A Case For Sitting On Cash In 2016
"As long as the music is playing, you've got to get up and dance. We're still dancing."
-- Charles Prince, then-CEO of Citigroup (C), speaking in July 2007
Things didn't ultimately work out so well for Charles Prince or Citigroup nine years ago, and they might not work out so well for stocks now following their recent six-year rise.
It seems like we're in a tug of war right now. On one hand, we have a manufacturing and profits recession and a meek, decelerating rate of worldwide growth. On the other, we have continuous liquidity injections from central banks, as well as from corporations that prefer the financial engineering of stock buybacks to capital spending. This fight seems to be tilting towards sub-2% U.S. real gross domestic product growth right now.
I made the case last week that stocks' recent recovery from their January/February lows was just a bear-market rally rather than a new bull-market leg. That idea will make a number of people unhappy, especially the "perma-bulls" and strategists who never met a market they didn't like -- not to mention people who're trying to sell you something. (And there are many of those!)
Personally, I've chosen an aggressively short route given my risk profile and investing timeframe/horizon. But as I've continually written, I recognize that shorting is only for the few. For most players, I think there's a strong case to be made for staying heavily in cash this year.
I have a high degree of conviction that staying out of the U.S. stock market could be an appropriate move for the balance of 2016. Will there be occasional buying opportunities over the next nine months? Of course, just as there were late last summer and during the fall, as well as twice already in 2016.
But remember, the concept of "T.I.N.A." ("There Is No Alternative" to stocks in today's low-rate environment) is a fairy tale that's told by strategists who fail to recognize cash as an alternative asset option.
Here's why I believe U.S. stocks aren't a good thing to go long on this year:
* First and foremost, I have fundamental concerns about the market.
* Then there are my technical concerns, along with evidence that we made an important and major market top in May 2015.
* Rising bullish sentiment is another headwind.
* The S&P 500 is currently about 8% above my fair-market-value estimate of 1,860.
* Even more concerning is the market's wholesale confidence in the world's central bankers and monetary policies to generate escape-velocity GDP growth or even something resembling historic secular-growth rates.
* We're also seeing carnage in the hedge-fund community, as well as near-record closings over the last 12 to 18 months. That should deliver a loud and clear message to those who're trying to "outsmart" the tape. It ain't "easy being green," and it's getting harder -- even for the "2-and-20" crowd whose staffs are (or were) armed with the best Wharton, Harvard and Stanford MBAs that money can buy.
Six Years Of Monetary March Madness
"They throw the ball, I hit it. They hit the ball, I catch it. "
-- Willie Mays
Why are we in today's situation?
To begin with, central bankers have successfully suppressed volatility and elevated asset prices over the past six years out of necessity, as our fiscal authorities have had their collective heads in the sand.
Of course, six years of doing anything can have complications. A Zero Interest Rate Policy (ZIRP) encourages corporate financial engineering over capital spending, as well as consumers' personal savings over personal expenditures. Zero-percent rates also distort numerous asset classes' prices.
In fact, ZIRP is the "mother's milk" of speculation, Consider:
* Zero rates encourage corporate borrowing to fund share buybacks and preposterously ill-conceived entities like Valeant Pharmaceuticals (VRX), whose debt load has risen from $350 million to $31 billion in just six years. These kinds of actions all too often reward company management, as well as supportive hedge funds who participate in the "bubble-finance" trade.
* ZIRP encourages companies like Tesla Motors (TSLA) -- which, in my opinion, is burning through cash like a drunken sailor and has non-GAAP reporting standards that stretch sensibilities.
* Zero rates lengthen the life of sub-investment-grade companies that are unprepared for worsening economic activity or the inevitable rise in interest rates.
* ZIRP provides investment bankers with a one-time, non-repeatable orgy of fees that I believe could ultimately end in a 2007-2009 market meltdown.
0% rates eliminate natural price discovery and encourage speculative activity.
* ZIRP erodes markets' and economies' foundations by putting on a "band-aid" and pulling unsustainable economic activity forward. It provides near-term satisfaction, but has a defined half-life of benefits that can't extend indefinitely. Structural issues inevitably overcome policies that limit natural price discovery.
Today, we see the byproducts of six years of ZIRP in sluggish U.S. economic growth and an imminent rise in inflation. For instance, the Atlanta Federal Reserve recently cut its GDPNow forecast to 1.4% growth for the first quarter from a previously projected 1.9%. We also recently got a large revision to January durable-goods growth, while on the inflation front, we've seen a 50% rise in energy prices.
All told, I believe that we're quickly moving towards stagflation, the distant cousin of"screwflation."
Sandy Koufax's Career as a Metaphor for the Bull Market (2009-2015)
I'd like to continue my thoughts about the market by talking about my cousin Sandy Koufax, the Brooklyn and Los Angeles Dodgers Hall of Fame pitcher.
There are many lessons to learn about today's market by looking at Sandy's career. Sandy followed his 1961 break-out season (18-13) with an unprecedented five additional seasons of greatness, but problems began to arise for him during the 1965 season.
After pitching a complete game in spring training, Sandy awoke to find his entire arm black and blue from hemorrhaging. The team doctor examined him and said that Sandy would be lucky to pitch once a week -- and that he'd ultimately lose full use of his arm.
Sandy combatted this by taking Empirin with codeine for the pain every night (and sometimes during the game). He also took Butazolidin for inflammation and applied a capsaicin-based ointment before each game. Lastly, Sandy soaked his arm in a tub of ice to ease the swelling after every game he pitched.
Despite constant pain in his pitching elbow, Sandy managed to hurl the ball for more than 330 innings and led the Dodgers to the pennant that year. He also led the league in wins (26), ERA (2.04) and strikeouts (382) -- the highest modern-day total at the time -- and won his second unanimous Cy Young Award.
In April 1966, a doctor told Sandy it was time to retire because the ace's arm couldn't take another season. But Sandy kept that advice to himself and went out every fourth day to pitch. He ended up working 323 innings, achieved a 27-9 record and a 1.73 ERA. Since then, no left-hander has had more wins or a lower ERA for a season. Amazingly (considering his arm's condition arm), Sandy even started 40+ games for the second year in a row.
Ultimately, the Dodgers had to beat the Philadelphia Phillies in the team's final 1966 regular-season game to win the pennant. So in the second game of a doubleheader, Sandy faced the great Jim Bunning for the second time that season ... on just two days of rest!
This was a match-up between two perfect-game winners. Sandy pitched a complete game, notching up a 6-3 victory that let the Dodgers clinch the pennant.
The Dodgers then faced the Baltimore Orioles in the 1966 World Series, with Game 2 marking Sandy's third start in eight days. He pitched well enough -- Orioles' first baseman Boog Powell told Koufax's biographer: "He might have been hurtin', but he was bringin.'"
But three errors by Dodger centerfielder Willie Davis in the fifth inning produced three unearned runs. My pal Orioles' pitcher Jim Palmer pitched a four-hitter, and the Dodgers ended up losing the game 6-0.
The Dodgers lifted Sandy at the end of the sixth inning with the idea of getting him extra rest before pitching in the World Series' fifth series game, but that never happened. The Dodgers were swept in four games after failing to score a single run in the final three contests.
After the series, Sandy announced his retirement at age 30 due to his arthritic condition. I remember my Grandma Koufax telling me at the time that if Sandy didn't retire, his left arm could have been lost.
The Bottom Line
Like Sandy's six-year streak, I believe the market's 2010-2016 streak is about to come to a close as investors begin to lose confidence in our monetary authorities.
Just as Sandy applied various remedies to keep his pitching arm working, central bankers have embarked on a six-year period of unparalleled easing and massive liquidity injections. However, the resulting artificiality of financial-asset prices might soon be a thing of the past. Confidence in central bankers is beginning to erode, which helps explain stocks' four 10% drops since mid-summer 2015.
We're now likely at the point where the longer governments delay a handoff from monetary to fiscal policy for stimulus, the higher the probability of lower and more-volatile stock prices. The greater intensity of political partisanship as we move toward November's U.S. presidential election won't help.
I believe that the Federal Reserve has failed to understand that in a flat, networked and interconnected world, America can no longer be an "oasis of prosperity." Our open domestic economy can't be manipulated in the same way today as it once was "controlled" in a monetary sense decades ago. And don't forget the quants, whose cue from "money-for-nothing" lending rates is to go long and lever up.
The unintended consequence of multiple years of monetary largesse isn't only the so-called "paradox of thrift," where cash-hoarding consumers "save their way into a recession." It's also the pulling forward of economic activity, sales and profits (watch for"Peak Autos" and "Peak Housing").
Even in today's artificiality of central-bank intervention and quants, machines and algos, cash levels are beginning to fail to mitigate risk. After all, we're living in a world where asset-class correlations are breaking down and have become less reliable, making risk management more difficult through classic portfolio diversification.
I believe our recent, relatively narrow trading ranges are now likely to widen, and I fear the breakdown of trading ranges will be on the downside. That's unless the fundamentals strengthen or we see a smooth hand-off from U.S. monetary authorities to fiscal ones (something that's unlikely in a highly partisan presidential-election year).
Wider spreads could contribute to a "negative wealth effect" that contaminates the already weak global economic trajectory and compromises what little bipartisanship remains in our highly polarized political landscape.
The bottom line: Like ballplayers' careers, bull markets sometimes end sooner than we'd like them to. I believe investors should learn a lesson from Sandy Koufax's decision to retire at age 30. There's only so much that can be done to resuscitate a pitching arm -- or to generate escape velocity and self-sustaining growth in the U.S. economy.
That's why I believe that 50 years after my cousin Sandy Koufax bowed to the inevitable and retired, most investors should follow his lead and "sit it out." So, I recommend that you consider staying in cash for 2016.