Risk/Reward Vol. 367
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
Wow. Both of the major indices are up 15% year to date with no end in sight. As I have written ad nauseam fundamentals do not justify these nose bleed valuations. Indeed, as of midday Friday, the Shiller CAPE price/earnings ratio was 31.2, higher than it was before the '29 Crash. Indeed, it has exceeded 30 only three times: 1929, 1999-2000 (dot com) and now. But what do fundamentals have to do with this market? I say nothing. The fact remains that for the vast majority of investors, There Is No Alternative (TINA) to the stock market. Traditional alternatives (bonds, cd's, money markets) produce no return at all and actually are much riskier given the uncertainty surrounding interest rates.
The earnings report issued this week by Blackrock, the world's largest money manager, underscores TINA. Blackrock now has over $6trillion under management. It and its major competitor, Vanguard, now manage over $11trillion. To put that into perspective, the gross domestic product of China (the world's second largest economy) is $11 trillion. As for their percentage of the market, the total amount of assets under management worldwide is somewhere between $70 and 80 trillion. But more significant than their market share is how they are growing. The lion's share of new funds being managed is going into passive, index funds. In other words, everyone is investing in the same thing---stock indices. Little wonder then that the two largest stock indices, the Dow Jones Industrial Average and the S&P 500 continue to increase in value every day. I hesitate to use the word Ponzi, but self fulfilling prophecy works.
So, when, if ever, will it end? Simple: when there are alternatives. But alternatives won't arise unless and until central bankers stop suppressing rates--- which they continue to do despite hints to the contrary. Don't forget, the German 6 year bond still pays a negative interest rate and the 10 year yields only 0.41%. Similar yields prevail in France and Japan. Why? Because central banks, under the guise of "quantitative easing", continue to bid up sovereign bond prices (thereby depressing the yields) so that no one else can or will buy the bonds. This negatively affects the yield on all other debt because all debt is priced in relation to government bonds (the "spread"). The natural consequence is for investors to buy equities in lieu of low yielding debt. Yield suppression has been tolerated in the decade since the Great Recession in order to spur employment which in turn is supposed to spur inflation and economic growth. But the connection between low unemployment and inflation (the Phillips Curve) is slowly being debunked as is the perceived infallibility of central bankers, most of whom view the Philips Curve as the Holy Grail. In the meantime, central banks have run out of tools should we face another true, economic crisis. That is why some conservative monetarists are clamoring for speedier rate hikes. Notably among them are John Taylor and Kevin Warsh, two of the leading candidates for Federal Reserve chair. Should either be nominated, look for Mr. Market to take a pause. But even if one of these two is elevated, the entrenched bureaucracy of the Fed will be hard to turn. So I do not expect any significant jump in debt yields and thus no great stock reversal any time soon.
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