I came across an interesting data set for stock-market performance for incoming presidents of the United States. In their initial month, the results might be described as underwhelming.
Upon the November election of Donald Trump, investor hope reigned supreme on everything from corporate-tax reduction to Dodd-Frank regulatory restructuring to monumental spending on infrastructure enhancement. Six weeks later? Many may be troubled by the haziness surrounding the specifics.
Take the “unaffordable” Affordable Care Act (ACA). A large percentage of citizens and small businesses want the ACA to disappear, but many of those same folks and businesses do not want it to be repealed without a suitable replacement. It follows that we really do not know what the next health care package will look like. Will the investing public blindly decide that anything is better than what currently exists? Or will optimism for small business wither under a watered-down replacement?
If the latter occurs, the run up in small cap stocks via iShares Russell 2000 (NYSE:IWM) may bear the brunt of risk repricing. The exchange-traded tracker is already testing its 50-day moving average.
And it’s not just repeal-n-replace the ACA that may create angst for U.S. stocks. For example, if you listen to CEOs on recent conference calls regarding earnings guidance, few things get mentioned as often as tax rate reductions. Will tax policy change occur in some form, way or shape? Certainly. Yet the potential for over-promising and under-delivering is enormous.
Equally worthy of note, favorable fiscal policy shifts may not be able to “trump” the dizzying number of negatives that continue to haunt. For instance, how long will investors disregard insolvent European banks, the rapidly fading Chinese yuan, the potential peril of higher borrowing costs alongside Fed rate hikes, a dollar that has appreciated 25% against global currencies and/or exorbitant asset valuations? On the latter point alone, stock prices land in the first, second or third most extreme valuation levels across one dozen or more traditional measures.
Keep in mind, investing optimists who believe that we are on the cusp of another “Reaganesque” revolution may not be accounting for the differences in 1982 stock valuations and 2017 stock valuations. For instance, in the chart above, median S&P 500 EV/Sales in 1982 hovered around bargain basement levels of 0.5. They are off the proverbial chart at 2.7 today. And the comparison between 1982 and 2017 does not appear any more favorable when one checks out equity capitalization to gross national product (GNP).
Yes, I am well aware of the differences between the exceptionally high interest rates in the early 80s versus the exceptionally low rates today. Yet therein lies the rub that the “low-rates-are-everything” crowd tend to miss entirely. Rates dropped 50% in the heart of the 80s, providing monetary stimulus at the same time as Reagan’s fiscal stimulus measures. Right now? The Fed’s plan is to continue tightening. And that is coming after a rate spike of 50% that occurred in the 2nd half of 2016.
There’s more. EPFR fund flow data has been depicting less enthusiasm than one might glean from Dow 20,000 cheerleading. Specifically, bond flows logged their 4th consecutive week of inflows ($4.5 billion) while U.S. stocks experienced outflows in four out of the last five weeks. Perhaps not surprisingly, the S&P 500 has actually churned sideways since breaching 2270 in the 2nd week of December.
Granted, the technical uptrend for domestic equities may simply be taking a breather. On the flip side? When I review the list of conditions that often correspond with market tops – economic cycle deterioration, asset valuation extremes, monetary policy tightening, inflationary pressures, financial instability, political unpredictability – I appreciate my higher-than-usual allocation (25%) to cash.