Our expectations for weak growth and decreasing faith in central bankers have become almost a consensus base case. That has boosted bonds and precious metals a good deal in recent weeks. Confidence in the most popular stocks is eroding, but not dramatically as investors have decided to add a few handles to P-E multiples this year even as earnings estimates have come down a lot.
As expected, the Fed cut rates by 25 basis point last week. It was also unexpectedly forced into a new round of quasi-QE this week because of intense funding pressures in money markets. Even those of us who are concerned about liquidity in the financial system were surprised by how quickly this event unfolded. The Fed was caught off guard and we will wait to see whether this becomes a bigger issue.
If you have been reading our posts over the years, then you know we are not exactly surprised by any of what is currently going on. Foolish policies didn’t work, though they tell us that they did. They were never able to exit the realm of emergency measures for any length of time. That is meaningful. We are astounded that so few pundits and participants seem to openly acknowledge the problems that these guys have wrought. Many of them want more action from the Fed, as if it didn’t already dominate events way too much. Bernanke, Draghi, and a host of others made a lot of decisions about the shape of the future economic landscape of the planet and we are stuck with their mess because their rabbit hole only grows deeper with no path for escape.
About $15 trillion in global debt has priced to a negative yield. Hello! We are astounded by the ability of investors to behave as if any of this is normal. Clearly their well-spun synchronized growth story resulting from tax cuts was completely inaccurate, but they won’t let that get in their way. Now many are trying to act like the “cure” of negative interest rate policies isn’t the stupidest, most capitalism-distorting idea known to mankind, nor do they see it as a sign that something is wrong.
The deciders are desperate and will try to sell us anything that gives them some control of the narrative. Their “new” idea of handing over the reins to fiscal policy to drive the world’s growth is laughable. It’s as if government debt growth has not already been exploding globally with debt-to-GDP’s through the roof just about everywhere you look.
In response to the dysfunction at the top, the 10-year Treasury yield fell to near 1.50% recently from over 3% last year. Gold has rallied from $1,200 to over $1,500 an ounce and silver has bounced from $14 to over $18. These big rallies may well be overdone for now as the crowds jump on board. We could never predict when these moves might happen or their magnitudes, only that they were quite likely given the landscape we have described and relative valuations.
We feel the same patience is required to take advantage of the potential mean reversion of growth versus value stocks. We strongly suspect it will happen. We just don’t know when. It may have begun in recent weeks, or this price action could be just a head fake. Identifying catalysts even in hindsight has been a fool’s errand in the past, but the collapse in some recent IPO’s is certainly interesting because it seems to be bleeding into the enormous faith investors have in growth stocks.
We still think the growth/value reversion could be a big move given how dramatically value stocks have lagged in recent years. It could happen without much fanfare, even as indices seem stable or it may evolve out of pronounced volatility. Investing is baseball, not basketball, in the sense that the length of games is not determined by a clock. This one is in extra innings for sure.
Perhaps the most interesting factor is that many stocks that currently exhibit price momentum are not just those with high revenue growth. Investors have also piled into low-growth companies they perceive as stable. This has created a dynamic in which growth, momentum, and stable stocks have been lumped together as highly desirable “low volatility” stocks. Like a sort of safety trade that has gained steam as interest rates fell. We think volatility will assert itself in all three because this pursuit has become so intense.
This herding has all been part of the move to passive investing with ETF’s. An individual stock often trades well above its intrinsic value even after an earnings disappointment simply because an index or sector fund must buy it regardless of the fundamentals. These risks will remain hidden until enough stocks in ETF’s disappoint or lose favor. It is slowly happening.
At over two times normal valuations, we remain cautious on broad exposure to U.S. stocks simply because it is tough to make an investment case. At the same time, value stocks in the U.S. and elsewhere continue to offer a much better risk-reward profile versus growth stocks, many cyclicals considered growth stocks, utilities, REIT’s, and numerous staples.
Underlying the entire landscape is the dawning realization that central banks have very few tools left at a time when most investors have become entirely dependent on dovish monetary policy as a key driver of their confidence to maintain exposures. This old habit may die hard, but gravity may prove tough to fight when the fundamentals become impossible to ignore.
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.