July 25, 2016

Could buying stocks now be as risky as picking nickels in front of a train

Today's unprecedented level of partisanship and division between Democrats and Republicans will likely set the stage for more market volatility ahead.

We're already seeing this division and vitriol at this week's Republican National Convention, and we'll probably see it at next week's Democratic convention as well.

In its extreme, this animus could continue to exert a headwind and stasis in fixed business investment, which is already weak. A consumer-spending slowdown could also develop -- in fact, we're already seeing one in high-end homes and expensive art.

But it's not just the hatred between the two parties and their constituents that has me worried about the market. It's also today's valuations, fundamentals, technicals and unusually optimistic sentiment. Nonetheless, many of business TV's "talking heads" are rationalizing the swift rebound that the S&P 500 has seen since the big drop that followed Britain's June 23 Brexit vote. They're saying that the "fundamentals are improving," or that central banks will keep interest rates "lower for longer."

But to be blunt, I think these market watchers are fugazis. I'd note that:

- Many "talking heads" have short memories. They all too often went on TV following the Brexit vote to declare that they "hated" stocks, even though the S&P 500 was some 150 handles below where they "love" equities today. These market watchers are simply "carpet sweepers" who forget or choose to ignore their previous concerns because stock prices have risen since then.

- Central banks are losing their effectiveness.

- We've likely seen a generational low in bond yields.

- The fundamentals aren't improving, Instead, we're seeing numerous signs of peaks in important segments of the global economy.

- Analysts' consensus forecasts for S&P 500 earnings have proven to be too high for a fourth consecutive year. So far, the level of "beats" for second-quarter earnings is running about average -- but much like Monty Python's "Twit Olympics," the standards are low. And all too often, investor-relations departments are manipulating the results, with the sell-side lemmings blindly following anyway.

The Bottom Line

At the very least, this year's election will likely serve as a market-volatility source over the coming months. And at worst, it will represent an albatross around valuations' neck and cause a hiatus in business and consumer spending.

But as the great Howard Marks of Oaktree Capital Management (OAK) once wrote: "Risk lives higher. ... The absence of a risk event's occurrence does not mean risk doesn't exist."

In other words, those of us who worry about risk vs. reward should remember that risk rises and rewards decrease whenever stock prices go up. That's true even in our current market, where buyers live higher and sellers live lower in an investment world that's dominated by volatility-trending and risk-parity strategies that depend more on price action than company fundamentals.

Even hedge funds are increasingly dominated by a quant component that's governed by machines and algos who know nothing of balance sheets or income statements. This helps explain the absence of "downticks" during run-ups like the one we've had over the past two weeks.

However, all of these influences are rapidly moving our markets to the point where buying stocks will be as risky as picking up nickels in front of a steamroller. Still, I've decided to be more reaction-oriented than anticipatory in my strategy -- even though that means I run the risk of losing out on some profits by not being short in a major decline's initial stage.

via realclearmarkets