I have recently been accused of being a paid up member of the gloom and doom club. Well, actually accused might be too strong; informed is probably more accurate. I don’t spend a lot of time thinking about how these weekly missives might be perceived but based on recent feedback the perception out there seems to be that I’ve turned into one of those perpetually gloomy types that is always warning of a disaster right around the corner. So, in the tradition of all recovery programs, my name is Gloomy Gus and I’m a bear. I don’t know why I can’t seem to just enjoy the market as it makes new highs but I’ve been reviewing my beliefs and it is obvious now that there are a few things that I just need to get on board with so I can improve my mood:

  • Central bankers know best: Central planning may not have worked when applied to the economy as a whole but central bankers are different. They obviously have the tools to determine the exact right level of interest rates and if they think zero isn’t low enough, then by golly buying up government bonds and mortgages makes perfect sense. Sure it distorts market prices but who’s to say the market is right when a PhD in economics requires so much math? I need to get over my trust issues and remember that Ben Bernanke has an economic model that is a perfect substitute for the real world.
  • News is always good: The economic data and corporate earnings announcements are irrelevant market noise. Bad economic data means the Fed will just keep doing more of that QE magic and good data means we’re on the verge of a self sustaining recovery. Earnings growth? We don’t need no stinking earnings growth. P/E multiples can keep going higher because interest rates are still low and the Fed will keep them there forever.
  • The wealth effect works: I know there are a plethora of studies that show the wealth effect is weak but that’s because we’ve never had a central bank that was able to keep stock prices at a permanently high plateau. If stock prices stay high long enough, people will believe it is permanent and spend their new wealth. And they won’t have to sell to do that since they can just borrow against their gains. If it hasn’t worked yet that’s just because the Fed hasn’t done enough but they’re working on it so just wait.
  • A rising market is a buy signal: The fact that stock prices are rising is sufficient reason to buy some more. I don’t need to worry about valuations or other silly fundamentals since I can always just get out when it starts to go down. And of course it won’t go down much because Bernanke’s got my back so just buy’em while they’re hot.
  • Debt doesn’t matter and if it does it’s good: Reinhart and Rogoff made a spreadsheet error so their entire thesis that higher debt is associated with slower growth is wrong. Sure, those other researchers found the same thing but they haven’t figured out yet whether slow growth causes debt or if debt causes slow growth therefore we should just assume that it is the former. And the best way to raise growth is to add leverage to our corporate balance sheets and buy back stock to increase the wealth effect (see above).
  • Currency wars are good for growth: The BOJ’s QE is good for the world because everyone will start doing the carry trade again buying up all kinds of assets in other currencies. Sure, Korea and China are pissed but there won’t be any consequences since they can just start their own QE programs if they want. The US won’t mind if everyone is devaluing against the dollar since the Treasury Secretary always says a strong dollar is in our best interests. The carry trade will inflate asset prices in other countries creating an even bigger wealth effect which will create more growth and a bigger wealth effect which will create more growth, ad infinitum.
  • Inflation is good except when its not and the Fed knows the difference: The biggest problem we have right now is that inflation is too low. Sure, people aren’t buying as much stuff as they once did but if prices start rising that’ll give them the incentive to get out there and buy today before the price goes up more. And we need people to buy stuff today, not tomorrow, so we can create growth that will let them buy stuff the day after tomorrow. Asset inflation – stocks,bonds, real estate and such – isn’t really inflation since those things aren’t in the CPI and bubbles just happen all by themselves. Besides the Fed learned from the last two bubbles – not that they had anything to do with them – and can now fine tune these things to create growth without all the messy aftermath.

Warning: The above bullet points should be read with a sarcastic tone. 

Yes, alright, I admit it. I’m bearish on the US economy and US stocks. It isn’t something I’ve chosen though; it is just where the data points me. When I was writing more optimistic commentaries back in 2009, 2010 and 2011 I got accused of being a permabull. Now that I’m more pessimistic, I’m accused of being a permabear. I’m not a perma anything except a skeptic. When things look their worst, when everyone is bearish, I look for the silver linings. When everything is sunny, when everyone is bullish, I look for the clouds. As far as I’m concerned that is what being a good investor is all about.

Investing today seems very simple. Interest rates on safe investments are low and everyone knows what everyone else has to do to get a decent return – buy stocks or other assets with higher yields. Everyone knows that QE is driving stock prices higher and will continue to do so. Everyone knows that if the economy falters, Bernanke will just do more QE and keep stock prices from falling. Everyone knows that QE isn’t inflationary because it hasn’t been yet and the Fed will figure out a way to reverse it without upsetting the market. Everyone knows that austerity is dead and that means growth will get better.

All I know is that it is often the things that people are surest about that turn out to be wrong. Everyone knew house prices couldn’t fall until they did. Everyone knew the Fed would bail out any big financial institution that got in trouble until they didn’t. Everyone knew the Fed could fine tune the economy until they couldn’t. And now, for some unknown reason, people have decided that the Fed has regained its magic touch, that doing more of what got us in this mess will get us out of it.

I am a Gloomy Gus right now because asset prices are high and fundamentals are deteriorating. The S&P 500 is up almost 50% since the lows of 2011 while earnings are flat and the economic data has gotten worse. Maybe the economy is about to improve and earnings are about to resume their growth. That’s possible and if you believe that’s how things will turn out, then you should be fully invested. Personally, I don’t put a high probability on that outcome and I don’t think that is why most people are buying stocks now. I think most people are buying because stock prices are rising and they don’t want to get left behind. Just like they bought houses for the same reason last decade and dot com stocks the decade before. Maybe it will be different this time. Maybe fundamentals don’t matter. Maybe the Fed really can print us to prosperity. Maybe. I’m just not willing to bet on it.

Someday, when stock prices are lower relative to the fundamentals, when the economy looks even worse than it does now, I’ll be urging you to buy stocks and look at the bright side. I can’t do that right now but that day will come and I hope you’re still reading when it does. I’ll probably have to write a weekly commentary about all the emails I’m getting telling me I’m too optimistic.

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For information on Alhambra Investment Partners’ money management services and global portfolio approach to capital preservation, Joe Calhoun can be reached at: jyc3@4kb.d43.myftpupload.com or   786-249-3773. You can also book an appointment using our contact form.