Saturday, September 3, 2022

Stock Market Prognostication-- the Bear Side

Consider this post a public service. It concerns the stock market, a topic about which, to say the least, I know precious little. Like most of you, when I do not know about an important subject, I try to find the most rational and sensible advisors.

When it comes to the markets I find that cranky old guys, guys with decades of experience, are the best guides. They are not necessarily the best at calling short term moves, but they do not think that the short term matters much. They have a longer term outlook, and often seem to be wrong until the moment when they are right.

One will recall that in October of last year I posted about Bitcoin. At that time, most of the cranky old guys thought that Bitcoin was a bubble. I tended to agree. At the time of my posting, Bitcoin was selling at around $60,000. Currently, it is hovering below $20,000. That means, it still has some downside.

Anyway, the stock market collapsed in the earlier part of the year, only to rebound strongly and smartly. Even before last week's rather bad action, the cranky old guys were pessimistic; they thought that we had seen a bear market rally.

The key to investing, as best as I can tell, is to identify the larger more secular trends. If we are in a bear market, you sell the rallies. If we are in a bull market, you buy the dips.

So, we begin with major money manager, Jeremy Grantham. His view: we are setting up for a tragedy. That means, for a market collapse.

The New York Post reported:

Despite a summer rally, the US stock market is still an unprecedented “superbubble” that will cause financial “tragedy” for investors when it bursts, according to famed investor Jeremy Grantham.

Grantham, the co-founder of asset management firm GMO in Boston, said the current superbubble is entering its “final act” due to deteriorating economic conditions. A recent “bear market rally” that saw the S&P 500 recoup 58% of its losses from a June low follows the pattern of past stock market crashes in 1929, 1973 and 2000, he added.

“The current superbubble features an unprecedentedly dangerous mix of cross-asset overvaluation (with bonds, housing, and stocks all critically overpriced and now rapidly losing momentum), commodity shock, and Fed hawkishness,” Grantham wrote in a letter to clients dated Wednesday.

“Each cycle is different and unique – but every historical parallel suggests that the worst is yet to come,” he added.

But, it is not just the stock market. The housing market is on a precipice, too. One is also not overly optimistic about commercial real estate in major cities, or about the mortgages that developers have taken out on buildings.

“Previous superbubbles saw a much worse subsequent economic outlook if they combined multiple asset classes: housing and stocks, as in Japan in 1989 or globally in 2006; or if they combined an inflation surge and rate shock with a stock bubble, as in 1973 in the US and elsewhere,” Grantham wrote.

“The current superbubble features the most dangerous mix of these factors in modern times: all three major asset classes – housing, stocks, and bonds – were critically historically overvalued at the end of last year,” he added.

And then there is Michael Burry, who became famous for being among the very few who knew to short mortgage backed securities in 2007-08. Written up in Michael Lewis’s book, The Big Short, Burry became something of an investing legend.

Currently, his views correlate nicely with Grantham’s. The New York Post reports:

In June 2021, he cautioned that irrational “fear of missing out” trading activity around cryptocurrencies and meme stocks were likely to end in disaster for overextended retail traders.

“All hype/speculation is doing is drawing in retail before the mother of all crashes,” the investor tweeted. “When crypto falls from trillions, or meme stocks fall from tens of billions, #MainStreet losses will approach the size of countries.”

Stocks had rallied since June on investor optimism that the Fed could ease its policy stance. But indices gave back their gains after Fed Chair Jerome Powell indicated rate hikes would continue even though it would cause “some pain” for US households.

When the S&P 500 posted its worst first-half performance since 1970 earlier this year, Burry warned the selloff was “maybe halfway” over.

Obviously, market action over the past few days lends credence to his views.

And then there is Nouriel Roubini, an NYU professor who has garnered a reputation for being bleakly pessimistic. If he were consistently wrong, that would be one thing. Unfortunately, he has been more right than wrong.

This comes to us from Market Insider:

The economics professor at NYU Stern, whose nickname is "Dr. Doom," shared his grim outlook during a recent eToro webinar. He argued the Federal Reserve might have to double interest rates to 5% in order to curb inflation, but hiking to that level could choke economic growth and cause a spike in joblessness.

Moreover, raising rates could spark a debt crisis, Roubini said. American consumers, companies, and other entities have borrowed aggressively over the past decade, and could struggle to repay their loans if interest costs jump, he explained.

The upshot is the rate hikes needed to rein in inflation could tank the economy, and cause crashes across stocks, bonds, housing, credit, private equity, and other assets in bubble territory, 

Roubini said. If that fallout spurs the central bank to give up on fighting inflation, price increases could spiral out of control as well, he continued.

Stubborn inflation — fueled by Russia's invasion of Ukraine disrupting global food and fuel supplies, and the COVID-19 pandemic continuing to prompt lockdowns and restrict international trade — might force the Fed to drive the US economy into an even deeper recession than the one it avoided, he added.

"I worry about a stagflationary debt crisis, because you have the worst of the '70s in terms of supply shocks, and you have the worst of the global financial crisis because of too much debt, and that combination is dangerous," Roubini said.

"If you're behind the curve, eventually the recession is going to be more severe, the loss of jobs and income and wages is going to be more severe," he noted, referring to the Fed's rate hikes relative to inflation. "You need to be ahead of the curve."

The economist, who was one of the few experts to foresee the collapse of the US housing bubble in the late 2000s, also dismissed the recent rebound in stocks as most likely a bear-market rally. He cautioned that if the US economy suffers a "hard landing" due to the Fed's rate hikes, stocks could tumble by another 35%, based on how they've traded in past recessions.

Finally, Roubini warned that both stocks and long-term bonds would likely slump in value if inflation remains a problem. He suggested investors hedge their portfolios with alternative assets such as short-term and inflation-indexed bonds, gold and other commodities, real estate, infrastructure, and even bitcoin.

Finally, economic historian Niall Ferguson has joined the chorus of pessimists. This comes to us from CNBC:

Top historian Niall Ferguson warned Friday that the world is sleepwalking into an era of political and economic upheaval akin to the 1970s — only worse.

Speaking to CNBC at the Ambrosetti Forum in Italy, Ferguson said the catalyst events had already occurred to spark a repeat of the 70s, a period characterized by financial shocks, political clashes and civil unrest. Yet this time, the severity of those shocks was likely to be greater and more sustained.

"Why shouldn't it be as bad as the 1970s?" he said. "I'm going to go out on a limb: Let's consider the possibility that the 2020s could actually be worse than the 1970s."

Among the reasons for that, he said, were currently lower productivity growth, higher debt levels and less favorable demographics now versus 50 years ago.

"At least in the 1970s you had detente between superpowers. I don't see much detente between Washington and Beijing right now. In fact, I see the opposite," he said, referring to recent clashes over Taiwan.

Of course, I am not trying to ruin your weekend, but still, if this many savvy and decidedly cranky old guys are pessimistic, you should certainly take heed.

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