4 Reasons Not to Assume the Worst Is Over

Financial Times pundit John Authers presented a logical case for investors to be very careful assuming the worst is over for the markets. Here are four reasons to tread carefully into a long term bullish stance:

First, someone will have to pay for the stimulus that has been administered. That means inflation, higher interest rates or higher taxes. None would be good for stocks.

Second, companies still have to raise a lot of capital. That will dilute the stock market.

Third, measures of value that have worked as market timing indicators - such as cyclically adjusted price/earnings ratios - show stocks did not get anything like as cheap at the bottom in March as they did at the bottom of the bear markets of the twentieth century.

Fourth, there are demographic issues. The developed world is ageing. This will put a greater drag on public expenditures and lead to sales of stocks as the baby-boom generation retires and cashes in what is left of its savings.

According to Auther, these are overwhelming arguments that the secular bear market is not over.

What will derail the present rally? I agree with Auther that once bond yields go over a certain level - say, 6% or so, they may become a better investment than common stock. It is my belief that the enormous debt accumulated (and growing) by the United States alone may well make the Carter years of double digit interest and the yields of 1976-80 look meek in comparison.

In fact, it might be appropriate to bring back one item from the Reagan era - the "Misery Index". This was the addition of unemployment plus inflation plus interest rates. Some just used unemployment plus inflation. Either way, if your bet is that the Obama train will derail, as did Carter's, approximately three years into his presidency, buying iShares Treasury Inflation Protected Securities (TIP), short term bonds and commodities make sense.

Climate Change (the new "global warming" mantra) may have to take a back seat to just making ends meet within the family budget if the Misery Index becomes pronounced. Legal tax avoidance to sidestep higher taxes, including a wealth tax in addition to an income tax, will likely become Rule #1 for financial planning.

Hopefully, the gloom and doom above will somehow be avoided, and all will be the right with the world. Seasoned investors know that precious few assumptions turn out as expected. Thus, consideration of both positive, neutral and negative investment scenarios is prudent.

Comments

[capitalisth...:]

I agree double digit inflation is on the way. Buying a house is great hedge against inflation. I know this sounds counter intuitive as house prices continue to decline. But it is a reasonable idea when you considered you can get a 30 year fixed at 5% and inflation will soon be 15%-20%.
Read capitalisthero.com/Hed... where I crunch the numbers.

May 12 05:55 AM

[sether:]

Stanford Educated Economist. Gentleman physician. Amateur Webmaster. World class narcissist and chest-waxer. I bet your big empty house in Vegas is full of mirrors.


On May 12 05:55 AM capitalisthero.com wrote:

> I agree double digit inflation is on the way. Buying a house is great
> hedge against inflation. I know this sounds counter intuitive as
> house prices continue to decline. But it is a reasonable idea when
> you considered you can get a 30 year fixed at 5% and inflation will
> soon be 15%-20%.
> Read capitalisthero.com/Hed... where I crunch
> the numbers.

May 12 07:25 AM

[capitalisth...:]

Yep, mirrors and stripper poles.


On May 12 07:25 AM sether wrote:

> Stanford Educated Economist. Gentleman physician. Amateur Webmaster.
> World class narcissist and chest-waxer. I bet your big empty house
> in Vegas is full of mirrors.

May 12 07:51 AM

[reluctantQuant:]

Adding the interest rates doesn't seem to work that well. It suggests that we were less miserable in this past january than we were in June of 2005. (9.5 vs. 14.1) Nah. In fact, it says that Jan 14, 2009 was the happiest period since April 2004. nah.

For a good misery index, we have to stick with the data that Fed Guv's are TRYING to control, as opposed to those they DO control (albeit temporarily).

Interestingly, on the "formal" misery index (cpi yoy + usurtot), we're very close to the 20 year average (8.50 vs avg 8.47). So as an exercise, go find some miserable guy and see if he feels average today.

--rq

May 12 10:25 AM

[User 337732:]

i would agree with your logic if i could find an institution willing to give me 30 year credit at 5% fixed. If you're offering to lend on those terms sign me up.




On May 12 05:55 AM capitalisthero.com wrote:

> I agree double digit inflation is on the way. Buying a house is
> great hedge against inflation. I know this sounds counter intuitive
> as house prices continue to decline. But it is a reasonable idea
> when you considered you can get a 30 year fixed at 5% and inflation
> will soon be 15%-20%.
> Read capitalisthero.com/Hed... where I crunch
> the numbers.

May 12 10:27 AM

[Larry House:]

All true. Also, we don't know if hyperinflation can be avoided. The road ahead is indeed tricky.

May 12 11:07 AM

[buyitcheap:]

Yeah, stagflation 70's style seems to be consensus. That means high interest rates, no growth - investments hard assets, GLD, short bonds TBT, short equities, long TIPs

May 12 10:29 PM

[CJJ:]

Inflation would raise stock prices and would inflate away debts. It would also lead to high interest rates which as long as it is not runaway inflation would let Savers maintain fairly static amounts of wealth.
The idea that buying a house or hard assets is exactly the same argument of why stock prices would rise. Basically the price of everything would rise.

This whole stagflation would actually be growth returning to sustainable levels. People who say the growth was never sustainable at least need to stop painting the growth rate returning to sustainable levels(which to get there has to first fall) as a negative.

You can't both be doom and gloom on the current state of the economy and then suggest solutions and also cause your solution doom and gloom. If that's the case you and your solution are stupid.

May 12 11:08 PM

[Moon Kil Woong:]

CJJ. Inflation only helps your debt issue if you aren't adding to your debt. Otherwise, it just makes the interest rate on your new debt higher and makes it a lot harder to raise capital to pay for it. The US is not on a long term track to put it's house in fiscal order and the trade deficit still looks terrible. So inflating won't help the US yet.

As for the article. The author points to 4 good issues. Although the stimulus incites the most angst it it is the least problematic. Compared to the massive debts the US has been shouldering throughout the Bush Jr. period, a promise of short term stimulus with a commitment to prevent long term indemic deficits is a positive if it actually happens. Needless to say, the sticking point is persistent deficit spending.

An aging population is a long term problem the world is facing with adverse impacts to social programs that prey on working age people to cover government social commitments.

Corporations running to lock in low bond yields will exacerbate any trend towards higher inflation with higher yields. The Fed is already losing control of long term US Treasury rates which are rising. This is a big problem of which it's impact won't be fully appreciated until it is in full swing.

Regarding stock prices. They are not cheap for a few reasons, first falling profit. The second issue is becoming woorysome. With bond yields at artificially low rates and with their risk seeming to be unusually high, equities may not seem that bad of an investment in comparison. Furthermore, signs of inflation and rising bond rates make bond's even less attractive. Thus the attraction for equities may not be because they are particularly good but more because they are percieved as a better hedge against inflation than low yielding bonds.

Thus a resurgence of the stock market may just mean a fear of inflation more than a resumption of economic growth. Rising bond yields may be because of inflation utterly lacking a growth component. Corporations and banks rasing money may be a interest rate hedge more than due to any need to expand. And an aging population may mean we all will get to work a lot harder for less in the future.

However, the good news is: In all these cases we will, on average, probably live a lot longer.

May 13 12:02 AM