The Main Reasons Why Market Lambs Should Fear a Slaughter
"Like a lamb to the slaughter .... He was oppressed, and he was afflicted, yet he opened not his mouth: he is brought as a lamb to the slaughter, and as a sheep before her shearers is dumb, so he openeth not his mouth."
-- Isaiah 53:7
History may not repeat itself but, as Mark Twain insisted, history rhymes.
Over history, as we have learned, a Minksy Moment develops when investor sentiment becomes complacent after long periods of prosperity and the data is ignored and doesn't seem to matter anymore, as I wrote in "It's a 'Bohemian Rhapsody' Market: Nothing Really Matters ... to Investors."
During these times the respect for one's capital seems to diminish even as the downside risks may be mounting relative to the upside rewards.
During these times the skeptics are ridiculed and the self-confident optimists paraded in the business media are heralded.
During these times it seems foolish not to be invested in the U.S. stock market and particularly in the market leaders.
But, history has shown that it is exactly during these ebullient and non-discriminating times that investors should be more, not less, concerned with risk.
What is most alarming at this juncture in history compared to the past is that, in contrast to the optimistic baseline expectations of so many, there exist a record level of market, economic, political and geopolitical outcomes that potentially are adverse (see "This Ain't No Seder- I Now Have Eight Questions"). The answers to these questions are also being ignored.
To this observer, the summer of 2017 feels similar to the important market highs of the first half of 2000 and the last half of 2007. ("Goodbye Yellow Brick Road -- It's All Over for the FANGs")
During the dot.com boom in 1997 to early 2000 there was the promise (and dream of a new paradigm and concentration of performance in a select universe of stocks. The Nasdaq subsequently dropped by about 85% over the next few years. I recently wrote about that period in "An Eerie Similarity to 2007, Before the Bulls Were Slaughtered."
I got to thinking how many conditions that existed back then exist today -- most importantly, like in 1999, when there emerged the untimely notion of "The Long Boom" in Wired Magazine. It was a new paradigm of a likely extended period of uninterrupted economic prosperity and became an accepted investment feature and concept in support of higher stock prices! The article began:
"We're facing 25 years of prosperity, freedom and a better environment for the whole world. You got a problem with that?
A bad meme - a contagious idea - began spreading through the United States in the 1980s: America is in decline, the world is going to hell, and our children's lives will be worse than our own. The particulars are now familiar: Good jobs are disappearing, working people are falling into poverty, the underclass is swelling, crime is out of control. The post-Cold War world is fragmenting, and conflicts are erupting all over the planet. The environment is imploding - with global warming and ozone depletion, we'll all either die of cancer or live in Waterworld. As for our kids, the collapsing educational system is producing either gun-toting gangsters or burger-flipping dopes who can't read."
--Peter Schwarz and Peter Leyden, Wired Magazine (1997) "The Long Boom: A History of the Future, 1980-2020"
And in 2007 new-fangled financial weapons of mass destruction -- such as subprime mortgages that were sliced and diced during a worldwide stretch for yield -- were seen as safe by all but a few. Here are some particular outlandish quotes from former Federal Reserve Chairman Ben Bernanke right before the world fell into the economic abyss in the deepest recession since the early 1930s.
"We've never had a decline in house prices on a nationwide basis. So, what I think what is more likely is that house prices will slow, maybe stabilize, might slow consumption spending a bit. I don't think it's gonna drive the economy too far from its full employment path, though."
--Ben Bernanke (2005)
"With respect to their safety, derivatives, for the most part, are traded among very sophisticated financial institutions and individuals who have considerable incentive to understand them and to use them properly."
--Ben Bernanke (2005)
"At this juncture, however, the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained. In particular, mortgages to prime borrowers and fixed-rate mortgages of all classes of borrowers continue to perform well, with low rates of delinquency."
- Ben Bernanke (2007)
And, just like during those previous periods of speculative excesses, many of the same strategists, commentators and money managers who failed to warn us then are now ignoring/dismissing (their favorite phrase is that the "macroeconomic backdrop is benign") the large systemic risks that arguably have contributed to an overvalued and over-loved U.S. stock market.
Instead they own and are buying FANGS (after being up 30% year to date) and other speculative and league-leading stocks -- or, like Boca Biff (who doubled up on Tuesday), are buying calls on the anointed stocks and on the S&P Index. But, as shown by Friday's Nasdaq carnage, the stocks that took the escalator up may take the elevator down.
As Bertrand Russell wrote, "The problem of the world is that fools and fanatics are always so certain of themselves and wiser people so full of doubts."
Here are my top 10 reasons why investors should be scared as hell of the U.S. stock market:
Reason #1: Machines/Algos, Quant Strategies and the Broad Acceptance of Passive Investing (and ETFs) Raise Systemic Risks. The animal spirits that initially took our markets up now have morphed into machine spirits -- both are dangerous in impact and in terms of investment ramifications ("'Something Else is At Work Here; 'Machine Spirits,' Methinks," "When, Not If, Risk Parity Takes Markets Lower, Remember This Post" and "Don't Think The Machines Could Turn to Selling? You've Forgotten 1987")
Reason #2: The Slowing Trajectory of Domestic Economic Growth ("Will There Be Growth in The Spring?") and the Likely Disappointing Rate of Recovery in U.S. Corporate Profits, Best Observed In The 15-Month Low in Citigroup's US Surprises Index. Importantly, this is occurring at a time In which debt loads are elevated. ("Mr. Leverage Meets Ms. Slowing Growth")
Reason #3: A Narrowing Stock Market ("The Technicals (Finally) Are Starting to Signal Trouble Ahead') The preoccupation with (T)FAANG is now in the extreme and "I Continue to Prefer White Fang to (T)FAANG."
Reason #4: The New Administration's Tax, Regulatory, Fiscal and Growth Initiatives Are Becoming Unglued. ("Increasingly Likely Trump Initiatives Will Be Delayed, Diluted") Republican Lindsey Graham warns of that potential and so does the conservative Wall Street Journal.
Reason #5: The Orange Swan: A Disorganized and Atypical Administration and Rising Political Uncertainty.
Reason #6: The Federal Reserve Plans to Raise Interest Rates at a Time When the U.S. Economy Faces Continued Intermediate-Term Challenges and Has A Weak Core Foundation.
Reason #7: Rising Geopolitical Uncertainty. China, Russia, North Korea and Iran are disrupting the world order.
Reason #8: Near-Record Stock Valuations (Most Metrics Are Now At the 95% Decile) and Risk Is Mispriced ("For What It's Worth")
Reason #9: Absence of Fear of a Meaningful Stock Market Drawdown -- aka, The Bull Market in Complacency. ("Disequilibrium Balloon Filled By 'Group Stink' Hot Air Soon May Pop")
Reason #10: Secular Trends Will Depress Prospective U.S. Economic Growth and Pressure the Job Markets, Coupled With the Continued Schism in Income and Wealth Inequality ("The Screwflation of the Middle Class")