Am I Too Bullish?
Over the past few weeks, I have been trying to push back against the usual contingent of bears. In particular, I have argued that this bull cycle is not yet over, markets are not in a bubble and that people have been sitting for too long in way too much cash.
John Coumarianos of the Institutional Imperative is a prudent value guy. He wonders aloud in a recent blog post if I am too bullish?. He raises a number of interesting points via (mostly) valid criticisms.
I am not a rampaging bull, but if I come across that way to a reasonable guy such as John, then I am probably miscommunicating my thoughts. I am going to use his critique as a jumping off point to clarify some ideas and positions. I know that nuance and subtly are not necessarily my strong suits -- nor the Internet’s, for that matter -- but I will avoid all hyperbole in this discussion, click-throughs be damned.
My biggest pushback is a misinterpretation of my attempt at making larger points about cognitive foibles. I do not now, nor have I ever made exhortations that YOU MUST BUY NOW! But given my recent spate of posts on excess cash, bubbles and errors, I can see how some might get that impression. I hope this post will correct some misconceptions regarding my investment posture. (And it is just dumb luck that I am posting this on a day when futures are up strongly).
First, our discussion on recent surveys of affluent investors revealing them sitting on $6 trillion and as much as 50 percent cash in their portfolios was about investor psychology. That pile of cash is not likely the result of carefully studied market history and astute observations of timing. Rather, it is most likely the result of fear. It has been a drag on portfolios for at least four years; it typically reflects a combination of poor planning and emotion.
That discussion was decidedly not an exhortation to “jump in right now leveraged long or you will miss the gravy train!” No, I do not mean “In other words, investors should stop sitting on cash, which is a drag on portfolios, and own more stocks.” Rather, I hoped it would provoke thought and self-reflection from investors who essentially just missed a generational rally. Indeed, last June, I came up with a list of 10 things investors who miss a big market rally should do. Having a plan is better than wishful thinking.
Second, the classic problem with too much cash is the investor's ability to re-enter the markets. A broad contingent of cash-heavy investors never seems to be able to get back into a properly balanced portfolio. To quote Peter Lynch, "Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.” That quote succinctly describes the circumstances for many since the March 2009 lows.
As to cyclically adjusted price-to-earnings ratio, it is undoubtedly expensive, and suggests 10-year returns will be below historical medians. That certainly is a realistic possibility. But I keep bringing CAPE up in the context of confirmation bias. One should not cherry pick the valuation measure that supports a prior view to the exclusion of all other measures of what is dear. Indeed, as discussed back in August, Merrill Lynch’s quant team looked at 15 valuation metrics and concluded that stocks were not overvalued; by most metrics, they were fairly valued. My reasons for discussing CAPE was to critique newfound discoverers of Bob Shiller’s valuation metric who were attracted to it for all the wrong reasons. That sort of cognitive error cries out to be recognized.
We see that U.S. stocks are indeed costlier today than they were, thanks mostly to rising prices and multiple expansion. This is why some investors -- myself included -- have tilted their portfolios somewhat away from U.S. equities and toward more reasonably priced European and emerging market stocks. The European trade has worked out splendidly; I cannot say as much for the EM position. However, valuation is a highly imprecise tool, and value-based investments often are in the red prior to becoming profitable.
Next, comparing corporate profits to gross domestic product is a metric that has been used by bears for about a year now. But just like the flawed Fed Valuation Model, there are two variables involved. Mean reversion of that ratio does not have to occur only by an earnings collapse. If GDP were to accelerate on improved hiring or spending, that would also satisfy the mean reversion of that ratio.
As to stock mutual fund flows, after five years of huge outflows from equities, most of which flowed into bonds, less then a year of positive flows is hardly the stuff of market tops. Prior equity flows ran in the green for many years, not months, before the cycle came to its ignominious end.
Finally, I have been calling this the “most rally hated in history” since 2009. The vitriol directed at the Federal Reserve, forecasts of hyper-inflation and currency debasement, the worship at the Altar of Gold are part of the liturgy of equity dislike. Coumarianos suggests these are strong words requiring an “impressive knowledge of the sentiment of previous rallies.” I hope that its something I have demonstrated previously (See this and this and this).
I continue to see signs that sentiment has gotten frothy. We are long overdue or a 10 percent to 20 percent correction. But I do not see any market internals suggesting that this bull market is over. Perhaps that discussion is worthy of a column unto itself.
I cannot tell you what will happen tomorrow, but we all know what happened yesterday. My goal is to get investors to think about the errors they made previously, and how to avoid repeating them in the future.
I hope these columns in some small measure accomplish that. And I trust that if they don’t, you will let me know . . .