By: Steve Smith
Before we get started, let me differentiate between investing and trading. I’m going to speak in very broad strokes for the purposes of this article, so if you want to nitpick you can. But, it still won’t change the point I am making which is what you should be focused on.
Investing, as I am defining it, is buying a stock (or another asset) with the purpose of holding it for an extended period of time.
Trading is buying a stock (or another asset) with the intention of selling for a profit in the short or mid-term.
For me, I can’t imagine investing in stocks right now. It is, in my opinion, likely going to end badly for buy and hold investors who are buying right now. The time to buy will arrive, but I don’t think that time is now.
On the other hand, this volatility is a trader’s dream. More on that in a moment, but first…
Let’s start with the Buffet Indicator. It gets its name from the legendary investor, Warren Buffet.
We find the Buffet Indicator by creating a ratio between the total market cap of all US stocks and the US GDP.
That means as stocks get more valuable, the GDP has to increase in order to keep the market ratio intact. If the market goes down and the GDP stays the same, investing in stocks look more attractive.
However if the market cap goes up and the GDP doesn’t, stocks look less attractive…
And if stocks go up and GDP goes down, stocks can REALLY start looking bad.
That is exactly what is happening right now. The market cap for the entire market is moving up and the GDP is slowing because of COVID, the riots, et al.
Here’s a chart:
You can see that we haven’t been this overvalued – based on the Buffet Indicator – since just before the Tech Wreck. I remember those days, it wasn’t pretty! A lot of people lost everything.
If there were no other reasons to be skeptical of buying and holding right now, this might be enough. However, there are other reasons I am so absolute on this point in this market environment, especially for the retail investor.
First, look at this chart:
This is the size of the Fed’s balance sheet. You can see in 2008 before the crash it was about $800 billion. The Fed was never really able (or they never took the opportunity depending on your point of view) to shrink its balance sheet back to that point after the Great Recession.
In September of last year, it was about $3.7 trillion.
When the Fed started entering the repo market late in 2019, the balance sheet started to rise again and suddenly in March of this year, it went to the moon.
Well maybe not to the moon yet, because Bill Dudley wrote in Bloomberg a few weeks ago that he expects the Fed’s balance sheet to go to $10 Trillion!
Bill served on the Federal Reserve Bank of New York from 2009 to 2018, and as vice chairman of the Federal Open Market Committee. Before that, he was chief U.S. economist at Goldman Sachs. Today, he is a senior research scholar at Princeton University’s Center for Economic Policy Studies.
That means that between 1913 and 2008 the Fed expanded its balance sheet to about $870 billion. Then between 2008 and 2020 (if Dudley’s article is right), we will have added an additional $9.1 trillion, for a total of $10 trillion!
For context, if someone spent $1 every second – it would take them 31,797 years to spend a trillion dollars.
The subtitle of the piece that Dudley wrote for Bloomberg is, “The enormous figure deserves attention, but for now the risks seem manageable.”
The words “seem” and “for now” concern me a little bit.
In my experience and opinion, money printing tends to make the markets respond like a leveraged investing account. Investors use margin because it allows them to control more assets with less money. That exaggerates gains for them when the market goes up, but it also exaggerates losses when the market goes down.
Money printing seems to do the same thing in the markets. They overreact to good financial data or news and overreact to bad financial data or news…
And at some point, we run the risk that all margin investors run…going bust. Don’t get me wrong, I’m one of those Perma bears who are wringing their hands about the Fed. I don’t know if we will go bust and if we do I don’t know when. I’m simply saying that it is something to keep in mind.
The volatility that this money printing seems to be creating is a dream for traders and a nightmare for investors.
When you help all of the social instability in the country onto the volatility the liquidity is causing… taking a long term approach is dangerous – in my opinion anyway.
Think about this, what is going to happen to commercial real estate now that people realize they can work from home. I’m sure lots of people like it. They certainly like that they don’t need to be scared of going out and getting sick, and lots of them will enjoy the freedom to move anywhere and still keep their job.
And businesses are realizing that keeping that expensive office space is an unnecessary expense in a troubled economy.
So what happens to commercial real estate? I don’t know, I’m not a commercial real estate expert – but it’s an important question to answer if you are buying and holding. A commercial crash could wreak even more havoc than the residential crash in 2007/8.
And what is going to happen to the travel industry? Entertainment? Are small businesses going to bounce back? Several aren’t right now.
Yes, the market is disconnected from the underlying economy, but someone has to make a profit at some point otherwise the entire thing will come down. And if entire industries are destroyed and millions of jobs at small businesses eliminated – it can have an effect.
For me, that makes me want to stay out of long term positions right now.
Don’t take this as some Doom and Gloom article. It’s not the end of the world…
But it is time to be smart about the markets.
Short to medium term trading with “safe” leverage (meaning a pre-defined downside and unlimited upside). You can do that with something I call the Main Street Derivative.
I wrote a report about it. It is, in my opinion, the best way to get in on the gains of this market without taking on the risk of buying and holding right now.
To Your Success