Much Ado About Nothing
Joshua M. Brown lists eight alleged concerns for the market. Usually he’s right, for example, being bullish in 2012, but he’s wrong here. Most of these items are either not a big deal or paradoxically bullish for equities. When something is supposed to be a big deal, 99% of the time it isn’t. Greece, Crimea, Russia, the debt ceiling, the fiscal cliff, stress tests, the sequester, the S&P debt downgrade, JP Morgan’s trading blunder and Bank of America’s math error were all supposed to be a big deal, but the market quickly brushed them off after the initial panic. No one Wall St. cares about pain at the pump, rising wealth inequality, or student loan debt being to high, either. Banks can’t pay dividends? Not a big deal. They’ll pay em’ later. So let’s go through them.
1. Collapsing home builder stocks and fading real estate data.
Not a big deal because: home builder stocks are a tiny percentage of the overall economy and the S&P 500; second, they have already had a huge rally since 2009 and are overbought. From bipartisanpolicy.org, the housing industry’s share of GDP stands at 2.2 percent, 2.3 percent below its 1980-2007 average of 4.5 percent. ‘Fading real estate data’ is a very vague statement. Most importantly, prices, especially in high income areas, keep going up. So we’re not sure what data he’s looking at. Construction, permits, starts, etc just are not a big deal, despite all the media attention they get. There’s already a huge housing glut from the last boom. The last thing we need are more homes. To say they will bring down the economy is like the tail wagging the dog.
But what about 2008? Didn’t bankers and housing cause the crash?
The markets have always been volatile. It fell 50% in 2000-2002, 50% in the early 70’s and 30% in the late 80’s. The banking problem caused a lot of people to lose money, including the rich, but in the early 2000’s crash it was over-valuation and 911 and then earlier it was for unknown reason. In the equity markets, it pays to hold. Those who held the S&P 500 through the bear market would have 30% more money now than they did in 2007. If you include the dividends it’s more.
The bankers made mistakes but we have no way of knowing how much of the decline was attributable to banking and how much was due to other factors, like panic selling and emerging market weakness. Google stock fell 50% even though the management reported no impact from the banking problem, so it would seem the panic that began in the financial sector spread everywhere. Sometimes there are events that can precipitate a crash, that later metastasizes to the entire market, and then people make the mistake of expecting a repeat of that same initial event to cause another crash when there’s no way of making that inference. Softness in the housing market doesn’t imply we will have a relapse of the 2008 crash.
2. A US dollar on the verge of ripping to the upside.
A surging dollar could hurt multinationals, but since 2009, the dollar has been strong and it hasn’t yet had negative effect on earnings. A rising dollar and falling yields lessens the debt burden and signals global confidence in our government, currency, and economy as a safe haven in a world of strife and uncertainty. Again, just not a big concern.
3. Treasury bonds refusing to back down, nudging their way higher daily.
As we wrote numerous times, the world is awash with liquidity. Yields are falling not because the U.S. economy is weak, but because there’s just so much liquidity that it has to go somewhere, including treasuries. Anytime there is a tiny panic like in Europe or Russia, a so-so job number, or a hiccup in the market, people POUR money into treasuries. They just cannot get enough of our debt, as much as the left wishes we did have a debt crisis. For example, Belgium has purchased $380 billion of US treasuries since the start of the taper. This trend will continue.
4. A deteriorating number of new highs for individual stocks as the indices flirt with record levels.
Crappy companies with shallow moats, weak earnings, excessive valuations are being sold while quality like Visa, Mastercard and Johnson & Johnson keep going up. 2014 has been a year characterized as a flight to quality, and what’s wrong with investors wanting quality over junk? This is part of our bigger is better thesis. Just not a big deal.
5. Influential managers who’ve been bullish for most of the rally starting to turn cautious (Einhorn, Cooperman, Tepper, etc)
Again, not a big deal. There’s a statistic that shows 50% of expert predictions are wrong. Being cautious is not the same as being bearish. What they are doing is trying to hedge their reputation while still not selling stock, so in the very unlikely event the market does fall a lot, they can say ‘we told you so..’
6. Stalling earnings growth.
From minyanville.com, in the most recent quarter, 75% of companies beat earnings estimates, slightly above the four-year average of 73%. 88 companies issued Q2 guidance, with 62 of it negative. The 71% negative ratio is actually a slight improvement from recent quarters when it was north of 80%. Speaking of that 80%, the stock market still posted huge gains. What we can infer is that earnings estimates and stock market performance is weakly or negativity correlated. Typically, stocks do best when expectations are low and poorly when they are too high. Furthermore, stocks can still rise when earnings are weak, simply because some earnings growth, however little, is still better than none.
7. Defensive stock leadership
This is part of the flight to quality. People are realizing bigger is better.
8. Huge divergence between small caps and large caps.
Over five years since the market bottom in 2009, we’re still emphatically optimistic about the prospects of the U.S. economy and the stock market. We predict considerable upside for the market for the foreseeable future with, as expected, small hiccups along the way that should be treated as buying opportunities. The market is cyclical in nature. Sometimes defensive stocks lag, other times they lead. Sometimes bonds are weak, or they rally. Predicting the cycles for individual sectors, individual stocks and components of the economy is harder and less productive than looking at the broader picture.
The data such a consumer spending at a historical high and record high S&P 500 profits & earnings suggests that the economy is anything but weak. Sometimes, the gains in an economic expansion will be uneven, but doesn’t mean we can generalize that the entire economy is weak. The rich generally participate first in the recovery because they own investments like stocks and those tend to rise before the recovery is reflected in other data – also known as hysteresis.