BALTIMORE, MARYLAND – We looked back yesterday. Today, we will look ahead. As we will see, the past casts its shadow over the future. Bloomberg is on the case:
Key Fed Yield Gauge Points to Rate Cuts for First Time Since 2008
Some of the most accurate gauges of economic health are pricing in lower Fed rates for the first time in more than a decade.
The little-known near-term forward spread, which reflects the difference between the forward rate implied by Treasury bills six quarters from now and the current three-month yield, fell into negative territory on Wednesday for the first time since March 2008. Two-year yields dipped below those on one-year paper in December.
“This is a crystal ball, it’s telling you about the future and what the market thinks of the Fed and what it will do with its policy rate,” Tony Crescenzi, market strategist and portfolio manager at Pimco, said in an interview with Bloomberg TV. “The market is predicting a rate cut at the beginning part of next year.”
Rang the Bell
A crystal ball? Probably not. The credit markets are warning of an approaching recession. And the stock market rang its bell last year when the S&P 500 peaked at around 2,900 in September – warning of a bear market.
But there are no crystal balls in the financial markets.
Markets provide information. It has to be new, surprising information or it’s not information at all. “Tell me something I don’t know,” says the investor.
That’s why the Fed’s price fixing of short-term interest rates is so destructive. The big players game the system. They know what to expect… so the risk of speculating goes down.
And with the inflation-adjusted rate of interest on Fed Funds below zero, the cost of speculating goes down, too. No wonder the amount of speculating goes up!
And since most speculating is done with borrowed money… the amount of debt goes up. Then, like an overloaded ferry, the extra debt weighs down the economy. Riding low in the water, there is still no guarantee the boat will sink. But watch out.
Back Into Whack
We’ll wait along with everyone else to see what Mr. Market will do. But we’ll keep an eye on the weather, too. There are patterns, trends, and moral lessons that make some outcomes more likely than others.
It’s not like flipping a coin where every flip is independent of the last one. A 20-year-old man may want a refrigerator with a lifetime guarantee. But a 90-year-old can save his money. Even a cheap icebox will probably last longer than he will.
And Mr. Market is a cynic and a spoiler. When he smells flowers, he looks for the coffin. And when he sees Humpty Dumpty sitting on the wall, he knocks him off.
The longer and higher the bull market goes, the less likely it is to continue. Why?
Because there are feedback loops and automatic stabilizers that bring an out-of-whack market back into whack. High prices bring low ones. And vice versa. And a boom built on stimulus gimmicks casts a particularly dark shadow; it always ends in a bust.
Mr. Market, of course, can do what he wants. Steel, concrete, and cabbages may be predictable. He’s not.
When something is widely expected, it usually doesn’t happen. Because, if you knew in advance what was coming, you would race ahead. It would be like knowing where you were going to have a fatal accident – that would be the last place you’d go!
And that’s why investor sentiment indicators are only useful as contrary indicators. When investors are extra bullish, it’s time to get out. When they are extremely bearish, it’s time to buy.
But you don’t have to trust surveys to find out – just look at the prices. Real sentiment moves with the ticker. And currently, stocks are very expensive.
In terms of Shiller’s P/E ratio, which looks at share price compared to the past 10 years of earnings, stocks are almost exactly where they were in 1929.
Tobin’s Q ratio, the ratio of market value to a company’s asset replacement cost, is 1.08. Again, that puts stocks higher than in 1929.
And many other measures put stocks way ahead, too, breaking all records – stocks/EBITDA… stocks/PEG… stocks/sales and profits… stocks/corporate profit margins… Hussman’s margin-adjusted CAPE… stocks to disposable personal income… and Warren Buffett’s favorite – the Wilshire 5,000 to GDP…
By almost any measure you choose, stocks are near the top of their trading range, a point rivaled only by 1929 and 1999.
In these circumstances, you don’t need a crystal ball. You need gold. If you stay in stocks, you could lose half of your money… or more… and then wait 20 years or more to get even.
If you get out of stocks, you will only lose the potential upside, which doesn’t seem worth the risk. And so far this century, an investment in gold has beaten an investment in the S&P – even when accounting for dividends – but with much less risk or volatility.
Most likely, stocks will rebound a little early in the year. Then, with the holidays over and the effect of the eggnog and cocktails wearing off, investors will go back to their desks and their laptops.
They will rub their eyes and listen for another clanging bell. Suddenly, or gradually, it will become clear that the good news economy of 2018 was mostly a fantasy.
Take away one-time mood boosters – the unfunded tax cut, the unfunded extra federal spending, the repatriated profits, buybacks, and extra debt – and the whole “growth” story disappears.
And then, a tinkling sound in the background… barely audible at first… will grow louder…
The tattered investor will shudder. And he’ll feel the shadow of 2018 creeping over him… the worst year since 2008.
He’ll look across the hall to the bond traders. There, he will discover that he can earn 2.64% on a risk-free 10-year U.S. Treasury bond.
Or he’ll look at gold. Late last year, while stocks were falling, gold was going up – about 6% over the last two months.
“That doesn’t seem like much,” he will say to himself. “But it’s a damned sight better than losing money this year like I did last year.”
More to come…