After nine years, we think it has become obvious to market participants that the central bankers have trapped the world in a “Hotel California” of endless monetary policy meddling. We can say we are checking out, but they won’t ever let us leave (not anywhere near completely anyway) because they realize that returning to a point where they are much less involved is impossible for them and the system they have created to tolerate.
The PhD monetarists have used both words and actions way beyond the bounds of what we used to consider normal and they won’t stop. The Fed has admitted as much by indicating that its balance sheet will never return to pre-crisis levels.
Investors cannot rely on underlying vibrancy of the economy. This cycle has proven that. The powers that be promise growth that never arrives, but they do a fantastic job of blowing rolling bubbles in asset classes and industries. Some bubbles, like those in energy, retail, and autos feel so real until they pop. Others simply await a needle.
Stocks in this cycle were largely propped up by the willingness of corporations to lever and that has already driven debt metrics to about the least creditworthy they have ever been. That leaves fearless retail investors plowing into the most overvalued equity market ever without doing much analysis as the final marginal buyer. They think the “diversity” of an ETF will save them. That’s not going to happen.
We cannot emphasize enough that financial system liquidity conditions, limited as they already are, should deteriorate a bit as the central banks look set to try to back away a bit from QE in coming months as political pressure to do so builds. The Fed’s theory is that if it backs away just one iota from the emergency measures of QE by letting a small portion of its holdings mature, then it can declare victory for extreme monetary policies. It’s hogwash.
We think it’s a mistake to conclude that central bankers’ obsession with markets makes stocks less fragile, let alone bulletproof, especially as central banks appear set to act with a bit less dovishness. Based on historic returns, at current valuations stocks will have a hard time beating the 2.20% yield of the much hated 10-year Treasury bond until its maturity.
Holding a basket of stocks versus owning the 10-year is high-risk, low-reward proposition. In other words, investors are paying for the “privilege” of taking risk. That makes no sense and that is exactly why equities are on shakier ground over time than many realize. The notion that a basket of certain stocks or those on overseas bourses will somehow be insulated from any significant downdraft in the U.S. has not been borne out by historic experience.
Both bonds and the dollar have reversed post-election excitement to a significant degree. The disconnect between levitating equities and economic reality is simply the manifestation of an enormous central banker policy mistake that equity markets have yet to recognize.
The economists in charge have stayed too easy for too long at the same time China has been growing outstanding credit by ridiculous amounts for years. Right now, investors see the constant meddling as a wee bit less of a good thing than they did a few years ago, but that can change quite suddenly. Markets have buckled in times past even when the central banks intervened as investors simply became risk-averse. 2008-2009 is but one example of such a loss of faith.
While investors grapple with the implications of “Hotel California,” one thing is for sure: stocks have never been more expensive.
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.