A Review Of Stock Market Valuations - Part 2

Meanwhile, the actions necessary to fix some of these bubbles are mutually exclusive. A stock market or housing bust requires much lower interest rates and bigger government deficits, while a currency crisis brought on by rising inflation requires higher interest rates and government spending cuts. Let everything blow up at once and there will be literally no fixing it. And the “everything bubble” will become the “everything bust.”

John’s website is called Dollar Collapse, of the two end-games he outlines above, letting the US$ slide is the least painful short-term solution, no wonder the US administration keeps labeling other countries' currency manipulators.

The Stock Market’s Nemesis

Having lain dormant for so long, its return to prominence may come as a shock to newer participants in the stock market: I am of course referring to the US Treasury Bond market. The chart below shows the 10yr yield over the last quarter-century: -

Source: Trading Economics

10yr yields hit their all-time low at 32bp last March, today (24th February) they have risen to 1.39%. The table below shows a selection of forecasts for year-end yields: -

Source: III Capital Management

Central Bankers are holding short-term rates near to zero but the longer end of the yield curve is being permitted to express concerns about the inflationary consequences of excessively accommodative fiscal and monetary policy. Meanwhile, central bank buying of corporate bonds has insured that credit spreads have shown a muted response to the recent increase in yields. At some point, there will be an inflection point and credit will reprice violently. For those adventuring in the stock market, these words attributed to James Carville – a political adviser to President Clinton - remain worthy of careful reflection: -

I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody.

Unless, as I expect, the world’s leading central banks intervene to fix the price of government bonds, the bond market, left to its own devices, will bring the stock market back to reality with a crash.

Conclusion and Investment Opportunities

Having written more than 6,000 words in this two-part Macro Letter I still feel as if I have merely scratched the surface of the conflicting and contrasting factors which support the bull and bear case. Taking a step back, I encourage you to read Five Lessons From History By Morgan Housel, The Collaborative Fund a short-ish article that presents five lessons which can be applied to investing and to life in general. In the interests of brevity: -

Lesson #1: People suffering from sudden, unexpected hardship are likely to adopt views they previously thought unthinkable.

Lesson #2: Reversion to the mean occurs because people persuasive enough to make something grow don’t have the kind of personalities that allow them to stop before pushing too far.

Lesson #3: Unsustainable things can last longer than you anticipate.

Lesson #4: Progress happens too slowly for people to notice; setbacks happen too fast for people to ignore.

Lesson #5: Wounds heal, scars last.

Reflecting on the current great viral crisis (GVC) and its aftermath, I see many signs of irrational exuberance but remain cognizant of the low likelihood of any sudden policy reversals by developed nation governments or their central banks, this is primarily due to the fragility of the current global economy. The scars of Covid will take many years to heal, unsustainable things may last longer than anticipated and, as JM Keynes famously observed: -

The markets can remain irrational longer than you can remain solvent.

The cult of the personality, personified by the likes of Elon Musk, remains ascendant, so reversion to mean maybe postponed a while. There is widespread evidence of what the French philosopher Rene Girard dubbed mimetic desire; the idea that, because people imitate one another’s desires, they tend to desire the same things; in the process, this desire creates rivalry and increases the fear of missing out. In the classic evolution of a bubble mimetic desire leads from the momentum or awareness phase to the hallowed halls of mania and euphoria: -

Source: Dr. Jean-Paul Rodrigue – Holstra University

Now is not the time to be rushing headlong into the stock market, but the upward trend remains firmly intact. Alan Greenspan observed irrational exuberance in 1996, it took the market another four years to reach its high, mimetic desire makes it hard for investors to risk-taking profit for fear of missing an exponential rise. There are several risk reduction strategies, but these statements, attributed to two of the most successful investors of all time are always worth keeping in mind: -

Be fearful when others are greedy. Be greedy when others are fearful.

Warren Buffett

The time of maximum pessimism is the best time to buy and the time of maximum optimism is the best time to sell.

Sir John Templeton

 

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