Fundamentals: What Me Worry?

This may be the trickiest stock market of all time.  Usually when you have a stock market bubble, with extreme overvaluation, there is a lot of euphoria surrounding it.  There is nothing close to a feeling of euphoria.  Even when stock investors were at their most optimistic, both in regards to the stock market and the economy, January 2018, you didn't get a feeling of euphoria.  It was just widespread complacency as volatility selling was en vogue.  Now, everyone knows that the global economy is slowing, and will be slow in 2020, but that hasn't stopped the SPX from making all time highs almost every day over the past 5 weeks. 

We haven't had a deep correction this year.  The May, August, and October pullbacks all stopped after 6-7% moves.  What was more surprising during those downturns was the reaction to them, instead of treating them like a normal pullback with relatively little fear, there was definite sense of gloom during those brief periods. 

Some are saying that the recent breakout higher in the SPX is because Elizabeth Warren is falling in the polls.  I don't think traders and investors are thinking that far out.  It still seems like everyone is focused on US/China trade, and the global central banks, to a lesser extent.  But it is interesting to see that the person benefitting the most from Warren's slide in the polls in Peter Buttigieg, who's been compared to Alfred E. Neuman by Trump.  What Me Worry? 

The only true guiding light in this kind of market is sticking with the view that the stock market will not go down hard unless the bond market is showing overt weakness.  And at no point in 2019 has the bond market shown overt weakness.  Therefore, you could never be short with conviction.  That is why I rarely tried to short this year, sticking by the conservative principle that there must be real bond market weakness before you get real stock market weakness. 

Those who have ignored the bullish signs coming from the bond market have probably shorted stocks regularly this year, seeing the stock market go up despite a weakening economy, no earnings growth, and high valuations.  More and more, the economy is having less of an effect on the stock market while the bond market is having a bigger effect.  This makes sense when you realize that debt has grown enormously over the past 20 years while the financial markets have become more closely aligned with the economy.  With very low population growth and almost no productivity growth, you have a moribund economy that can only find growth through financial repression, i.e., forcing investors to take more risk and increase the velocity of investment capital by going from Treasuries to corporate bonds and then to stocks and private equity.  That push is fueled by the central banks buying the Treasuries and MBS, giving investors the cash to buy riskier assets. 

So naturally, lower bond yields will keep the Ponzi scheme going longer as corporations have lower interest payments, and can issue more bonds at less interest expense.  Those bonds being sold to investors helps fund the massive stock buybacks which are the backbone of the demand for stocks in the SPX.  But at some point, bond yields are so low that unless they go negative, (very unpopular and unlikely in the US as they hurt the banks), you aren't going to have a meaningful impact on investor behavior with incrementally lower yields.   We are not at that point yet, but I would guess that if 10 year yields get below 1%, further decreases in yield will have diminishing positive effects for stocks. 

At that point, earnings will be all that matters, and that will be dependent on economic growth and margin expansion, both which don't look to be future positive catalysts for stocks. 

If we step back from the news cycle and take a long term view, there is really no good place for a long term investment in either stocks or bonds.  Which means that you can't sit on a 60/40 stock bond portfolio and ride the risk parity gravy train like you have been able to for the last 35 years.  And when investors are not making money, they get more nervous, and volatility rises.  So that should make the next 10 years much more volatile than the previous 10 years.  2009 to 2019 has been a great 10 years for long term investors.  It hasn't been so great for most traders.  Even with all the quants and HFTs making the markets more efficient, it should be a more favorable environment for traders in the coming 10 years when investors are dealing with losses more frequently.   Nothing provides a catalyst for volatility like losses. 

Of course, the global central banks and governments could go on an MMT printing and spending frenzy over the next 10 years and make everything go higher in nominal terms.  While I see that as a distinct possibility in the US, I doubt that has the support from citizens in most other countries. 

First day of December, and we are seeing one of those rare days where the bonds are noticeably weaker while stocks are flat.  If we get further bond weakness while stocks trade either sideways or down, it will be the first sign that we are making a top.