Decision Time
Posted on Sunday, November 3rd, 2019
Zero earnings growth, falling PMI’s and slowing GDP growth are not indicators of high times around the corner but here we go. The market has been moving sideways for 22 months – since January 2018. Perhaps, Friday was the day of the breakout. I think I need a bit more convincing as markets are stretched shorter term. The difference between this breakout and others over the last few months is that the October window is now closed. Investors know that over the last 50 years the November to May time period holds all the gains. If you had bought stocks in May and sold in November every year for the last 50 years you would have returned close to zero. If you bought in November and sold in May you would have reaped almost all of the gains in that period. Professional investors are back at work and ready to jump on a breakout in stocks.
I am a risk manager by trade and in general root for the market to go down. Why? I am constantly a buyer of stocks. It is much harder to buy them with valuations so elevated and with economic indicators sliding. We have been writing for months that Trump has something up his sleeve. He knows he will not be reelected with a slumping stock market and an economic malaise. He needs spending and job growth. For months he has badgered the Federal Reserve into rate cuts and QE with his trade war being the final piece of the puzzle to convince the Fed. Now that the monetary heroin is flowing again payroll tax cuts and a truce in the trade war are just what Trump needs to get things really humming in front of the election. It is going to be an interesting spring. All of these recent changes in policy may have huge effects down the road and adds to our thesis that a blow off top and even higher equity prices could result. We are not excited about chasing returns and momentum with valuations this high but we don’t get to choose the markets we have to invest in and invest we must.
If you follow us you know that we are always on the lookout for several leading investors whenever they speak. One of our favorites is Jeffrey Gundlach from Doubleline. While most investors just talk markets up we think Jeffrey speaks truth to markets. He gave an interview this week to a German finance magazine. We have long talked about the effect of corporate buybacks and their support of equity prices. One thing that we know is eventually that fuel to the markets will sputter. Gundlach explains the current Achilles heel of the US corporate debt market and how things may play out.
How big is the problem (corporate bonds)?
Morgan Stanley Research put out an analysis about a year ago. By only looking at leverage ratios, over 30% of the investment grade corporate bond market should be rated below investment grade.
Is it better to own stocks then?
The US equity market will be the worst performing equity market in the world if you look at the past three major economic downturns, globally. Before each of those three downturns there was one segment of the global stock market that outperformed in a noticeable way, and the economies related to that stock market were perceived as to be invincible.
This time US stocks are crushing every other area. It’s due to some fundamentals like the better economy, but also due to tax cuts and share buybacks. In the next recession, corporate bonds will collapse, and buybacks will stop. The dollar has already topped. It may begin falling in earnest during the next downturn and US equities will lose the most. They will probably not make it back to the peak for quite a while. When the US market drops, it will drop a lot.
We agree with Gundlach that, at some point, the fuel of corporate buybacks will stumble and bring down historically elevated US equity valuations. Europe and Japan look much cheaper and may provide better risk reward opportunities going forward.
I think we aspire less to foresee the future and more to be a great contingency planner… you can respond very fast to what’s happening because you thought through all the possibilities, – Lloyd Blankfein
To learn more about us and Blackthorn Asset Management LLC visit our website at www.BlackthornAsset.com .
A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty. – Winston Churchill
Disclosure: This blog is informational and is not a recommendation to buy or sell anything. If you are thinking about investing consider the risk. Everyone’s financial situation is different. Consult your financial advisor.