There's No Alternative to Stocks? That's Just B.S.

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Lucy Van Pelt: You think you're so smart with that blanket. What are you going to do with it when you grow up?

Linus Van Pelt: Maybe I'll make it into a sport coat.

-- Peanuts

The world's central bankers have taken control of the asylum by purchasing bonds and stocks of every description.

As a result, Mr. Market has become like Peanuts character Linus Van Pelt -- it can't live without its security blanket of central bankers' help:

Unfortunately, this security blanket distorts stock and bond markets, creating artificial conditions that make any fundamental assessment of genuine asset prices an afterthought. Consider how this affects:

* Bonds. Overseas, negative interest rates have become routine for sovereign debt thanks to central bankers. This means that yields in no way compensate or even take into account governments' abilities to repaying.

* Stocks. Central banks like the Swiss National Bank and the Bank of Japan are buying ETFs and stocks routinely and in historic amounts. But in doing so, the banks are expanding their mandates with unknown consequences.

Central banks have designed this unprecedented strategy to catalyze global economic growth, but the subpar expansion that we're seeing shows that these policies are failing to "trickle down." Instead of increasing spending, low and negative interest rates are simply increasing savings.

The Virtuous Cycle

"I think there are gonna be history books written about this period that rational people will read at some point, [and] they are gonna ask this question of economic historians with complete bewilderment in their voice:

'Professor Jones, did investors REALLY invest in bonds of basically bankrupt countries that printed money to make interest payments and [buy back] bonds they just issued in failing currencies? ... Were investors really that stupid?'"

-- Subscriber 'BadGolfer,' as quoted in Doug's Daily Diary, Introducing Subscriber Post of the Week! (April 15, 2016)

A trio of factors are artificially inflating stock prices these days:

* Central-bank policies are succeeding in encouraging risk takers to take more risks in long-duration financial assets, while central-bank purchases have sent financial-asset prices spiraling upward and reduced volatility (as measured by the VIX). This has created what I call the Bull Market in Complacency -- an almost universal view that any drawdown in market prices will be limited.

* Many U.S. corporations that face lackluster top-line growth are repurchasing stock in record amounts at record prices rather than doing capital spending to bolster their physical plant. This boosts stock prices, satisfying large shareholders and feathering insiders' portfolios.

* While many retail investors are long gone from the stock market, volatility-trending strategies, risk-parity trading systems and other quant programs keep pushing stock prices to new all-time highs.

All this feeds on itself, but what's surprising is that few question how the above factors contribute to higher asset prices. They fail to recognize that if there were no adverse consequences low or negative interest rates, massive liquidity injections and central banks buying stocks, these would have become permanent and continuous monetary-policy strategies decades ago.

What Can Go Wrong

Unfortunately, several factors could cause an unceremonious change in the market's direction at any moment. These include:

* An Abrupt Growth Slowdown. Low U.S. interest rates have pulled forward demand, and from my perch, we're already seeing "Peak Autos" and "Peak Housing." I wonder whether U.S. consumer spending's recent strength is sustainable ... or just the last gasp of growth?

* A Possible Deeper 'Earnings Recession.' Will corporate profit margins get squeezed even further going forward?
An Abrupt Reversal for Stocks. This could "just happen" out of the blue, or it could stem from an exogenous political or geopolitical shock. Or it could follow something else that investors aren't even thinking about. My concern is that an abrupt change in sentiment or stock prices could ignite a selling stampede from the influential quant community, just as "portfolio insurance" precipitated the October 1987 Wall Street crash.

* A Quick Climb in Interest Rates. This could, among other things, curtail mergers and acquisitions and/or stock-repurchase programs.

* An Abrupt Rise in Inflation or Inflationary Expectations. This could spark higher interest rates.

* A Federal Reserve Policy Mistake. We can never rule this out.

* A European Banking Crisis. This could have a "contagion effect" around the world.

* Policies that Destabilize Currencies. Again, this is always a possibility.

* A Zika Virus Outbreak or Other Health Event. Few investors are even thinking about this.

* A Monumental Hacking. A major computer hack of the U.S. banking and investing complex could disrupt everything.

* Something Else. We face all sorts of other risks that no one is even considering.

The Bottom Line

In my view, "T.I.N.A." ("There Is No Alternative" to stocks ) is B.S.

Likewise, "F.O.M.O." (the "Fear of Missing Out") is nothing but a tired, hackneyed phrase from Kim Kardashian. Instead, I'd say that smart investors should consider "C.I.T.A." ("Cash Is the Alternative").

With the S&P 500 trading at more than 25x GAAP earnings and about 18x non-GAAP profits (one of the largest differentials between GAAP and non-GAAP in history), risk vs. reward simply looks unattractive to me.

I believe the upward revaluation in price-to-earnings multiples that we've seen over the past seven years could soon come to an end. That's why I personally remain net short in the market.


Doug Kass is president of Seabreeze Partners Management Inc. This essay originally appeared at  

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