We’re currently witnessing an incredibly fascinating time in the financial markets. All kinds of people and media outlets are now talking about heightened risk in the stock market and I haven’t seen any real case made against it (just a LOT of logical fallacies). Still, investors keep pouring money in and the market keeps heading higher. It’s as if they’re laying down in front of a speeding locomotive, tying themselves to the tracks with their own greed.
Here are the 8 things we can all agree (based on their popularity in the press and lack of rebuttle) will doom investments made in the stock market today:
- Quantitative Easing is losing its efficacy and creating major imbalances. Ray Dalio recently argued that QE is now beginning to suffer from its own success in boosting asset prices. At the same time, the general public is realizing the whole program, by relying on the “wealth effect” to boost the economy, disproportionately benefits the rich while they see little or no benefit at all.
- But the Fed can’t stop or even taper QE without major repercussions in the financial markets. If QE’s greatest accomplishment has been boosting the economy via the wealth effect, it stands to reason that removing or even reducing it will have the opposite effect.
- Hence, the Fed is trapped. Richard Koo can’t find anyone to dispute this.
- Still, it can’t “print money” forever. At the current pace, the Fed is printing $1 trillion of new money every year and then spending much of that buying treasury bonds, essentially monetizing the debt. Even the Fed admits this cannot go on for long.
- Yet stocks are priced as though they will. Based on numerous metrics, including Warren Buffett’s favorite valuation metric, stocks are valued significantly higher than they have typically been in the past. In other words, very little risk is priced into the market at current levels.
- And investors are clearly optimistic about future returns. Why else would they pour record amounts of money into equity funds and use record amounts of leverage to boot?
- Even though they are guaranteed to be mediocre at best. Investment returns are based on the price you pay. Because prices are relatively high today future returns from current stock prices are reasonably estimated at 0-4% over the next decade.
- All of which means many investors are doomed to be let down. With potential “reward” in the low single digits and potential “risk” being 40-55% to the downside it seems investors have once again set themselves up for failure.
Isn’t it absolutely amazing how this happens time and time again?
Chart of the Day:
Oil has been a very good signal for stocks so far this year and it just took a pretty nasty tumble:
