We thought we would list a few things for readers to think about when contemplating the US stock market.
1. The first is a brilliant research observation from Morgan Stanley’s Andrew Sheets, who writes from London:
“The result can materially boost the income a USD investor receives if they buy overseas assets and remove the currency exposure: the hedged carry on a 10-year German Bund for a US investor is ~3.5%, not that 0.5% yield one sees on the screen. The hedged carry on Swiss equities is 7.0%. Who says there’s no yield?”
2. Adam Johnson of Bullseye Brief ( www.Bullseyebrief.com ) phrased the investor’s dilemma well:
“Let markets plummet 3–4% overnight as CNN pundits react to NYT text alerts... Wait for strategists to downgrade S&P targets... Sit tight as oil approaches $70... Then buy five favorite names, the ones which have no business being down 8%, and/or write out of the money puts struck another 15% lower to capture vol blow outs. Three days later, markets have rebounded and our accounts are a little fatter. Got it?”
3. Lindsey, a brilliant Cumberland reader, sent this note:
“It seems that the scale for measuring periods of market calmness is at best one day now. In thermodynamics terms we are in a state of high entropy requiring a release of energy (i.e., volatility), and thus spontaneous reaction occurs to maintain equilibrium. Things start to unwind when enthalpy goes to a negative condition in which no level of chaos (entropy) can maintain equilibrium. How far things drop depends on the amount of energy needed to be extracted to arrive at a level in which equilibrium can be maintained. Have we arrived at the max free energy? If I could answer that I wouldn't be sitting here babbling away.”
4. Michael Cembalest enlisted a marvelous metaphor in his Annual Energy Paper from JP Morgan Asset Management:
“That’s why ‘Pascal’s Wager’ comes to mind. According to the French philosopher, if you believe in God and he does not exist, you experience a ‘finite loss’. But if you do not believe in God and he does exist, you experience ‘infinite loss’. Consider the following theories. Greenhouse gas emissions impact temperatures, which in turn impact sea level rise. And/or efforts to substantially decarbonize via wind and solar power will fall short of climate-related goals….”
Cembalest concludes:
“Maybe that’s right, and maybe it isn’t. However, the infinite loss case (you don’t believe the theories are true) is much worse than the finite loss case (theories are wrong but you prepare anyway). As a result, after looking at electric vehicles and other renewable energy topics this year, we also examine flood mitigation projects in coastal cities, which may be needed just in case. We conclude with thoughts on the intersection between food, energy, urbanization and proposed changes in the US Electoral College: maybe drafters of the US Constitution had more foresight than they’re being given credit for.”
(Kotok personal note: The 35-page Cembalest paper is a magnificent assemblage of thinking about energy-related investment issues.)
5. Ian Bremmer (@ianbremmer) offered a list to contemplate (hat tip to Dennis Gartman):
“[The] market return for the first 444 days in office: FDR: 70.4%, Reagan: 41.4%, Teddy Roosevelt: 37.4%, Obama: 32.5%,Clinton: 32.2%, George Bush Sr: 21.4%, Trump 20.7%. Sources Bloomberg/Axios.
Dennis notes:
“We shall not scoff at 20+% returns, for that would be illogical, but this is winning by beating only the negative returns that accrued to those investing in equities in Mr. Carter’s or Mr. Ford’s first years in office. If ‘winning’ is coming in 6th… well we’ve said enough, haven’t we?”
6. Credit Suisse offered that the US equity market is “53% of the global stock market” as of the end of 2016. They noted how the number of listed companies has been shrinking (7322 in 1996, down to 3671 at the end of 2016). Note that the number was 4796 in 1976. That’s right. And further, says Credit Suisse, “The Wilshire 5000 Total Market Index, established in the mid-1970s to capture 5000 or so stocks with readily available price data, now has only 3816 stocks.” The Credit Suisse research paper (The Incredible Shrinking Universe of Stocks, March 22) is packed with citations of serious research and data. Congratulations to Michael Mauboussin, Dan Callahan, and Darius Majd for this superb analysis.
Some closing takeaways.
If the number of stocks is a shrinking universe & if the nominal GDP of the US is rising (from $12 trillion in 1996 to $19 trillion in 2016 in constant 2016 dollar terms) & if the taxation of those companies has improved their outlook (via last year’s tax reform act) & if the number of passive holders of those stocks is rising (there were two ETFs in 1996 compared to 658 in 2016, and there was under $2 trillion in mutual funds in 1996 compared to almost $9 trillion in 2016) & if corporate profits as a % of GDP are now much higher & if, if, if… then we have an explanation for a strong upward trend in stock prices. It is a strategic trend.
Credit Suisse estimates that the “listing gap” between the US stock market and the rest of the world is about 5800 companies. They cite research that suggests the US “should have MORE THAN 9500 LISTINGS.” The paper also describes reasons why companies delist and why there is a shrinking “propensity to list.”
Cumberland’s position:
We remain nearly fully invested in our US ETF portfolios. We are sticking with our estimate that the S&P 500 index will cross 3000 around the decade’s end (in 2–3 years.) We like the Energy sector and we like the Financials (banks). We think that “machine learning” AKA “artificial intelligence” is a powerful force that will raise US productivity and accelerate America’s GDP growth without inflationary pressures, provided the inflation rate is properly measured and hedonically adjusted.
We must remind our readers (our clients already know these details) that all of this could change on very short notice, or it could persist for years. The present chaos of political governance makes for unpredictable outcomes. And the world is a dangerous place. That complexity and risk makes our daily work demanding and never boring.
In a speech in Cape Town in June 1966, Robert Kennedy said: “There is a Chinese curse which says 'May he live in interesting times.' Like it or not we live in interesting times. They are times of danger and uncertainty; but they are also more open to the creative energy of men than any other time in history.”
Quote Investigator offers some history regarding this quote about interesting times. See: https://quoteinvestigator.com/2015/12/18/live/. It may not have originally had a Chinese attribution. However, given the world today and US-China relations, we like the sourcing and the reference to Chinese philosophy, proper or not. In our view, Robert Kennedy was prescient.
David R. Kotok
Chairman and Chief Investment Officer
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