I was saying before the U.S. election that no matter who won that I felt sorry for him or for her. It turned out to be him.
I feel sorry for Donald Trump because, just like George W. Bush in 2000, he is coming into the office at the peak of a massive price bubble in the equity market. Whether you look at valuations in terms of price-to-earnings, price-to-sales, price-to-book, the smoothed CAPE or the Buffett indicator, the S&P 500 is simply off the charts.
Call it a 2 standard-deviation event and the top 5% of excess valuations in recorded history. The Equity Risk Premium being close to zero means that stock market investors are overtly throwing caution to the wind, willingly (blindly?) taking on equity risk and not getting compensated for it.
Everybody is “all in” with hedge fund net bullish positioning at record highs, portfolio manager cash ratios at unprecedented lows of less than 2%, and fully 70% of the household asset mix concentrated in equities – versus just 9% for bonds. Nobody has bothered in this “don’t fight the tape” bull market to take profit or rebalance the portfolio, preferring instead to treat ‘diversification’ as a dirty 15-letter word. Sentiment is wildly bullish as well, to the point of surreal complacency.
In addition to the illegal immigration boom, the AI craze, and rampant government fiscal stimulus, the equity wealth effect on spending via the ever-compressed personal savings rate has been a major driver of the growth we have seen in the real economy these past few years.
But as economist Herb Stein famously posited, “If something cannot go on forever, it will stop.”
At some point, this bubble will burst, and this is the greatest tail risk there is for the economic outlook – more so than geopolitics, in fact – and the social ramifications will be pernicious considering that at no price bubble peak in the past have so many households, including the aging and aged boomers, been as exposed to equity risk as they are today.
What the pundits don’t tell you is that there have been as many bear markets in the past as there have been bull markets, that bull markets are escalators going up while bear markets are elevators going down, and at the bubble peaks nobody is thinking about how fear is a far more primal emotion than greed.
But this is what we are going to be experiencing at some point in this new Trump tenure — and not even the President elect, as powerful as he is, will be a match for Mother Nature and the eventuality of a bear market. Markets do move in cycles, and asymptotic bull markets may go further than anyone thinks (we are living through this in real time), but they never correct the extreme price condition by moving sideways.
What the catalyst pricking the bubble will be is anyone’s guess. When it happens, all the pundits begin to apply the narrative to the price action, without realizing that often there is not one catalyst — it can often just be pure exhaustion. As Merrill Lynch Wall Street legend Bob Farrell used to put it, it is the market that makes the news; the news does not make the market.
I firmly believe that we are in one of the most pronounced price bubbles of all time. And because once bubbles burst, and the flight to safety becomes so acute that it triggers an average 300 basis point plunge in the 10-year Treasury note yield, I cannot in good conscience back off from my bullish call on bonds. Every tick higher this S&P 500 bubble goes, the more bullish I get on the Treasury market.
Why? Because I adhere to the wisdom of Warren Buffett, who famously said that “the one thing we learn from history is that nobody learns from history.”
Well, nobody can accuse me of suffering from that condition.
To repeat, the greatest single tail risk ahead is not inflation, it is not a global trade war, it is not geopolitical risks; it is what happens when this equity price bubble bursts in spectacular fashion, and the economic and social upheaval that it ends up creating.
This only ends in tears for those who pull a Chuck Prince circa July 2007 and keep dancing to the music until it stops.
David Rosenberg is founder of Rosenberg Research.
More from David Rosenberg:
Chill, bond investors. There’s no reason to hyperventilate over the inflation threat posed by Trump
Investors are partying like it’s 2016-2018 again under Trump. That’s a mistake
A Donald Trump win means big trouble for the Canadian dollar
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