In my Monday column “One Bite, Everyone Knows the Rules!” I outlined my view that when (motley) fools rush in most investors’ are destined to have an adverse outcome.
Indeed, the market silliness is now deafening at the end of a speculative cycle.
I see a pivot in monetary policy and disappointing (relative to consensus) 2022 S&P EPS. There is also possibility for a broad valuation reset lower for stocks in the months ahead.
I also expect Peak Portnoy, Peak Reddit/WallStreetBets and Peak Silliness in Speculation in the near term. Few stocks meet my criteria for selection today.
Remember, history always rhymes…
Now I want to first look back and then look forward (and expand upon Monday’s views) in light of the calendar and the near culmination of the first six months of the year, and the launch of my new hedge fund, Seabreeze Capital Partners LP later this month.
— Forbes Magazine cover (1998) – h/t Peter Boockvar
The First Half of 2021 In Review
- Stocks moved steadily higher throughout the first 5 1/2 months of the year.
- A bull market in speculation and in (motley) fools also characterized the first half of 2021.
Most equities steadily rose higher during the first 5 1/2 months of the year — importantly abetted by the excess liquidity and stimulation provided by fiscal and monetary policies aimed at countering an unprecedented global pandemic.
Retail inflows into funds were conspicuous and robust.
The impact on an unprecedented level of speculation have been profound. As an example:
Traders spent **$11.6 billion** on options premium for AMC (AMC) last week — more than on (SPY) , (QQQ) and Tesla (TSLA) COMBINED “These traditional relationships between volatility and stocks have been turned on their heads” — Wall Street Journal
That excess liquidity found itself in both well known large capitalization equities and the speculative gewgaws (SPACs, meme names (GME) , (AMC) , etc.). The latter category was aided by the closure of many businesses (many trader/investors were forced to stay at home), the proliferation of commission-free trading, the rising popularity of trading forums (Reddit/WallStreetBets), and the availability of credit/loans/margins to trade speculatively.
Both SPACs and meme stocks experienced popularity and markedly higher prices early in the year. The rise in meme stocks ended abruptly a few months ago and many of the popular speculative issues fell dramatically soon thereafter.
In recent weeks, meme stocks have reclaimed their leadership position and popularity. Though meme stocks have regained their popularity in May/June, SPACs and other gewgaws ( (CAN) , (MARA) , (PLUG) , (PTON) , (MSTR) , etc.) remain firmly in the dumps.
Unprecedented liquidity also found its way into other asset classes — particularly cryptocurrencies — an asset class that erupted in price in early 2021 only to fall by nearly 50% in recent months. Though meme stocks have rallied bigly, cryptocurrency prices have failed to recover from that consolidation/schmeissing.
Key bullish macroeconomic features of the next 12-18 months are likely to be:
- An impressive year over year gain in 2021 S&P EPS.
- Elevated and above secular historic economic growth.
Key bearish macroeconomic features of the next 12-18 months are likely to be:
- A likely pivot from excessive monetary stimulation to less stimulation.
- A continuation of signs of rising inflation and inflationary expectations.
- A moderation in the rate of expansion in global and domestic economic and profit growth beginning in the second half of 2021 and intensifying next year.
- The failure of our political system (both sides of the pew) to overcome a sickening and intensified level of partisanship – this has policy implications.
There will be numerous other factors that will influence stock prices in the 1-2 years ahead.
Some more questions I ask myself include:
* Will the absurd speculation (in meme stocks), NFTs and other gewgaws cool off?
* Will the absurd leverage provided to traders and gamblers (and even with some large hedge funds) in a number of asset classes result in comeuppance to those assets and a significant drag on the broader markets?
* Will the emergence of safety issues and the further increase of the supply of new digital currencies produce a further crash in cryptocurrencies?
* Will a cryptocurrency crash feed into other markets and asset classes?
* Will the strong support of retail investors cool off or fade away if any of the above occur?
* Will retail traders/investors – as they did in the early 2000s (following the dot.com bubble) and in 2007 (at the beginning of The Great Recession) – flee the markets?
* Will interest rates finally rise on a sustained basis?
* Will inflation get out of control?
* Will the higher costs of materials, labor, transportation and regulations adversely impact U.S. corporate profits and profit margins?
* Will high valuations grow ever higher or finally readjust to historic or even lower levels?
* Will the pressures to raise corporate and individual taxes intensify – pulling down economic and EPS growth?
* Will geopolitical issues resurface with a new Administration in Washington, DC?
* Will additional, new and/or variant viruses surface?
There is not enough time and space to deal with all of the issues above — but I will briefly deal with some of the major subjects introduced, and naturally follow up with the others over the next few weeks.
Here are some of my core expectations and brief responses to the above. They form the basis for my negative market(s) outlook.
In late 2021 I expect monetary policy to begin to pivot from its aggressive stance in recent years. The trajectory of economic growth is now sufficiently so far above trend-line that “panic policy” is no longer appropriate. Moreover, as noted in my previous post, low interest rates are now losing their effectiveness. As well, there is a belief that excessive ease has widened the wealth and income gap and is contributing to rising inflation and inflationary expectations, which also hits the have nots relative to the haves.
Stocks discount the future and will not necessarily prosper even though economic growth is positive and well above trend line – as so many seem to insist on Fin TV. As I have written bear markets/consolidations are borne out of good news (early 2000, late summer 2007) and bull markets are borne out of bad news (March 2009, December 2018 and March 2021). So, a revaluation lower in price earnings multiples, though counter-intuitive to some, has a basis in investment history, especially with rising interest rates, higher inflation and expanding inflationary expectations. In other words, buy the rumor, sell the news.
In terms of inflation, it is a bonafide threat – and, not in my judgement, a transitory event as, once out of the bottle it can not easily be put back in. Labor shortages and daily product price increase announcements are now routine. Yesterday Sherwin-Williams (SHW) announced the implementation of a +7% August 1 price increase in its Americas Group, and Chipotle (CMG) has just raised menu prices by almost 4%.
We start the second half of the year with substantially elevated valuations – particularly in light of some of the risks discussed in this opening missive.
As noted, the forward 12-month P/E ratio for the S&P Index is over 21x, above the five year average of 18x and the 10-year average of 16x:
U.S. company profits and profit margins are now exposed to higher costs. Though economic growth over the near term is a tail wind, the positive operating leverage expected by my pal Thomas Lee and others may disappoint. Optimistic and heightened consensus 2022 S&P EPS estimates may be many integers too high.
As to a continuation of stock market speculation (in meme names), as noted by the 1998 Forbes cover above, the dominance of thoughtless retail gambling is nothing new and, if history rhymes, and is our guide, it always ends badly. The uniqueness of today’s silliness is that some relatively sober minded corporate executives and investment “talking heads” are pandering to them! It will likely end badly for them as well.
I see Peak Portnoy, Peak Reddit/WallStreetBets and Peak Silliness in Speculation.
In terms of speculation in other asset classes, notably cryptocurrencies, this too, I am afraid – and have written volumes on – could end badly. It is already bad as privacy, taxation and (near infinite) supply issues have recently surfaced – producing a halving in price of some digital currencies. As to NFTs, which are neither an artform nor a platform, the outlook is even worse than for Bitcoin, IMHO.
“I will be calm. I will be mistress of myself.”
– Jane Austen, Sense and Sensibility
As I have written, the market’s structural change from active to passive investing has produced the least educated investor and trading base in history.
Frankly, I see so much foolishness and poor judgment being displayed these day — by market participants and by “talking heads” — in their continued and spirited search for superior trading and investing returns.
Indeed, the speculative silliness, to this observer, is now deafening.
Many of the generally accepted and upbeat consensus macroeconomic views seem to be threatened or might have a reduced probability of being achieved given the threats discussed in this column.
As to equities, upside rewards are likely dwarfed by downside risks and few stocks meet my criteria or standard for selection these days.
The premium between S&P cash (4230) and my calculation of the “fair market value” (about 3300) is in excess of over 20% and at the widest overvaluation in years.
Given my concerns, I am a non-consensus bear on most asset classes.
My investment conclusion and strategy is to sell in June for the anticipated market swoon.
(This commentary originally appeared on Real Money Pro on June 9. Click here to learn about this dynamic market information service for active traders and to receive Doug Kass’s Daily Diary and columns from Paul Price, Bret Jensen and others.)