Everyone likes to say that the hardest part about being in a bubble is knowing you are in a bubble. I don’t find that hard at all. For me, the hardest part about being in a bubble is stopping myself from betting on that bubble bursting.
There is no doubt in my mind that today’s financial markets are priced at levels that make generating decent long run returns difficult.
The bulls will tell you that corporate profit growth is sustainable – I am not so confident.
To me, it seems like a bad bet to count on this trend expanding. Especially when you examine corporate profits as a percentage of GDP:
Corporate profits as a percentage of GDP have never been higher. To bet on this expanding even further seems foolish.
But what about GDP growth? Maybe we are set to explode higher and corporate profits as a percentage of GDP will just have to stay constant to generate positive growth.
Let’s have a look at US GDP estimates for 2014:
US GDP Estimate for 2014</a> </div>
The world GDP estimate for 2014 is an even uglier looking chart:
World GDP Estimate for 2014</a> </div>
GDP is consistently and continually disappointing. The stock market better not be counting on a robust world economy to create economic growth.
But yet stocks just keep chugging higher.
S&P 500 chart</a> </div>
What the heck is going on? I have thought long and hard about this.
I have always been worried about the massive monetary fuel that the Fed (and other Central Banks) have poured on the economy since the 2008 credit crisis. Mistakenly I assumed that the Fed would not be able to control what ignited. My theory that things we needed like fuel, food and other basic consumption items would rise while things the Fed wanted to go up, like stocks, bonds and other financial assets would sag. This theory is increasingly looking plain wrong.
The Fed’s monetary madness has not spread to anything except financial assets. I am not sure about the long term wisdom of blowing this financial asset bubble, but that is beside the point for traders like me. My theory was wrong. The bubble is being blown in financial assets without any of the negative side effects of rising prices in other assets.
The reason why the inflation is being contained to stocks and other financial assets is that the Fed’s monetary stimulus is mainly being taken up by corporate America. The Fed has pushed all this money into the system, and for a long time it was refusing to go anywhere but sit on the banks’ balance sheet. Yes, some individuals were able to refinance their homes, but the loan growth from the consumer has been surprisingly tepid. America was suffering from a classic balance sheet recession and it seemed that no matter what the Fed pushed into the system, the economy refused to ignite.
But lately corporate America has figured out that money is basically being given away and that it is a no brainer to lever up their balance sheet. Therefore the Fed’s stimulus is not being used by the average American to buy a home, nor is it is being used by companies to expand their factories. No, the Fed’s stimulus is being used by corporate America to issue debt and buy back stock.
Bed Bath & Beyond recently had the good manners to announce both events in the same press release to make it nice and easy for us to understand.
BBBY REPORTS $1.1B ACCELERATED BUYBACK
BBBY REPORTS CLOSING OF $1.5B SR UNSECURED NOTE
This sort of levering up of the corporate balance sheet is where the Fed’s monetary stimulus is being taken up. This is why the inflation is not spreading to the rest of the economy – it is not being taken up by the general public, nor is it being taken up by companies who are spending it on factories or other capital expansion. The monetary stimulus is being taken up and spent on Wall Street.
I have been foolishly fighting this rise, and it has chewed up way too much of my thoughts, capital and profits. Although I know that from a trading perspective we are way overbought and due for a pull back, I am still going to flatten my short positions.
We are in a bubble, and although I know this will end badly, I always underestimate how long these bubbles can continue. The Fed has poured a ton of fuel into this economy, and if corporate America has figured out that they can issue debt and buy back stock, then the inflation will continue to manifest itself in the form of higher stock prices.
Although I am covering my shorts, I would not buy stocks with my worst enemy’s money as I think that on the inevitable exit there will not be nearly enough seats for everyone. In fact the higher we go, the more sure I become that the correction will be much more than a simple pullback and the chances of a crash greatly increase.
Although the market is pushing to new highs, it is not nearly as orderly as in past rises. We are not getting the slow constant grinds higher. Rather we are getting manic swings up and down with emotional sell offs followed by gaps higher.
Also I still think that from a geopolitical point of view the market is greatly under appreciating the risks.
Therefore although I am covering my equity shorts, I am going to buy some VIX. I previously thought that the next accident would originate in the bond market, but as corporate America has increasingly levered up their balance sheet, I am becoming more sympathetic to the notion that equity vol is underpriced as well.