October 27, 2019

This is what you have to believe if you’re a stock market bull

Are you bullish about the stock market? Me too. But there's a limit to my bullishness. I'm cautious and I don't trust the market to continue moving higher unless some things break the right way. I have a list of these things.

1. The stock market is not overvalued

Possible. This one is open for debate, but the debate is fairly lopsided in favor of the overvalued side. One of the favorite arguments offered by the 'fairly valued' side is low interest rates. Another is Fed support. Both of these arguments deserve attention but history is on the side of overvaluation, and I like history. 

2. The next few years will be as good as the last few years in terms of stock market returns

Very unlikely. Market returns are mean reverting. There is ample evidence throughout history that says long periods of above average returns like we've had since the market bottom in March 2009 have been followed by below-average returns. This is mother nature's way of restoring the very long-term average market return to 9.5%.

If you disagree with this, please leave a comment below with supporting evidence.

3. The next recession is far in the distance

Possible. However, few would deny that the U.S. economy is in low gear right now. 2% GDP growth is barely enough to sustain an expansion, but that's what we have. If you think the economy is really growing faster than 2% please leave a comment below and provide supporting data. (Also, see belief #6 below.)

4. Corporate earnings will soon begin to recover and grow rapidly

Plausible. This is a good argument. Earnings are due for a recovery, but are they going to return to the fast pace of growth we've become accustomed to over the last 10 years? Only if there is a catalyst like another round of corporate tax cuts or a resurgence in economic growth. Without a catalyst, earnings will rebound but will not likely take off in a meaningful way. 

5. Government debt and budget deficits don’t matter anymore

Unlikely. This is a big one. If you believe that debt and deficits don't matter anymore, you must also believe that the government can continue to spend money and put those purchases on Uncle Sam's credit card without fear of having to settle up at some future date. 

But here's the uncomfortable truth. Paying Uncle Sam's credit card bill falls to the taxpayers, not Sam himself. Sam's unlimited credit line is based on his ability to impose ever-higher taxes on the working class. Instead of thinking about the unlimited ability to borrow, spend, and tax - think about your own ability to pay escalating taxes in a 'debts don't matter' world. I argue that debts do matter when I'm on the hook to pay them.  

6. The Fed will do whatever it takes to prevent another recession

Likely. This is another good argument by the bulls. As of today we are in the longest economic expansion in the history of the Republic. Does that mean the Fed has figured out how to eliminate recessions altogether? Has the business cycle finally been repealed? 

It would take a giant leap of faith to believe this. I'm going to assume that you don't. Therefore it's a matter of when the next recession will arrive, rather than if it will arrive.

7. The Fed will not allow the stock market to crash

Highly unlikely. If you believe this, you have to answer this question: How will the Fed stop the next market crash? What new tools do they have that they didn't have in 2008 or 2000 or 1987 or 1973? If you're being honest, the answer is the Fed's money-printing ability. Unlimited stimulus, zero interest rates, and bailouts for big banks that get into trouble.

The Fed could postpone the next crash. But I think you're kidding yourself if you believe the Fed can eliminate all future crashes.

8. Interest rates and inflation will remain low for years to come

Possible. The Fed sets a target for short-term rates, but they have little control over long-term rates. The Fed tries to manage the inflation rate but it doesn't control it directly. Therefore the trend of interest rates and inflation are determined by supply and demand for credit  in the economy. 

In order for interest rates and inflation to remain low, economic growth must also remain low.  If the economy slows from here, there is a risk of recession and or deflation. If the economy pick up up speed from here, the Fed may need to raise rates to combat possible inflation. 

In either scenario, the stock market is likely to perform below its long-term trend. 

9. The unemployment rate will continue to decline or at least not rise

Unlikely. With unemployment nearing a 50-year low, something has to give. Either the labor force must expand (unlikely, due to retiring Boomers and closed borders) or companies will have to pay more to attract new workers (inflationary).

10. The U.S. will win the global trade wars

Possible but irrelevant. The global balance of trade has already shifted to accommodate the new tariff policies that have been put in place. If the U.S were to announce tomorrow that it got what it wanted, the newly established trade relationships would still remain in place. (Fool me twice.)

11. The global economy, especially China, will soon pull out of its slump

Plausible. The question is how soon? Given enough time, the global economy will pick up again, but we may need to go through a global recession before we return to robust global economic growth.

12. U.S. consumers will find ways to ratchet up their spending

Probable. They always do. Unless they lose their jobs or worry that they might lose their jobs. The American consumer is not stupid. She knows when things in the economy and the job market are heading south, and she pulls back in response.

Today's typical consumer is carrying a large debt burden, but low interest rates help to ease the financial strain. (See #5 above.) When rates begin to increase, consumers will do what they have always done - cut back on spending.

13. Corporations will soon begin to ramp up capital expenditures

Possible. However, corporations had a golden opportunity to do this in 2017 when the Trump administration pushed through a sizable cut in the corporate tax rate. A spending spree by corporations did not materialize. Corporations used the tax cuts to buy back shares instead. what's their incentive to expand today?

14. The U.S. Congress will come together to pass a massive infrastructure spending bill

Unlikely. There is no indication that Congress can agree on anything, let alone a massive spending bill. As they bicker and dither, our roads, bridges, tunnels, power grid, and airports will continue to deteriorate.

15. U.S. multi-national corporations will finally begin to bring high-paying factory jobs back home

Highly unlikely. They had their best chance when Congress passed the big corporate tax cuts in 2017, and unfortunately they blew it. Congress would have to cut the corporate tax rate to near zero and pay for the relocation expenses for corporations before there will be any serious movement on this front.

16. The U.S. economy will remain the largest in the world

Plausible. But China is growing faster than the U.S. How long before they overtake us?

17. Nuclear powers like Russia, China, North Korea, and Pakistan will never use their weapons against us

Terrifying but irrelevant. Just having the capability of launching a nuclear attack is enough to level the geopolitical playing field. This means that the U.S. can no longer cajole, bully, and threaten other countries into doing our economic bidding. 

18. We will never allow Iran to develop nuclear weapons capabilities like North Korea has done

That ship has sailed. Iran is now aggressively pursuing their nuclear weapons program without interference from the global community. If you think Kim is a dangerous man, wait until you see a nuclear armed Ayatollah Khomeini.

19. China will never sell the $1.1 trillion of our treasury bonds they own

Probable. If China decided to dump our treasury bonds on the market, prices would go through the floor. That would hurt them financially. But it would also kill our economy by spiking our interest rates.

The question is this - does Xi care more about capitalism, money, and profits - or the Communist philosophy? Would he be willing to send the U.S. economy into a tailspin just because he can? Think about it.

20. Japan will never sell their $1.2 trillion of our bonds, no matter how much they need the money

Likely. Unless China makes the first move to unload their treasury holdings, in which case Japan isn't likely to sit back and watch the value of their holdings go down the tubes. More likely they would join in the selling and really crush our economy.

About the author 

Erik Conley

Former head of equity trading, Northern Trust Bank, Chicago. Teacher, trainer, mentor, market historian, and perpetual student of all things related to the stock market and excellence in investing.

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