By FS Staff
"We are in the very late innings" of this bull market, Ned Davis of Ned Davis Research told Financial Sense Newshour in a recent interview. Ned also offered his thoughts on risk management, why professional forecasters get it wrong in predicting downturns, his thoughts on a passive investing bubble, the problem of high debts, the likely path of interest rates, and much more.
"I see us in the latter innings. A lot of people look back and say, well, we are nowhere near where we were in 2000 or even 1929 - that the run-up in the final ends of those bull markets was spectacular. For example, after Allan Greenspan in 1996 famously said that the market might be at a level of irrational exuberance. After that the Nasdaq turned around and doubled in value in a very short period of time. So, people are taking comfort from the fact that…this is not as big a bubble as 1929 or 2000, but I think if you look at any other market top…I think you'd have to say we are in the very late innings."
On the US economy and leading economic indicators:
"We use very similar measures that we use to analyze the stock market to analyze the economy. Again, you want to try to get with the trend and you want to try to avoid the big mistakes, the big recessions. And, fortunately…they have indicators which tend to turn down and up before the overall economy; others that turn with the economy and some that lag the economy. So we put most of our emphasis on the leading indicators and we try to look at the trend of those and there are some factors that bother me right now - the consumer in particular - but most of the leading indicators are positive... So we still hold to a mildly bullish stance on the economy. It's not growing like it should be but it is growing and we continue to see that."
Professional forecasters, animal spirits, and the debt supercycle:
"The same factor that drives stock prices, which John Maynard Keynes called animal spirits, also drives the economy and I think the models that they have used historically, like unemployment or the inflation rate, were not really factors of measuring animal spirits so I think a lot of mistakes are because of that. Also, one of those animal spirits that I think that shows up that's important is the debt supercycle. This is very, very long-term trends in debt and debt was rising but from very low levels during the '40s, '50s, '60s, and then in the 1970s it had gotten so fast that it was beginning to put upward pressure on inflation; growth, however, was still really good but now you've got debt at a very high level and I think the Fed pays very little attention to that. It's confusing because rising debt can be a positive. It can be showing rising demand but when it gets to excessive levels, there's repayments, there's debt service, there's lower credit scores and also people just feel trapped by the debt so normally when debt gets very high the tendency is to try to want to reduce it and try to cut consumption somewhat and I think that really, again, we're talking animal spirits here - that is one of the things that a lot of economists and the Fed has missed. People blame a lot of other things - globalization, bad trade, trade deals, and this and that but I really think that, to me, tells me more about why we were running above trend for 30-40 years and why we've been running below trend for the last 20 years or so."
On a passive investing bubble:
"There's themes that run through the economy and the stock market at various times a lot of which are very good solid themes. The problem is…when it gets too popular and everybody wants to do it then you get a crowded trade and, if something goes wrong, then it becomes a bubble that bursts. So, when it comes to passive investing, the idea is you have a lot of active investors and they're all competing with each other, then on average they are going to have average performance. So, why pay extra fees when you can just buy the averages and get the same performance without the fees so it's really a solid idea. But it's just gotten more and more popular to where now it's just everybody wants to be a passive investor and the problem with passive investing is you buy all 500 stocks in the S&P 500 without regard to whether they're doing well, to whether they are low quality, high quality, whether they have good values or poor values and you can push the stocks that have poor values up to higher and higher heights and really make for an unstable situation. So there's nothing wrong in my opinion with passive investing, it's just that it's gotten overly popular and I think that's where we are today. The flows have been phenomenal and yet, lately, the passive investing type vehicles have not done as well as the active and the stocks in the S&P 500 are not going up and down together; they're not correlating well and that's telling me that there are some strains with passive investing."
The problem with high debts:
"It's sort of a catch-22. The Fed wants the economy to grow rapidly, certainly the Trump administration would like to see growth at 3-4%; however, if that were to happen, then interest rates would probably rise and maybe substantially and that interest rate cost on top of that debt would put you right into slow growth. So having this much debt, it really is a very long workout. We've seen this in Japan when their debt got very high in the 1989 peak and they haven't been able to grow out of it yet. Another way we did it was during the Great Depression when people just defaulted and the debt went bad and you wiped it out that way; and then there's been other cases where we tried somewhat in the 2008-2009 period where debts were restructured and rewritten at lower interest rates or some was forgiven but, anyway, it's a difficult situation so I think that people are talking about growth being lower for longer is probably a good bet."
On interest rates and currency wars:
"We looked at interest rates in the US and we tried to come up with a model to show what drives those rates so we could have some sort of idea where interest rates were going and where fair value was and the number one factor that we found that correlated to rates was core inflation in the US. The second largest factor we found that determines our interest rates were German bond yields, which was very interesting. So, yes, [macro-economics]…is a big factor in that people can shift money from German bonds to US bonds or back and forth in a global marketplace, that's something we have to think about and this is true with trade flows as well. There are very heavy trade flows and we found in the past that sometimes countries will try to take advantage of that by lowering their currencies or raising their currencies and that can create quite a bit of havoc as well so I think currency wars are something that we have to watch for as well as risk managers."
On managing risk in today's environment:
"One of the things that we have suggested because we see somewhat better valuations overseas - this was certainly true at the beginning of the year - we suggested maybe somewhat less weighting on the US and somewhat more in other countries with better valuations. Another thing you can do is take some of the risk out of your portfolio by buying more value stocks with strong dividend yields. I think cash is a good alternative. I know they say that cash is trash but if you have a bear market it can give you the opportunity to buy stocks at very cheap levels. Finally, in my own dealings, I'm buying put options on the stock market right now where it's like an insurance premium that you can buy to protect yourself on the downside and [the cost of] these are at some of the lowest levels that they've been in in many years - the past 10 years so."
On the danger of investing based on political beliefs:
"One book I wrote is called Being Right or Making Money and…I remember when Barack Obama was elected people said this should be a disaster for the United States because he's going to take us to socialism and ruin the capitalistic system and, therefore, they told me they are selling all their stocks and getting out of the market and that's the way they thought the world worked and that's the way it should be. Well, I know some other people that are of the left-wing persuasion and the day that Donald Trump was elected they said, in my gut I just know this is a disaster for the country and I want to short the market. People make their own reality. This is the way they see the world. It doesn't mean they're wrong; it's just not a good way to invest in the market. If you go back and look at various times, we've had horrendous bear markets under Democrats and we've had them under Republicans. Politics is just not a good way to approach the market and there are a lot of other things that people do where they look at the world and try to figure it out very rationally and then say that's the way it should be and, it turns out, that's not the way it is. So, we said in Being Right or Making Money, yes, everybody wants to be right, everybody wants to figure it out but what we're going to do is try to stay in harmony with what is the reality at the time either bull market or bear market."