to-GDP ratio are the definition of scary high. Now, understand that the first three metrics are all calculated on a per/share basis -- and take a look at the next chart:

S&P 500 Shares Outstanding:

So what's that mean? Well, it means that (while the scaling of the chart exaggerates the effect a bit) S&P 500 companies have spent a fortune buying back their own shares; taking them out of circulation in the process. Which in effect exaggerates their sales and earnings results on a per/share basis. Which means those per/share valuation metrics would be all-the-more higher were it not for the engineering of the numbers by corporate execs whose -- in many instances -- bonus schemes are tied to their respective companies' results per/share. 

Here (last paragraph of the following snip) is what Investopedia has to say about one such team of execs:  click to enlarge....

Okay, so, again, despite my cherry-picking enough bad stuff to make a point, why do I say it makes sense that stocks could continue their march higher? Just one more thing before I answer.

I actually have two questions for you: 1. Does it make sense to you? I mean, amid all of the evidence that you just perused (and I left out the corporate debt mess that I've been illustrating herein for months), do you think stocks can indeed march higher from here? And 2. Assuming you do, do you believe that you, or any prudent investor, should attempt to participate?

As for why I say yes to #1, I'll analogize:

The reason I believe stocks can continue setting records is akin to the same reason I expected certain bulked-up MLB batters back in the late-90s to hit home runs at a single-season pace never seen before, or since. Their secret lied in the secret sauce that had them all "bulked up" to begin with. The risky thing -- aside from being illegal -- was that while the injection of steroids into their systems gave them the super human strength and speed needed to consistently knock baseballs out of the park, health care professionals tell us that they were playing with fire -- with their lives, or their longevity, if you will -- when it came to their internal organs. 

You see, in economic terms, the first slug of charts above would be the under-the-surface stuff -- the economy's internal organs, let's say -- that goes unnoticed by most stock market fans. The second grouping is the stuff they do see as they frequent the malls, the restaurants, the new subdivisions and so one. The steroids would be the injection of liquidity by most central banks these days; the resulting low interest rates, the increased borrowing at the consumer, and, especially, at the corporate level, and so on. The fact that the under-the-surface data is no longer responding to the juice — at least not lately — calls into question the true underlying health and longevity of the bull market from here. 

Take a look at the bulked-up balance sheets of the world's 4 heaviest hitters (this -- via assets these central banks have taken onto their balance sheets and out of the system, in exchange for cash/bank reserves -- represents the degree of stimulus they've injected into their respective economies) and how fast they've piled on the mass the past few years:

Again, I ask question #2 above. Do you believe that you, or any prudent investor, should attempt to participate? Or, let's say, to participate in unbridled fashion -- as if everything under the surface is in perfect shape?

Neither do we!

And if we happen to manage your money, rest assured that given the present under-the-surface reality, we've zero interest in swinging for the fence at this point. That is, we're content for the time being to lay low (compared to our game plan from the bottom of the last collapse to late last summer) and to string together a few singles here and there while working to keep your portfolio’s innards healthy and strong so we can confidently reengage when the game is legitimately back on: I.e., when the risk/reward setup once again makes sense.
"Every time a bubble bursts, a bull market collapses or a silver bullet fails to work, we hear people bemoan their error. The skeptic, highly aware of that, tries to identify delusions ahead of time and avoid falling into line with the crowd in accepting them. So, usually, investment skepticism is associated with rejecting investment fads, bull market manias and Ponzi schemes."
"Investment success requires sticking with positions made uncomfortable by their variance with popular opinion."
--Howard Marks 

Thanks for reading!

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