“It’s Cloudy” Fatigue

Mike WilliamsEconomic Update, Market Review0 Comments

There have been times in the past where “crowd fatigue” was itself a drag on markets in the near-term.  It seems pretty clear to me we are jogging through a period just like that now. The combination of the feared earnings recession continuing, the interest rate hike media-mania and the election vitriol is more than enough to push anyone out of the markets.  It is indeed creating a headwind in the business surveys.

Equities are clearly the loser in the risk profiles of many today and bonds remain the go-to leader as noted for you yesterday on the massive over-subscription for the Sprint and Saudi deals.   Speaking of angst toward equities, the latest sentiment stats are in from AAII and get this – surprise – bulls are vanishing faster than a warm summer breeze.  This week’s AAII Sentiment Survey results:

  • Bullish: 23.7%, down another 1.7 percentage points
  • Neutral: 38.4%, down 2.4 percentage points
  • Bearish: 37.8%, up 4.1 percentage points

To put this in some context, this week’s reading tells us that over 90% of all other bullish readings in their 29-year history (over 1,500 surveys) were higher than we are now.   Still a different view is this:  we have now gone a full year with bullish sentiment staying well below the historical averages noted for you here:

  • Bullish: 38.5%
  • Neutral: 31.0%
  • Bearish: 30.5%

Fear is Clear?

Sentiment is not the only indicator of fear.

The demand for cash – the need to have liquidity is a clear indication of fear.  The type of fear that is unfortunately long-lasting and takes (usually) a very lengthy, slow jog upward in prices to restore confidence.

No doubt remains:  all across the world, investors of all shapes and size have driven a soaring demand for money (using M2—currency, retail money market funds, time deposits, checking accounts and bank savings deposits—as a proxy) since 2008.

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 Scott’s chart above makes this very clear:  The world wants to hold more cash relative to nominal GDP than ever before.

I am pretty sure these fears are deeply seeded and will not be dissipating anytime soon. Nothing in the current news cycle is likely to do anything but make it worse.  No matter the event, risk is all that is currently being focused upon.

People everywhere are more risk averse; caution permeates our daily lives; uncertainty abounds.

People worry about QE, about the risk of another financial collapse, about the direction of politics, about the rise of terrorism, about instability in the Middle East, about the proliferation of nuclear weapons, about the elections, about the Fed, about crude oil; the list is nearly endless as there seems to be no shortage of things to worry about.

Many did not understand the value at the time that Bernanke had spent so much time studying the forces of deflation.  In time, likely many years from now, we may begin to see that it was the public’s insatiable demand for money which essentially drove the Fed to adopt Quantitative Easing (QE).

Bernanke understood the Fed needed to rapidly increase the supply of money in order to satisfy the world’s huge demand for same. What most do not recognize is that if he had not driven these programs, we would have experienced significant deflation, which is what happens when there is a shortage of money.

While it does not help the Black Swan teams telling their end-of-the-world stories, it does help explain why the massive fears about igniting skyrocketing inflation because of QE never even remotely materialized.  Indeed – every dollar of QE is in the $9 trillion++ pile of cash idled in bank accounts.

More on Earnings and Value

Many stay focused on P/E’s as though they have a consistent sign of security implied by their number.  This is a fallacy.  However, it also does not give one a real view of earnings. Standard measures of earnings which conform to FASB accounting standards are not necessarily the same as “economic profits” noted in a P/E over a trailing 12-month period. Especially when that period covers a collapse in one specific sector.

The chart below helps us blend the picture better since it works directly from the estimate of economic profits found in the National Income and Product Account (NIPA).

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This is right from tax returns.  In taking this different view, one see that PE ratios today are only marginally higher than their long-term average – and have been far higher.

Considering the near-historical low interest rates and discount rates the market continues to drive, one must wonder aloud, “does it not make sense for PE ratios to be at least somewhat above average?”

One Last Item on Risk

I have written on the equity risk premium before.  To get to the heart of the matter here is what it tells us today:

Today investors are showing a near insatiable willingness to pay what is now $57 for $1 of annual earnings on T-Bonds.  However, they are only willing to pay about $19-$20 for $1 of annual earnings from equities.

Now seriously, if that is not a sign of some very significant, deeply-seeded risk aversion, I am unsure how else it could be indicated.  Said another way, the market of investors are saying that it is extremely unlikely that we will see companies maintain their current earnings into the future.

…this even as we see the turn becoming more and more evident.

In Summary

While none of this takes away that “cloudy” feeling I noted above, it does tell long-term investors what we often see during periods of value.

You see, being bearish or concerned in a world that has been extremely risk averse and bearish for years has not usually been a winning long-term viewpoint.

Unfortunately, this is where patience and discipline arise as more valuable assets in your arsenal.  Admittedly, never fun to watch – but historically valuable nonetheless.

I remain confident that a quarter or two into 2017, maybe sooner, we find markets are not that “over-valued” after all, based on 2017/2018 earnings.

I say we pray for a correction or setback around the election. Be prepared to take advantage of same in your long-term planning – even when it hurts – while many will be focused instead on the short-term.

Think demographics – not economics.

Think Barbell Economy – and rapid change – even as we have chopped, the cushion over the markets remains solid if one remains patient.

Have a nice weekend.

Until we see you again, may your journey be grand and your legacy significant.

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