What Byron Wien (and Cole Porter) Tell Us About Stocks

"In olden days, a glimpse of stocking
Was looked on as something shocking.
But now, God knows,
Anything goes.

Good authors too, who once knew better words
Now only use four-letter words
Writing prose.
Anything goes."

-- Cole Porter, Anything Goes

The global landscape is rife with unexpected but high-impact possibilities ahead. Indeed, with so many possible outcomes, it's surprising how complacent many investors are today.

While my pal Byron Wien of The Blackstone Group (BX) is fond of saying that "disasters have a way of not happening," he could be understating today's realities. I stand by my opinion that the market's downside risk eclipses its upside potential based on a distribution of reasonable scenarios and their likely impact.

Technical analysts generally use price and other factors like volume to determine expectations, but fundamental analysts like myself use assumptions about the economy, inflation, interest rates and corporate profits to create fair-market-value estimates.

I calculate the S&P 500's fair value (or "equilibrium") by looking at better-than-consensus, worse-than-consensus and in-line-with-consensus expectations for global growth. Based on a melding of these scenarios and possibilities, I'm sticking with my S&P 500 fair-value estimate of 1860 -- some 182 handles below yesterday's close.

Quarrel with my calculus if you will, but you can't quarrel with the wide array of possible outcomes -- many of them adverse -- that the market currently faces. Nor can you quarrel with the fact that with the S&P 500 within 5% of its all-time high, most investors remain remarkably complacent.

Zero and negative interest rates in and of themselves complicate valuation calculations, as historically low inflation and interest rates have produced high valuations and elevated price-to-earnings ratios. On the other hand, historically low inflation and interest rates also imply very weak cash-flow and earnings growth.

But if the bond market knows something that the stock market doesn't -- namely, that we're facing weak economic and profit growth -- then we could be in deep trouble. And the more time that transpires (and the more debt that's tacked on) before we fix things, the more difficult and destabilizing a normalization of rates will become, as I expressed inA 2016-18 Financial Crisis Lies Ahead.

Remember, there are three questions that I ask myself every morning:

* In a paperless and cloudy world, are we as investors and citizens as safe as the markets assume we are?

* In a flat, networked and interconnected world, is it even possible for America to be an "oasis of prosperity" and a driver or engine of global economic growth?'

* With the G-8's geopolitical coordination at an all-time low, how slow and inept will the reaction be if the wheels do come off?

Let's ask several additional questions this morning:

* What is the "message" of negative interest rates, and what's their long-term impact on growth? If markets correct downward and stay there for some time, how much of a "negative wealth effect" will we see, and what will the social impact of a "trickling down" be?

* What additional policies will it take to produce "escape velocity" and self-sustaining growth for the U.S. economy?

* How much business activity has been "pulled forward" by interest rates remaining so low for so long? Are there uncovered areas of malinvestment that will soon surface?

* How low might profit margins fall given the possibility of higher corporate-tax rates, a normalization of interest rates and the likelihood of accelerated wage growth?

* What's the value of a dollar's worth of earnings in a deflationary backdrop of negative interest rates and limited business-pricing power?

* Will the quants grow into an even more dominant factor in the market? Does this raise the probability of a market "accident" or major "flash crash"?

As New York Times columnist David Brooks recently suggested, is the Republican Party about to recast itself? What would the fallout be for markets if America winds up with a three-party system?

And let's add one more important question that keeps me up at night regarding the possibility of a major European bank failing (Deutsche Bank (DB) or any major French or Italian financial institution comes to mind).

Such a collapse could represent a "blind-side hit" for the global financial system. Consider the fact that all of the European Union's sovereign debt currently carries a zero-risk weighting. EU banks would need to raise huge amounts of capital should that change, even though financial firms are already struggling at a time when interest rates are materially negative.

Could we even contemplate the economic ramifications of how Italy, Spain and France would struggle to survive amid ballooning budget deficits if borrowing costs rose substantially?

The Bottom Line

"Times have changed
And we've often rewound the clock
Since the Puritans got a shock
When they landed on Plymouth Rock.

If today
Any shock they should try to stem
'Stead of landing on Plymouth Rock,
Plymouth Rock would land on them."

-- Cole Porter, Anything Goes

Rarely has our world faced the possibility of so many previously low-probability, disruptive events actually happening, with the potential for such a high degree of impacts (many of them adverse).

Byron Wien is probably correct -- he almost always is -- when he says that disasters have a way of not happening. But I'm worried, as it's different this time.

I have too many questions and concerns, and too much can go wrong. Because to quote Cole Porter, "anything goes" these days.