In contrast to the Bullish consensus, I remain bearish on the outlook for equities.
Recently, I expressed continued concern about speculative activity (which has run amok).
But there are more reasons to be a Bear.
The Large Stimulus Bill Holds Risks
In 2009, as we began to recover from the Great Decession, the government instituted what was then a meaningful package to stimulate economic growth. At the time, the gap between actual output and potential output in the U.S. was approximately $80 billion/month and rising. The stimulus instituted amounted to about $35 billion per month or a little less than the output shortfall. By contrast, in 2020, the CBO has estimated that the recently implemented stimulus package ($900 billion) will reduce the difference between actual output and potential output from $50 billion/month today to less than $20 billion/month by year end. The proposed $1.9 trillion stimulus package will result in approximately $150 billion/month (without any follow up) - or more than 3x the output shortfall!
In other words, the Obama stimulus package represented only half the output shortfall while the Biden stimulus package will represent 3x the output shortfall! Relative to the gap addressed the $1.9 trillion fiscal stimulus is 6x larger than the 2009 package!!!!
Another way of looking at this is thru the lens of incomes - how much of the lost family income is being impacted by the benefits. Currently incomes are running about $30 billion/month below pre Covid-19 levels (and is declining). 2021 payments, benefits and tax credits total an enormous $150 billion/month or 5x the lost incomes!
What is the impact of all this?
Larry Summers suggested (and I agree) in an early February Washington Post editorial:
"While there are enormous uncertainties... There is a chance that macroeconomic stimulus on a scale closer to World War II levels than normal recession levels will set off inflationary pressures of a kind we have not seen in a generation, with consequences for the value of the dollar and financial stability."
Though this massive injection of stimulus and the liquidity provided by the Federal Reserve has lifted the prices of financial assets to the sky.
This has generally been ignored by the Fed who still say there will be no inflation from the stimulus - perhaps out of fear that inflationary expectations will rise.
There Are Negative Ramifications of The Lack of Fiscal Discipline
For example, a decline in the US dollar and role as reserve currency may be at issue. If so, the ability to finance our burgeoning deficits may suffer. If so, the consequences are sizeable.
Covid-19 Still Poses Risks
The markets, until recently, embraced the notion that the vaccine program would squash the pandemic and, probably in the last half of 2021, will result in herd immunity. We all hope that we will swiftly move towards pre Covid norms. However, there is no guarantee to the efficacy of the vaccines and there is a continued risk of new variations of Covid. Unemployment may be slower to respond relative to bullish expectations - uncovering a continuation (pre Covid) or subpar economic growth.
Our Relationship With China Is Shaky
This, too, could upset global trade.
The U.S. is Fractured Socially and Politically
This has adverse policy (and tax) and economic ramifications. And so does unequal opportunity and treatment pose issues.
A Changing Domestic Economy Holds Secular Employment Risks and Issues
While the fiscal stimulus programs have plugged a hole in our economic problems they have not addressed reskilling and have not improved our nation's productive capacity. Many people and areas of our country will find formidable challenges in their displacement by technology. We have no intermediate or long term plan to address the issue of participating in a new economy. And we see the frustration on our streets in our politics.
Valuations Have Been Careening Higher
I don't have to repeat my valuation concerns here again. But I would point out that much of the climb in price earnings ratios is rationalized by low interest rates -- a condition that is changing (see point #1 above).
A 22x price earning multiple is now being accepted by many on the basis that the risk free rate of return is hospitable to valuations. But with rates climbing, the argument grows less compelling.
Let's look dive briefly into "equity risk premium."
Today's earnings yield (the inversion of the price earnings multiple of 22x) is about 4.5%. Against that the 10-year U.S. note is yielding 1.50%. The difference is the "equity risk premium" of 3.0% -- about the same it has been for the last several decades.
But if the risk-free 10-year U.S. note yield rises -- stocks grow more vulnerable with a lower risk premium. And this is what has been concerning investors of late.
Bottom Line
In the last few weeks the markets are beginning to make allowances for the above concerns.
I believe the markets are headed lower -- probably not in a straight line or as steep as the last few days, but in a saw tooth fashion lower.
My calculus suggests that "fair market value" (around 3100 for the S&P Index) remains considerably lower than S&P cash (about 3770).
I remain net short.
Most may consider larger than average cash reserves.
Think CITA ("cash is the alternative") not TINA ("there is no alternative").
(This commentary originally appeared on Real Money Pro on March 5. Click here to learn about this dynamic market information service for active traders and to receive Doug Kass's Daily Diary and columns from Paul Price, Bret Jensen and others.)
