Posts tagged ‘double-rip’
2014: Here Comes the Dumb Money!
Before this year’s gigantic rally, I wrote about the unexpected risk of a Double Rip. At that time, all the talk and concern was over the likelihood of a “Double Dip” recession due to the sequestration, tax increases, Obamacare, and an endless list of other politically charged worries.
Perma-bear Nouriel Roubini has already incorrectly forecasted a double-dip in 2009, 2010, 2011, and 2012, and bond maven Bill Gross at PIMCO has fallen flat on his face with his “2013 Fearless Forecasts”: 1) Stocks & bonds return less than 5%. 2) Unemployment stays at 7.5% or higher 3) Gold goes up.
Well at least Bill was correct on 1 of his 4 predictions that bonds would suck wind, although achieving a 25% success rate would have earned him an “F” at Duke. The bears’ worst nightmares have come to reality in 2013 with the S&P up +25% and the NASDAQ climbing +33%, but there still are 11 trading days left in the year and a Hail Mary taper-driven collapse is in bears’ dreams.
Source: Scott Grannis
For bulls, the year has brought a double dosage of GDP and job expansion, topped with a cherry of multiple expansion on corporate profit growth. As we head into 2014, at historically reasonable price-earnings valuations (P/E of ~16x – see chart above), the new risk is no longer about Double-Dip/Rip, but rather the arrival of the “dumb money.” You know, the trillions of fear capital (see chart below) parked in low-yielding, inflation-losing accounts such as savings accounts, CDs, and Treasuries that has missed out on the more than doubling and tripling of the S&P and NASDAQ, respectively (from the 2009 lows).
Source: Scott Grannis
The fear money was emboldened in 2009-2012 because fixed income performed admirably under the umbrella of declining interest rates, albeit less robustly than stocks. The panic trade wasn’t rewarded in 2013, and the dumb money trade may prove challenging for the bears in 2014 as well.
Despite the call for the “great rotation” out of bonds into stocks earlier this year, the reality is it never happened. I will however concede, a “great toe-dip” did occur, as investor panic turned to merely investor skepticism. If you consider the domestic fund flows data from ICI (see chart below), the modest +$28 billion inflow this year is a drop in the bucket vis-à-vis the hemorrhaging of -$613 billion out of equities from 2007-2012.
Will I be talking about the multi-year great rotation finally coming to an end in 2018? Perhaps, but despite an impressive stock rally over the previous five years in the face of a wall of worry, I wonder what a half trillion dollar rotation out of bonds into stocks would mean for the major indexes? While a period of multi-year stock buying would likely be good for retirement portfolios, people always find it much easier to imagine potentially scary downside scenarios.
It’s true that once the taper begins, the economy gains more steam, and interest rates begin rising to a more sustainable level, the pace of this stock market recovery is likely to lose steam. The multiple expansion we’ve enjoyed over the last few years will eventually peak, and future market returns will be more reliant on the lifeblood of stock-price appreciation…earnings growth (a metric near and dear to my heart).
The smart money has enjoyed another year of strong returns, but the party may not quite be over in 2014 (see Missing the Pre-Party). Taper is the talk of the day, but investors might pull out the hats and horns this New Year, especially if the dumb money comes to join the fun.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
Risk of “Double-Rip” on the Rise
Okay, you heard it here first. I’m officially anointing my first new 2013 economic term of the year: “Double-Rip!” No, the biggest risk of 2013 is not a “double-dip” (the risk of the economy falling back into recession), but instead, the larger risk is of a double-rip – a sustained expansion of GDP after multiple quarters of recovery. I know, this sounds like heresy, given we’ve had to listen to perma-bears like Nouriel Roubini, Peter Schiff, John Mauldin, Mohamed El-Erian, Bill Gross, et al shovel their consistently wrong pessimism for the last 14 quarters. However, those readers who have followed me for the last four years of this bull market know where I’ve stood relative to these unwavering doomsday-ers. Rather than endlessly rehash the erroneous gospel spewed by this cautious clan, you can decide for yourself how accurate they’ve been by reviewing the links below and named links above:
Roubini calling for double-dip in 2012
Roubini calling for double-dip in 2011
Roubini calling for double-dip in 2010
Roubini calling for double-dip in 2009
If we switch from past to present, Bill Gross has already dug himself into a deep hole just two weeks into the year by tweeting equity markets will return less than 5% in 2013. Hmmm, I wonder if he’d predict the same thing now that the market is up about +4.5% during the first 18 days of the year?
Why Double-Rip Over Double-Dip?
How can stocks rip if economic growth is so sluggish? If forced to equate our private sector to a car, opinions would vary widely. We could probably agree the U.S. economy is no Ferrari. Faster growing countries like China, which recently reported 4th quarter growth of +7.9% (up from +7.4% in 3rd quarter), have lapped us complacent, right-lane driving Americans in recent years. But speed alone should not be investors’ only key objective. If speed was the number one priority, the only places investors would be placing their money would be in countries like Rwanda, Turkmenistan, and Libya (see Business Insider article). However, freedom, rule of law, and entrepreneurial spirit are other important investment factors to be considered. The U.S. market is more like a Toyota Camry – not very flashy, but it will reliably get you from point A to point B in an efficient and safe manner.
Beyond lackluster economic growth, corporate profit growth has slowed remarkably. In fact, with about 10% of the S&P 500 index companies reporting 4th quarter earnings thus far, earnings growth is expected to rise a measly 2.5% from a year ago (from a previous estimate of 3.0% growth). With this being the case, how can stock prices go up? Shrewd investors understand the stock market is a discounting mechanism of future fundamentals, and therefore stocks will move in advance of future growth. It makes sense that before a turn in the economy, the brakes will often be activated before accelerating into another fast moving straight-away.
In addition, valuation acts like shock absorbers. With generational low interest rates and a below-average forward 12-month P/E (Price-Earnings) ratio of 13x’s, this stock market car can absorb a significant amount of fundamental challenges. The oft quoted message that “In the short run, the market is a voting machine but in the long run it is a weighing machine,” from value icon Benjamin Graham holds as true today as it did a century ago. The recent market advance may be attributed to the voters, but long-term movements are ultimately tied to the sustainable scales of sales, earnings, and cash flows.
If that’s the case, how can someone be optimistic in the face of the slowing growth challenges of this year? What 2013 will not have is the drag of election uncertainty, the fiscal cliff, Superstorm Sandy, and an end-of-the-world Mayan calendar concern. This is setting the stage for improved fundamentals as we progress deeper into the year. Certainly there will be other puts and takes, but the absence of these factors should provide some wind under the economy’s sails.
What’s more, history shows us that indeed stock prices can go up quite dramatically (more than +325% during the 1990s) when consensus earnings forecasts continually get trimmed. We have seen this same dynamic since mid-2012 – earnings forecasts have come down and stock prices have gone up. Strategist Ed Yardeni captures this point beautifully in a recent post on his Dr. Ed’s Blog (see charts below).
CLICK TO ENLARGE – Source: Dr. Ed’s Blog
What Will Make Me Bearish?
Am I a perma-bull, incessantly wearing rose-colored glasses that I refuse to take off? I’ll let you come to your own conclusion. When I see a combination of the following, I will become bearish:
#1. I see the trillions of dollars parked in near-0% cash start coming outside to play.
#2. See Pimco’s Bill Gross and Mohammed El-Erian on CNBC fewer than 10 times per week.
#3. See money flow stop flooding into sub-3% bonds (Scott Grannis) and actually reverse.
#4. Observe a sustained reversal in hemorrhaging of equity investments (Scott Grannis).
#5. Yield curve flattens dramatically or inverts.
#6. Nouriel and his bear buds become bullish and call for a “triple-rip” turn in the equity markets.
#7. Smarter, more-experienced investors than I, á la Warren Buffett, become more cautious. I arrogantly believe that will occur in conjunction with some of the previously listed items.
Despite my firm beliefs, it is evident the bears won’t go down without a fight. If you are getting tired of drinking the double-dip Kool-Aid, then perhaps it’s time to expand your bullish horizons. If not, just wait 12 months after a market rally, and buy yourself a fresh copy of the Merriam-Webster dictionary. There you can locate and learn about a new definition…double-rip!
Read Also: Double-Dip Guesses are “Probably Wrong”
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing SCM had no direct position in Fiat, Toyota, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
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