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US Stock Market Record Overvalued and Overdue for Bear Market

Crescat Capital 4Q17 Letter, January 27, 2018

“Believe me: We’re in a bubble right now. And the only thing that looks good is the stock market – but if you raise interest rates even a little bit, that’s going to come crashing down. We are in a big, fat, ugly bubble. And we better be awfully careful.” – Donald Trump, September 2016

  • Bull markets don’t last forever; they end in bear markets and recessions. Such is the natural ebb and flow of the economic cycle. We define a bear market as a 20% or more downturn in the broad, large cap market that coincides with an economic recession
  • The truth is that we are now in the most aged broad bull market in the history of the S&P 500 absent a recession
  • Just because the bear market has not started yet does not mean that the business cycle has been repealed. It simply means that the historic stock market and macro bubble that we are in today has only gotten bigger. It means that the looming cyclical market and economic downturn has also likely only gotten bigger as well
  • Tax cuts, deregulation, US-centric trade policies, and the potential for new infrastructure spending: while these all sound great on the surface and are fueling the mood behind the rise, undue ebullience over policies of a new Republican administration classically coincide with market tops
    • Hoover (1929), Eisenhower (1953), Nixon (1969), Reagan (1981), and Bush (2001)
  • With the equal-weighted S&P 500 index up 35% already since the Trump election and today’s record valuations, any potential benefits of the tax cuts are all already way-more-than priced in
  • Regarding corporate tax cuts, the new 21% corporate tax rate may sound low compared to 35%, but 21% was already the tax rate that the median S&P 500 company was paying on a cash flow basis
  • Stock market tends to top out on historically strong macro data at high valuation multiples, late in the business cycle after the Fed has been tightening credit conditions. It is at these times that asset bubbles tend to burst, i.e. when prices for overvalued assets fall, whether they be stocks, real estate, or credit, and then recessions tend to follow closely behind
    • Start of the recession and extent of the GDP decline tend to be discovered only after the fact, once past GDP has been revised down
  • Today’s global asset bubbles are arguably the biggest in history because global debt to GDP is the largest ever
  • We strongly believe that now is not the time to buy most stocks. They are over-crowded and record expensive. If one is too heavily long US stocks or long just about anything that has to do with China, one can sell now. And if one is an aggressive value investor, within the bounds of reasonable risk constraints, and wants to capitalize on the downturn, one should be selling short now

Image Source: BIS, IMF, BLS, Fed, Conference Board, Bloomberg, Crescat Capital

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