Risk assets have very little support – stocks are risk assets.
President Trump’s trade policy is high risk and has an unknown ending.
While valuations have come in, earnings are clearly peaking, making the CAPE ratio relevant.
Indexers and closet indexers will get hit badly in a correction or outright bear market.
Use market strength to lighten up allocations to stocks and raise cash levels.
The time has finally come to be a net seller of stocks. This does not mean that stocks cannot continue to go up a while. As I said nearly a year ago in a conversation with Mark Yusko, there is a lot of reason to believe we see 3000 on the S&P 500.
That said, a lot has changed in a year. A prudent investor is taking profits now and reducing exposure to risk assets that could be in for stormy (Daniels?) weather.
Trump Tariffs and the Unknown
As I have been warning in my webinars, the stock market is in uncharted territory. President Trump’s aggressive, and often conflicting, policies and rhetoric have made the markets jittery once again – https://youtu.be/2N7EQJT3GPE.
I won’t rehash the dangers of the trade tariffs. If you don’t believe me or most other economists by now, then you aren’t going to. The simply fact is this, tariffs reduce trade, a reduction in trade reduces global GDP, shrinking global GDP is bad.
Here are a couple articles:
Welcome To President Trump’s Economy And Markets
Here’s What Gary Cohn Sees: Tariffs = Inflation + Slow Growth = Stagflation
Iran, Tariffs, Inflation Vs. Deflation And The Fed
While I know those who can’t do math have a hard time grasping the dangers of tariffs, I have a couple simple illustrations I think can help, given we know that about 2% of global GDP is threatened by the newly enacted and proposed tariffs:
That illustrated, I’ve also said that I “Expect Positive Surprises On President Trump’s Trade Policies.” Here’s the problem, I’m not so sure anymore. The rhetoric combined with an emerging history of poor policy, wreaking of early 2000s, scares me – and I don’t scare easily.
Valuations Are High, Especially Cyclically Adjusted
Valuations are stretched across many sectors – though not as pronounced as in January before earnings jumped on tax cuts.
The CAPE ratio has become more relevant as we know earnings are unlikely to remain this high with inflation and interest rates rising.
And here is Warren Buffett’s favorite:
The Marginal Buyer Is Drying Up
There are also shrinking pools of money and buyers for risk assets. A recent Citigroup note pointed out the following: “the wall of money driving markets has stopped.”
What does this mean? Simply put, the marginal buyer, largely facilitated by easy money from central banks and excess liquidity in China the past several years, is going away. Central banks are at least cutting QE, and in the U.S. tightening, and China has been working for two years to reduce credit stress.
Here is an illustration from Citi’s credit strategist Matt King’s note:
We may or may not be in for a trade war and related recession or stagflation. We might or might not be completely overvalued. However, the markets are overvalued, buyers are drying up and there is a lot of unknowns with trade and the global economy.
While I am always bullish long-term, I think now is a time to lighten up on equities and high-yield debt. I am a seller of the broad S&P 500 (NYSEARCA:SPY) (NYSEARCA:VOO) at this point. Reduce individual stock holdings to 1-2% positions, excluding oil stocks, which we remain overweight (long and adding to (XOP) on pullbacks with total oil stock allocations up to 25%). See the asset allocation updates on our spreadsheets.
Disclosure: I am/we are long XOP.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I own a Registered Investment Advisor – bluemoundassetmanagement.com – however, publish separately from that entity for self-directed investors. Any information, opinions, research or thoughts presented are not specific advice as I do not have full knowledge of your circumstances. All investors ought to take special care to consider risk, as all investments carry the potential for loss. Consulting an investment advisor might be in your best interest before proceeding on any trade or investment.