Doug Kass: Only ‘Blind Faith’ Could Cause Me to Be Long This Market
Famed hedge fund manager Doug Kass had an interesting take on the market this morning. Blue comments are mine…
Following the breakup of Cream and The Spencer Davis Group, the rock and blues group Blind Faith was formed. An English band consisted of four music legends — Ginger Baker, Steve Winwood, Ric Grech and Eric Clapton — and although they produced only one album (of the same name), they made rock history.
The term “blind faith” incorporates the gestalt of today’s market. Even more outrageous is that the factors that are mentioned to justify what is, in certain cases, a 95% decile in valuation represent an optimal policy outcome in a world in which there rarely has been more policy and economic uncertainties.
Yesterday, CNBC’s “Fast Money” summed up the optimism when it asked the question, “Best Move: Just Buy Everything?”
Quite honestly, the presumption of optimal outcomes — especially of a fiscal kind — seems far-fetched in the current atmosphere of deep-seeded animus between the Republican and Democratic parties Those optimal outcomes presume an unlikely cooperation and thoughtful legislation — two conditions that have been an anathema in Washington, D.C., for years.
The next important catalyst for the markets may be the president’s congressional address on Feb. 28. In all likelihood President Trump will send a general outline of his broad fiscal policy plans. But it is important to recognize that in terms of implementing budgets, the executive branch is among the least powerful people in Washington, D.C. According to JP Morgan, “The White House budget is nearly always immediately dismissed and considered ‘DOA.’ The true tax and spending power lies in Congress, and thus (House Speaker) Paul Ryan, and especially (Senate Majority Leader) Mitch McConnell, will determine what happens on the fiscal front. At the end of the day, it really doesn’t matter what Trump or Ryan want; if legislation can’t get passed through the Senate, it won’t become law.”
Priced to Perfection?
For the markets to mount any positive return going forward, it can be argued that nearly everything must go right from now on. With valuations elevated on an historic basis, optimal outcomes must be achieved.
We have held the same view for quite some time now.
But, consider the following:
* The U.S. Dollar’s Strength: It is assumed to be a net positive, but won’t there be a negative impact on trade and a headwind to multinational companies? (Note: Nearly 40% of S&P companies’ sales are non U.S.). And how disruptive is a stronger U.S. currency on emerging markets as they try to service nearly $10 trillion in non-U.S. dollar denominated debt?
* A Rise in Interest Rates: Higher bond yields are assumed to be a neutral to positive for the markets, but with a staggering large debt load and a climbing deficit won’t this be a headwind to domestic economic growth?
* A Series of Fed Tightenings: Isn’t a less-than-optimal outcome likely from “the gang that couldn’t shoot straight” — i.e., our Federal Reserve?
* Lower Individual and Corporate Tax Rates: The BAT-based tax reform bill is intended to shift the U.S. from a global to a territorial tax system, raising $1 trillion in revenues over 10 years. But how the heck, especially without a BAT (border adjustment tax), will this be anything nearly deficit neutral, which is a requisite for passage from a meaningful portion of the Republican Congress? (Remember, the Republican Party can’t use reconciliation to pass permanent legislation that isn’t deficit-neutral. Passage of BAT requires support from the Democrats to get over 60 votes. The only way they can do it is to take out revenue neutrality and pass it through reconciliation that sunsets in 2027).
* Obamacare Repeal: What happens to the 20 million individuals who lose their insurance? Moreover, there is currently no consensus around health care within either the Democratic or Republican parties.
Global Credit Markets Are Not Feared: But with an anti-establishment winner likely in the French election, a worsening Italian banking crisis and a looming credit crisis in China, there are already signs of concern this morning in the German bond market.
* Consensus S&P EPS for 2017-2018 Are A “Hockey Stick” of Expectations: What happens if those projections fail to come to fruition — as they have in each of the last four years — as the recent impressive market gains are almost all a function of an expansion in forward price/earnings multiples?
“Come down off your throne and leave your body alone.
Somebody must change.
You are the reason I’ve been waiting so long.
Somebody holds the key.”
–Blind Faith, “Can’t Find My Way Home”
It is one thing when less-than-optimal outcomes occur when valuations are low. It’s another thing when, as today, valuations are high following a steady eight-year Bull Market.
While even extreme levels of investor sentiment (depressed and stretched) are not a viable timing tool, the readings provide a guidepost and necessary caution. I documented how extended stocks are in yesterday’s “Signs of a Blow-Off?”
I’d also cite the CNN Fear & Greed Index:
Further, as The Lindsey Group’s Peter Boockvar wrote yesterday:
“The 14-day RSI in the NDX yesterday closed at 84.7, the highest since January 1992. It was 84.2 in January 2000. The index is up 11 out of 12 days and that down day totaled 1.7 pts. The technology sector within the S&P 500 is up 14 days in a row…. Valuations don’t matter until they do and certainly haven’t mattered for a while but we can’t deny the fact of where stocks are trading relative to other historical peaks.”
There is little question that optimism over the Trump administration’s tax and regulatory policies are responsible for much of the $2.5 trillion increase in the market capitalization of U.S. equities since the election. But, as I described in “The Teflon Don(ald) and the Market Face Their Most Serious Test”:
“Tax and regulatory reforms from our politicians in Washington, D.C., are likely to provide a lesser and later contribution to economic and profit growth than the consensus expects… We could have no tax reform or a watered-down version at the same time global monetary policy is a headwind… This, too, should not be friendly to the market as the hockey stick of expectations likely will fall short of consensus.”
JP Morgan’s strategy group just expressed similar concerns, as I’ll remind you from above (with my own boldface emphasis added):
“When it comes to budgetary matters though the president is usually one of the least powerful people in Washington and the White House budget is nearly always immediately dismissed and considered ‘DOA.’ The true tax and spending power lies in Congress, and thus Paul Ryan, and especially Mitch McConnell, will determine what happens on the fiscal front. At the end of the day, it really doesn’t matter what Trump or Ryan want; if legislation can’t get passed through the Senate, it won’t become law.”
This does not sound like a possible optimal outcome.
In summary, given the general lack of certainty that exists in so many arenas — economic, trade, interest rates, inflation (and inflationary expectations, currency, political and geopolitical — I can’t make the pivot to Blind Faith of being long in today’s equity market.
Once again, we have held a similar view since the so called “Trump Rally” went off the rails. We are seeing valuation levels that are not only reminiscent of past tops, they are either at or near historic highs. Including record low volatility readings. To say that everything “must go right” here would be an understatement.
Plus, here is what else everyone else is missing. If corporate profits/earnings have failed to grow after 8 years of zero interest rates and trillions of QE, no amount of fiscal stimulus will help now. Sure, a proposed tax cut can bump up the earnings, but that’s likely to be a one time event.
Drunken optimism is a more appropriate headline here.
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