In case you've been asleep under a rock lately, let me catch you up: Markets are in the midst of an epic bubble that is being ignored by investors at their peril.
At 21x GAAP earnings (which are inflated by low interest rates, low corporate tax rates, and sluggish wage growth), the S&P 500 is trading just below the 24x PE it reached during the Internet Bubble. The S&P 500 rose 9.5% last year without profits increasing for the second year in a row. The index hasn't seen a decline of 1% or more in 84 consecutive trading sessions, a feat last seen in 2006 and before that in 1996. If investing were really this easy, everyone would be rich.
But sadly, all of this is an illusion and it is going to end badly – very badly.
Especially for companies like these two.
If You Really Believe This Market Is Going to Keep Rising, You're a Turkey
The bond markets are deep in la la land with trillions of dollars of paper trading at minuscule or even negative yields (right now the number is $4 trillion of negative-yielding paper, down from $14 trillion last year). This is the result of central banks fighting a debt crisis by printing tens of trillions of dollars more debt, governments abandoning fiscal policy, and citizens allowing this mess to fester. People should heed the lesson of the Meleagris gallapavo, otherwise known as the North American turkey. The turkey has a great life for 364 days of the year until Thanksgiving comes along, and then one awful day when it its head gets chopped off. That is likely to be the fate of complacent investors who seem to believe markets can keep rising without any relationship to economic fundamentals. I take no pleasure in assuring them that is not the case. There are no free meals in this life, and those who try to get away with skipping out on the check end up with serious indigestion.
Last week, of course, stocks hit new record highs after President Trump promised a spectacular tax plan. How do we know it will be spectacular? Because he said so! Never mind that it will take months to pass the plan and the specifics are unknown. Trust me, it is going to be fabulous! Markets certainly believed the president. The Dow Jones Industrial Average rose by 0.99% to a new closing high of 20,269.37, while the S&P 500 jumped another 0.81% to end the week at a record 2,316.10. The Nasdaq Composite Index added 1.19% to a record 5,734.13. We are told that these moves are supported by higher corporate earnings, but from where I sit, 2016 S&P 500 GAAP earnings are no higher than $110 (again, inflated by low taxes, low interest rates, and low wages), so that is a bunch of baloney. The market is trading at 21x trailing and inflated GAAP earnings, and that spells B-U-B-B-L-E to me.
The yield on the benchmark 10-year Treasury finished the week at 2.41% as the market began placing lower odds that the chicken-hearted Fed will raise rates in March. The U.S. Dollar Index (DXY) jumped back over the century mark to close at 100.71 as President Trump refrained from trashing the dollar for a few days while focusing on trashing federal judges (who were themselves trashing the U.S. Constitution). The yield on the iShares iBoxx $ High-Yield Corporate Bond ETF (NYSE Arca: HYG) (who comes up with these idiotic ETF names?) dropped to 5.25%, which is the farthest thing from a "high yield" and should be telling investors to run in the other direction.
Sadly, however, most investors know nothing and think they know everything. And that will cost them dearly.
How Not to Be a Turkey (and What to Do Instead)
Investors are now complaining if their managers hold cash. They whine that they are not paying managers fees to sit in cash, completely missing the point that they are supposed to be paying managers fees for knowing when to hold cash. Cash has enormous option value, and the greatest option value exists at times of maximum uncertainty, such as today. Naturally the average, uninformed investor believes that now is a time of minimum uncertainty that merits maximum bullishness. That is why people have swelled the coffers of indexing giant Vanguard to $4 trillion and withdrawn $40 billion from one of the greatest value investors in history, Jeremy Grantham. But that's what investors do – they buy what they wish they would have bought earlier and sell what they are going to need. Not to put too fine a point on it, but they have no clue what they are doing.
On the other hand, those of us who actually know what we are doing – and have the track records over multiple decades to prove it – understand that successful investing involves doing not what feels good but what feels bad. We may be miserable SOBs (though you'll get to love us when you get to know us), but we know how to take care of our own and other peoples' money.
So listen carefully: If you are investing in a way that makes you feel comfortable, you're almost certainly doing it wrong. On the other hand, if you are going against the crowd and doubting the bull market and giving yourself the willies, you're most likely doing it right. Take it from me, someone who has consistently made people money since the early 1990s regardless of whether the market was rising or falling – if investing is not making you miserable, you are going about it wrong and setting yourself up for big losses. Don't be a turkey! Cut back on your market exposure before you get your head chopped off!
If you look at the market today, there are some serious valuation anomalies. Take Exxon Mobil Corp. (NYSE: XOM), for example. This highly cyclical stock is trading at a ridiculous 44x earnings even after oil prices doubled over the last year. Or look at Kellogg Co. (NYSE: K), a mundane consumer staples company trading at 20x earnings while growing in the mid-single digits. These types of high multiples are normally reserved for companies growing much more rapidly but are now being awarded to slow growers because of the effects of indexing and ETFs. There are plenty of other companies sporting higher valuations than they deserve and those of us who've seen this movie before know they are vulnerable to collapsing when the market sells off. For many of you this may seem unthinkable today in the midst of an epic bull market, but that is precisely why you should be taking precautions rather than participating in the madness.
If you own either of these two stocks, you should get out – and if you want to profit, you should consider buying some long-dated puts.
Every market signal I see tells me that we are deep in bubble territory, especially the commentary coming out of Wall Street and the talking heads in the financial media, though I only read the print media and avoid CNBC and Bloomberg Television in order to limit polluting my brain with too much gibberish. The thing you have to understand about bubbles is that they are accompanied by extended bouts of rationalization by the lightweights on Wall Street and in the media who make their living keeping the phony rally going as long as possible. They hate guys like me, and I wear their hatred like a badge of honor. I also know that in the end, they are going to be proven wrong again. You see, turkeys always get their heads chopped off. That's one of the ironclad rules of nature.
The post Why We're In A Bubble – And Two Companies That Will Pop First appeared first on Sure Money.
About the Author
Prominent money manager. Has built top-ranked credit and hedge funds, managed billions for institutional and high-net-worth clients. 29-year career.