Market Malaise

ICangles Investment Post….

Stocks are cheap. The S&P 500 is yielding about as much in dividends as 10-year Treasury securities. Think about that for a second. An investor can get as much income by buying high quality blue chip stocks as purchasing a ten year bond. And there is good reason to believe that for long term investors stocks will post strong capital gains over the next decade (I will get more into that in a future post). But investors can be excused for not being overly enthusiastic about the immediate prospects for stocks. Then again nothing looks like a sure thing short term–even the safe havens aren’t safe. To borrow a term made famous by Jimmy Carter during the current secular bear market a malaise has fallen over today’s market for all manner of financial vehicles to store value.

Stocks get all the headlines and with their neck snapping volatility of late this is understandable. After more than a decade of the market going up and down, but gaining no ground, many investors are understandably abandoning stocks. This is actually, however, a long term positive. There are a lot of investors and a lot of cash on the sidelines now available to fuel a multi-decade secular bull market. When everyone owns stocks not much buying is possible and conversely when few own a lot of purchasing can transpire. In the short term, though, the fundamental picture for the stock market is mixed at best. I’ve gone on record expecting market risk to rise in 2012 with 2013 being a year to watch. But I’ve also said that if the market definitively broke below its 500-day EMA that would be a reason to go more defensive.

In the recent past when the S&P 500 established and then broke below an uptrend in its 500-day EMA that has been a sign of a market decline with the exception of 1998. Of course as fortune would have this decline resembles the 1998 stock market correction. Although this time it’s a European credit crisis rather than one in East Asia, helping spark a steep sell off and establishing at this moment a double bottom. So, maybe this is just a repeat of that temporary correction. Then again the points I made just prior to the market sell off are of concern—that investors should be more worried about the weak state of the U.S. economy versus S&P’s credit downgrade of U.S. government debt. That turned out to be prescient as stocks fell on economic worries and money flowed into Treasuries as a safe haven. Given all that this is a good opportunity for a short term investor to take some money out of the market if you are sitting on gains. On the other hand, for the long-term investor stocks are easily the best game in town.

This isn’t because they are a lock for huge gains over the immediate future. Rather it’s partly because the term market malaise should apply to all investments, rather than just stocks. Bonds have had a wonderful run. But yields are so low that Treasuries are not even keeping up with inflation. (I’ve also written about my concerns over future inflation.) The long term prospects for bonds are simply horrible. That doesn’t mean they couldn’t outperform over the next few years, but current yields make them more speculation than investments in my opinion. On a similar note cash may feel safe, but inflation is destroying purchasing power. Food, medical prices and the general cost of living isn’t going down. The best use of cash in my opinion is to look for opportunities to put it to work in the stock market over the next three years.

The prospects for all manner of commodities also put them in the class of speculation rather than investment. Multi decade charts of commodity prices show periods of significant rise followed by falls, but no sustained long-term appreciation approaching stocks. Some people love gold and further appreciation could be ahead, but gold is not an investment. It produces no income. And from a contrarian standpoint its best days are well behind. The list of suspect investments also includes real estate. A long term study conducted by Professor Robert Schiller at Yale showed that residential real estate basically tracks inline with inflation. After its strong performance preceding the bust the historical trend argues for poor returns over the foreseeable future.

Although I’m extremely bullish on stocks in the long term, for the short term there are simply no great investment options. Even from a sentiment standpoint the immediate outlook on stocks is mixed. Retail investors are bearish in their views, which is bullish, since to a statistically significant degree they get things perfectly wrong. But the professionals who often turn bearish at market bottoms remain too bullish. On the plus side company insiders are buying their stocks, and they are the one group of investors who get things more right than wrong (not surprising given their access to information on the prospects of their own company stock).

Then there is the economic outlook. European credit markets are on life support. The Chinese are struggling to both maintain growth and clamp down on worrisome inflation. In the U.S. fiscal policy failed to revive the economy and no significant changes in either the regulatory climate or fiscal policies is likely until the next election. The Federal Reserve has realized it’s pushing on a string, as low interest rates and quantitative easing have increased the money supply substantially, but failed to ignite growth or credit creation. In fact in a sign of the times a New York bank recently announced plans to charge large institutional clients to hold their cash.

Monetarists may have thought the Great Depression was all about supplying adequate money to credit markets, but it’s starting to look like the Austrian school had it right in terms of malinvestments from a speculative bubble needing to be worked off before sustainable growth could reoccur. Helicopter Ben as the Fed Chairman is nicknamed has tried dropping money from his proverbial helicopter with the most accommodative monetary policies in history and it turns out investors are mostly sitting on the cash out of fear—except for what is causing inflation, including money seeping into China where it is sparking real inflation problems. On top of all this Keynesian style government spending after failing to work in the Great Depression and Japan’s lost decade has registered—in contrast to its many successes on Ivy League classroom white boards—another real world failure in the form of Obama’s stimulus plan as measured by its own employment promises.

As someone who spends a fair amount of time studying the stock market I often have a strong opinion about the market’s future. Indeed right now I have a very strong opinion that stocks represent a great long term investment, and a decade or more hence no one will regret buying now. But in the short term I have no such strong views. Believable scenarios can be worked up for the market moving in any direction. European credit markets could deteriorate further, a supply shock from rising energy prices possibly spurred by more unrest in the Middle East or declining stimulus from governments could push stocks into a full blown bear market.

A neutral scenario is possible where stocks continue to bounce along in their current range as the economy neither strengthens or weakens appreciably, which would be inline with the forecasts of many economists. Then again with so much negative sentiment and cash needing a home it won’t take much to push stocks back into a rally mode. Forget good news, an absence of bad news is all stocks need right now to rise.  In closing I do have some advice if not a near-term prediction. With stocks representing a strong value presently and my long term outlook positive I recommend making stocks the largest portion of any long-term investment portfolio, regardless of the short term moves of the market, and increasing stock exposure in the event of a steep and sustained move down.



  1. It appears to me that the European debt crisis is playing to big of a roll in America’s stock prices. I think it is more Chicken Little than actual market forces.

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