This Week’s Message: No Hunch or Hyperbole

The treasury secretary told Bloomberg News this morning that:


Yep…. hmm… well… uhhhh… yyyyeah… that’s good. Because, well, here’s how the future of Federal debt is shaping UP:

In yesterday’s second post I promised that I’d attempt to explain how it is that we may be staring down a third epoch financial bubble in merely the last two decades. On second thought, if you’ve been reading our stuff since late last summer you virtually have to be sufficiently convinced that, indeed, conditions are bubbly; as our aim is to work from, and to present, data and empirical evidence, as opposed to hunch and hyperbole.
Now, as for equity markets — whether we’re talking bubbly or otherwise — a data driven, fundamentally-focused firm like ours will at times find its overall thesis to be at odds with prevailing price trends. Typically, such occurrences cluster around market tops and bottoms. I.e., if we’re doing the work and accurately assessing the risk/reward setup, we’ll more often than not be early to the party; to either its beginning, or to its ending, that is.
Of course I can’t throw that last paragraph out there without acknowledging something a good buddy said to me recently, quoting from the movie “The Big Short:”

“Being early is the same as being wrong.”

Which is absolutely the case! We simply can’t know for certain that we’re right when we’ve rotated to a defensive posture as the market keeps melting up, or to an aggressive posture while it’s tanking. In fact, in both cases, by definition, per my buddy, we’re wrong. Well, that is until we’re right…

But here’s the thing folks, us beginning to hedge portfolios late last summer, then rotating sectors and picking up some gold, etc., last December, then the many tweaks since then, had zero to do with a prediction that stocks were on the verge of tanking. It, on the other hand, had/has everything to do with our ongoing, painstakingly-deep dive into what lies beneath the noise of the price action (oodles of which we’ve shared [and will continue to share] with you herein), and, thus, had/has us surfacing with a confident assessment of the existing risk/reward setup, then acting accordingly on behalf of the folks who pay us to do that work. 

Here’s the analogy I find myself expressing to clients at virtually every review meeting these days:

So, we’re going ice skating on a popular lake, and I happen to be the instructor you hired to show you a good time. As you approach the lake you find me waiting for you, and you notice tons of folks having the times of their lives; cutting, sliding, skidding, kids romping all over the ice, etc. 

We have a seat, you lace up your blades, you rise up and I say “stand still a minute, we’re not quite ready yet.” I then proceed to strap onto you a big bulky life vest with a pully on its back, through which I thread a rope then toss it over the thick limb of a nearby tree.

You say to me, “Marty, what the heck are you doing? If I even get onto the ice before dark I’m not going to have much fun the way you’ve got me all bound up!” 

Me says to you, “Well, you know, I got here early so I could measure the thickness of the ice and take the outside temperature. And, unfortunately, while I understand how it looks on the surface, with all those folks having such a great time, I checked my notes from my own personal experiences (been taking folks out onto the ice for 36 years), as well as my studies of literally centuries of market/economic history, and, well, virtually every time the ice was this thin and the weather was this warm the ice ultimately broke. And, sadly, many of the skaters who were out there completely unprotected sank to the bottom, some never recovered.

Now, I honestly can’t know for sure if the ice is going to break this time as well, but I do know that the risk is very high that it will. And, frankly, I’m just not willing to take you out there completely unprotected. We’ll have some fun, but, you’re right, as long as the ice remains this thin, and as long as I’m your guide, it won’t be a ton of fun.

Of course, if/when a big freeze hits and the ice thickens back up, I’ll happily release the binds and we’ll have a ball. I love skating fast on thick ice when the odds suggest that our falls won’t kill us — which is absolutely not the case currently, believe me!

Speaking of measuring to determine risk/reward setups, when it comes to stocks, and to put it simply, consider the following ideal conditions that typically precede and accompany sustainably rising stock prices:

1. Low Valuations: Speak for themselves.

Unequivocally not — in the aggregate — the case presently.

2. Low debt levels and high interest rates: I.e., room to finance future growth, buyback shares, etc.. and room to boost markets, and lending, by reducing interest rates.

Well, both debt and interest rates are at or near record levels, but, alas, at the opposite extreme.

3. Profitability: Speaks for itself.

Not the narrative amid record corporate debt and the deepest recession since the Great Depression. 

4. High regulatory burden: I.e., room to reduce regs and free up resources and ideas.

The next regime of course will have much influence on future regs. Question being, are they likely to (on balance) be lessened or tightened from this point forward? 

5. Strong, improving demographics: I.e., real economic growth depends on a growing population, and is most robust when the age distribution favors the young.

Clearly not the prevailing trend in the U.S., or in much of the rest of the developed world for that matter. In the emerging world, however, there are indeed areas with favorable demographics, which we’ll be looking to exploit in the years to come.

So, again, thin ice… 

Richard Vague, managing partner at Gabriel Investments, economic historian, former bank CEO, current secretary of banking and securities for the Commonwealth of Pennsylvania, and author of A Brief History of Doom: Two Hundred Years of Financial Crises was recently interviewed on RealVision. The following resonated with me, as it speaks to a key, necessary element of every financial market bubble:

“I lived through several of these crises, and psychology has everything to do with over-lending. 

Here’s what happens: 
When I start to lend more, let’s call it more as a percent of GDP, in a given sector, and let’s keep it on real estate, if mortgage loans increase, that means you  have more buyers for houses. If you have more buyers for houses, prices go up. So the very beginnings of a boom are very encouraging. Things get better.
I’m a banker, I made loans, the collateral behind my loans has increased in value; I must be a smart banker. And the bank across the street might be reluctant to follow my lead. But at some point in time — and this happens every time, and I lived through this inside institutions so I know exactly the psychology — the bank that’s not lending so aggressively looks across the street and says “the bank over there is earning more than we are, they’re getting rewarded with a higher stock price, all of our hot young loan officers are going to work for them because they’re getting bigger bonuses, my board of directors is complaining that we aren’t keeping up with the bank across the street, we need to start doing some of this ourselves.” And when “we” start lending some more, prices go up even more.
So when more folks jump into this it becomes the hot thing, and it is all about psychology at that point in time.
…if you continue to say no, you are going to get dinged on your stock price, you are going to have your directors questioning your leadership, you are going to have your best employees go work across the street. Who is strong enough to resist that?
It turns out that just about the only folks who can are the folks who have 100% ownership of their institutions, and don’t have a boss to answer to. And there aren’t very many of those in the financial services industry. 
So I’d absolutely attest to that psychological dimension to these booms.”

Well, folks, make no mistake, the same psychology permeates/infects the portfolio management business as well. And we happen to be an independently owned and operated firm, unwilling to act in a manner that conflicts with what we view to be the prevailing risk/reward setup. Which is a good thing!

I’ll close here with a snippet from our close to last week’s main message, as it fits this week’s message nicely as well:

maybe infinite money printing and government borrowing and spending can indeed save the stock market’s day this go-round…

In our view, all one can (or should) do — one who sees forests through trees, that is — is dispense with the messy and profoundly futile business of market forecasting, while forever and painstakingly assessing the prevailing risk/reward setup and investing accordingly.

Which to us — along with hedging crash risk — means, at this juncture, recognizing, crash or not, how the powers-that-be will attempt to manage their way out of what is the greatest debt bubble in the history of mankind.

Well, as the present crisis — and all past modern-day crises for that matter — so vividly illustrates, the powers-that-be know of only one method of “managing” crises — print, borrow and spend money, while cutting interest rates to the bone.

A weak dollar regime — assuming they can sustainably fend off the effects of trillions of dollar-denominated foreign-held debt, and hold interest rates at bay — is therefore to be expected. Couple that with what will certainly be attendant yield curve control (i.e., capped treasury market interest rates), and seemingly obvious investible themes emerge. Gold is the ultimate no-brainer under such a scenario — its at times extreme volatility notwithstanding. Other commodities such as agriculture are likely to do well under such a setup as well.

New government spending will largely focus on infrastructure. The outcome of the coming election will determine the extent to which we invest in traditional infrastructure plays vs those catering to a more environmentally-focused regime.

Thanks for reading!



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