Trademark Market Perspective for 8/31/20

The Fed

Not much to say about the U.S. stock market overall.  I’ve been reading a lot of analogies lately, so here is mine:  Imagine northern California, circa 1849.  Gold has been discovered, and a lot of people are getting rich mining and especially by selling equipment to miners.  The cost of everything is up because there is plenty of money available relative to the supply of picks, pans, shovels, horses, denim, food, whiskey, etc.  You can argue that “in the real world” of New York or even St. Louis those items wouldn’t cost nearly as much, but if you were in San Francisco and wanted to mine, that was what it cost.  The point is that the Federal Reserve has opened up the credit spigot and the “gold” of easy money is inflating the stock price of the new pick and shovel companies like Nvidia, Zoom, Tesla, and others.  However, U.S. and foreign companies engaged in “real world” industries such as industrials, financials, real estate and utilities, haven’t felt nearly as much of a liquidity surge, as thus their stock prices really haven’t budged that much (and certainly aren’t at all time highs).

Now, we know easy money booms don’t last forever.  Going back to our analogy, whereas the supply of gold in California’s rivers was finite, the Fed’s ability to flood the world with liquidity seems to be limited only by the market’s concern about how much is too much.  I don’t get the sense we are close to that point, so while a correction may be overdue, it just might ultimately result in even more stimulus.

A Thought Experiment

What conditions would create the perfect scenario for long-term underperformance of a particular country? I believe the following would need to be present:

1. That country would have to start out at very high absolute valuations, say over 25 times earnings.
2. That country’s market should be dominated by a relatively overrepresented economic sector as compared to other global markets, and that sector should be even more highly priced than its domestic market as a whole – let’s say 36 times forward earnings expectations.
3. That economic sector should be over-owned both in that country and globally as a percentage of global market capitalization.
4. That country should trade at a premium to the rest of the world, generated in no small part by its reputation for strength and stability. However, this reputation may not reflect the current reality of this country.
5. That country should have engaged in corporate financing practices that render the majority of its firms vulnerable to an increase in interest rates, such that it increasingly falls upon the country’s central bank to underpin its market by buying the bonds of its major corporations.
6. This country should have the world’s reserve currency, such that it has to run a trade deficit in order for the global economy to grow. This country’s currency should begin to experience weakness as foreigners become concerned about how much of that currency may flood the world at some point given its central bank’s massive credit creation.
7. The country should be experiencing deteriorating trade relations with much of the world, including the world’s second most powerful economy. That other country should be growing at a rate that would allow it to contemplate using its own currency to conduct global trade, or at the very least no longer doing business in the currency of its rival.

As I see it, the U.S. checks all seven of the boxes.  The U.S. is 4% of earth’s population and 55% of its market capitalization.  It is hard for me to imagine our relative advantage being greater ten or twenty years from now.  At some point, we are all going to own a much higher percentage of foreign securities, probably because of U.S. underperformance.

Stop Listening

I can think of no worse way to waste one’s time than to listen to investment companies discuss the upcoming election. Please keep two things in mind: (1) Investment companies have a terrible record determining the winner and, more importantly, (2) they are abysmal at forecasting the implications, even if they are correct about who wins

Furthermore, experience shows that even if one knew that Trump was going to be re-elected, one would still have no idea what he would actually do.  Do yourself a favor and stop listening. Remember, capital has historically found a way to flow toward productive capacity regardless of election outcomes.

The Bond Market

Bonds, having sold off quite a bit since August 4, are close to a major support level.[i]  Since we have a nearly forty year history of sell-offs in the bond market being a buying opportunity, respect precedent and do not jump to the conclusion that this is it for bonds for the next few decades.  The yield bottom may be near, but in an economy with double digit unemployment and a very active Fed, you have to allow for the possibility that if the economy falters, another run to record low yields is possible.

Disclosure 

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[i] Source: YCharts as measured by the Bloomberg Barclay’s US Aggregate Bond Index