For the last few weeks I have been ranting about some political nonsense or the other without keeping to my stated goals of writing interesting, thought provoking Substacks. Well that little digression is over and it’s back to the formula.
Originally, I was going to write about Jerome Powell and his renomination. My thinking was simple. He hasn’t done a bad job at all and most people feel he has done pretty well navigating some very unusual circumstances. I think his belief about “transitory” inflation is misguided and that belief is not helping the situation but his reticence to raising rates to combat inflation may ultimately be a smart move. Markets seem to think so and who am I to argue with the thundering herd?
Since he is off the table, what is propelling this overpriced, over hyped market to new highs seemingly on a daily basis? Unfortunately, the answer is complicated and I hate complicated answers. Be that as it may, I will go over some ideas and let you pick one of two from my menu.
One; Investors feel that this is just the beginning of a new bull market and like the last bull market, they want to be on board. I could find probably five or six good reasons to let investors know, that is not a good reason to invest. For one, maybe you are the last passengers on this ride and you are helping propel valuations that in the long run, are not sustainable.
Two; I like this one, there just is really no other place to put your money. Inflationary periods tend to have rising equity prices to go along with them. More money out there, more money to invest and while higher valuations are risky, it’s a vote on the country and the economy and what could go wrong? Yields on other investments are lagging so I want return and I don’t care that pricing is ahead of itself.
Three; The Fed has been very free with the money and that is always a good time to invest. Low interest rates and Fed repurchasing have made for a very meaty investment period. Argue if you want, it does come back to the Fed and very liberal monetary policies. That alone could sustain a market run and it has. Now, the question is, what will happen when the tapering is done and the Fed finally raises rates? I will answer that one in another Substack but I do believe it won’t happen until the Fed believes all the wheels are back on the bus.
Four; Its about earnings stupid! As my friend Larry Kudlow has said many times “Profits are the Mother’s milk of stocks” and what we have seen over the last 14 months has been an explosion of profits for corporations. I have repeatedly said that I don’t think those earnings and the multiples they have achieved are a true indication of how well companies are doing but, companies are profitable, there is no denying that fact. Comparing earnings this year to last year is not a true indication of how well companies are doing. Last year, companies were hard pressed to give direction on business because there were so many uncertainties so analyst did it for them and analysts did the best they could but they were invariably low balling earnings projections so throughout last year, companies were constantly beating those projections and investors took that to the markets and bought every sector (except energy). For this year, analysts and companies have been more closely aligned as the nuances of running a business during this highly unusual time became easier to see. Most companies have figured out staffing and supply issues and pricing and they have a much better idea of what the potential future looks like so investors can fully understand the choices they are making.
With all this being said, money still flows into the market and valuations continue to go up. Multiples are at historic highs and no one seems interested. They just buy. This blindness can only end one way, a correction. Bringing corporate PE multiples back to historical levels (they are historical levels for a reason) and rebalancing portfolios to a position where risk is countered with safety will happen.
I know, if you headed my call early on, depending on what sector you were loaded up on, you would have missed anywhere from 6% to 14% of this market move and while I won’t backtrack because people think I am running scared, I will continue to hold to my firm (and becoming firmer) belief that investors need to take those hefty profits and put them into something more modest. For the short term.
One other thing to think about is taxes. If the Build Better Back, or whatever it is called, gets passed the Senate, rest assured that the Capital gains tax will increase. So along with inflation and higher taxes, waiting for another 5% move in the S&P you probably lose most of your present value gains and be a touch behind at the end of the day.