I think by now it’s clear that the markets are materially disconnected from the underlying economic reality. Take for example the CEO of Fedex’s comment in their last conference call with investors:
“…the stock market, of course, is very bullish, but the industrial economy does not reflect any growth at all, worldwide, to speak of.”
In positioning the Global Macro Core Fund we spend a considerable amount of time thinking about macro economic trends. We began to see deceleration from early on in 2018 and the markets sold off later that year in part because the Federal Reserve (the “Fed”) was on “autopilot” raising rates despite the slowdown which had become rather apparent to us. Things were slowing. In fact, GDP for example has now slowed from 4% to what we expect to be nearly 0% in Q4 2019. This was foreshadowed for example by global PMIs (a gauge of manufacturing activity) trending from expansion to outright contraction in nearly all countries. However, since the beginning of 2019 none of this has mattered. Stocks have not cared that the economy is slowing. In fact, at the time of writing, the Nasdaq is up +48% from it’s December 25th, 2018 lows while the economy has slowed.
So why the disconnect? The disconnect is because the Federal Reserve has come to the rescue printing money with no regard to it’s long term impact. They have re-inflated the bubble massively in just one year. The small dip from all-time highs last year spooked the Fed enough that they came to the rescue before the markets even had a chance to fall. They have shown that they are immensely concerned about what impact a legitimate stock market correction would mean for the real economy. In a world where consumer spending accounts for approx. 68% of GDP, if equity markets were to fall and consumer confidence was hit hard – then it is all but a certainty that we would have a severe recession. In fact, already most other components of GDP are in recession.
However, the reality is the Fed is doing everything it can (and Trump is cheer leading) to keep equity markets afloat at all costs. Starting in October, they started a new round of balance sheet expansion (printing money) to stabilize the unstable repo market. It seems almost too perfect of an excuse to start a new round of quantitative easing (QE) – at all-time highs I might add. What was once an emergency measure (in 2008) is now just “normal” government intervention to keep equity markets sufficiently inflated. This recent interviewee CNBC describes with perhaps too much candor the situation. CNBC and other market oriented news programs are often referred to as “bubblevision” – meaning perpetually bullish and typically they have guests on that support that view. This guest, is in fact bullish, but for all of the “wrong reasons”. We agree with all of his points – he however believes that markets will continue to move higher because the Fed continues to print money despite what he describes as “insanity” and a market that is more overvalued than at any other time in history (in the “99th percentile” as he notes). By our measures the S&P500 has fully exceeded any prior periods of overvaluation. We are in uncharted territory of investors’ willingness to overpay for nearly all assets.
As he notes, however, despite the insanity the path of least resistance continues to be up. It is illogical and it will end badly but for now “buy stocks”. As such, we are more willing than we have been in some time to hedge against further moves higher. With that said, it is unpleasant to be a buyer up here if only temporary.
Here is a clip from an interview in September as well if you’d like to hear more of his very candid thoughts.
His reference to Japan – this is the Japanese Nikkei 225 (225 largest Japanese stocks)
Stock market peaked in 1989 (which ranked as one of the biggest bubbles in financial asset history) and was nearly 80% lower 24 years later. It’s recently had a good recovery but it’s still 40% lower 30 years later.
Japan’s debt to GDP ratio well over 200%, plagued by debt, no inflation, aging demographics and 0% interest rates for decades.
(0% interest rates are often used as a rationale to justify today’s valuations)
AND best of all – the Bank of Japan has been so desperate to get stocks up that it now (2018 statistic) owns 77% of the Japanese ETF market. They have spent 23 trillion Yen buying their own stock market since 2013.
There is nothing “free” about this “free market” – capitalism has been replaced by something entirely different. The same can be said about the Fed’s interventions since 2008.
Lastly, I’ll just place the Nasdaq (US) chart below here. See any similarities?
Notice 2008. Merely a blip at this point and yet many of the issues that caused 2008 have only grown larger. We have solved a debt crisis with more debt.