The Weird Reality of Replicating Manhattan

Our investment theme has been and will remain that most investors are placing too much credence in central bankers’ words and policies, which are celebrated on Wall Street, while mostly hurting those on Main Street.  The labor force participation rate is still stuck at multi-decade lows…even after all the money printing.  Housing activity has rolled over again. GDP growth was likely flat, at best, for the first half of the year.

Below the surface, many equities are not nearly as euphoric as the major indices.  Perhaps this spring’s buzz around the release of Flash Boys, a book describing the equity market high-jinks of recent years, has curbed rigged trading.  Bonds have rallied on the realization that growth is quite slow.  Gold and silver have rallied on the increased desire for insurance against policy mistakes.  From a valuation perspective time is absolutely on the side of those who don’t run with the herd.  Why bet that equity valuations become even more expensive than the most expensive valuations ever seen?  There’s no reason to assume the downside risk of those gambling that they will know when to sell.  History tells us that doorway will get crowded.

The U.S. equity market trades at a multiple of GDP that we have witnessed only during the historic bubble periods.  The median stock has never traded at a higher multiple of revenues in any data we have examined.  The divergence between company fundamentals and stock prices remains stunning.  Caterpillar Inc. (CAT) trades near all-time highs, yet sales trends for its heavy equipment are dreadful.   We struggle to find a retailer or restaurant company that is doing well, yet most of these stocks trade as if consumers were spending freely, not pinching pennies as their CEO’s will attest.  Auto sales have picked up on the back of a sub-prime lending surge, inventory building, and higher fleet sales, but that is not much cause for cheer because those tailwinds are hardly sustainable.

We may continue to see some slightly troublesome data on the inflation front in the near term, which the Fed will try to ignore.  However, the globe has too much labor and capital because policy in recent years has led to the creation of additional capacity at a time when there was already too much.  For the time being, that should contain inflationary pressures.  Meanwhile, wage pressures remain low as much of the job creation has been poor quality and part-time.  The weird reality of China building a replica of Manhattan is more than just an interesting story; it is a spooky sign of the magnitude of the current bubble.