When we step back from the current insanity which seems to pass for investment activity these days, there are some big picture opportunities which have worked quite well in decades past and we will stick to those. We concern ourselves with the investment cycle, which stretches five years or more. Nonetheless, let’s consider what bad quarters might mean for us given our current investment posture.
- First, lower quality stocks, which are already more overvalued than we have ever seen must become more overvalued.
- Second, interest rates must spike dramatically at a time when U.S. GDP is stuck between 1 and 2% in an extremely over-levered global economy that would crater if that happened.
- Third, prices for precious metals (real money) would have to move dramatically lower in an environment where central bankers are doing their level best to devalue fiat currencies by creating trillions more of them.
Obviously, all three of those can happen, but the odds suggest over time we should profit. We also think the occurrence of one of those risk scenarios would likely prove a benefit to one of the other two bets.
We found it quite a sign of the times that within the span of 24 hours recently, Flash Boys author, Michael Lewis, appeared on “60 Minutes” exposing the inferior trading structure of current equity markets to the masses and new Fed Chairwoman Janet Yellen spoke about the need for ultra-easy monetary policy to continue five years into the “recovery.” We do not think one can understand how this stock bubble formed without putting those two pieces together. Both elements serve to obscure reality and widen the gap between GDP and S&P.
The computerized exchanges of today are confusing, can make price discovery almost impossible, and heavily favor those who focus on scalping tiny gains over fractions of a second. At the same time, the Fed has encouraged highly speculative activity at the expense of organic economic activity to a degree that is embarrassing to any central banker with the slightest bit of common sense. Many investors act as if the Fed will literally make good on any losses that they suffer down to the last penny, like some sort of implicit insurance policy. Add in China’s incredible debt growth and Japanese QE and you just about have a complete picture.
Bubble has become the default economic scenario because the current system is unsustainable without it, but, of course, downside risks remain enormous when reality inevitably intervenes. For instance, we point to the stunning drop in mortgage loan originations in recent weeks as our choice for the one piece of anecdotal evidence that flies in the face of conventional “wisdom” this month. At the same time, from what we hear, hedge funds are no longer snapping up houses like they did last year with the Fed’s free money. That could be a problem for those betting on a real estate recovery.
The views expressed on this blog are the opinions of the authors. This information is not intended as investment advice or to recommend the purchase or sale of securities. More information on Strategic Balance, LLC may be obtained by contacting investor relations.