Kass: My Bearish Market Outlook for the Next 12-18 Months

In my Monday column “One Bite, Everyone Knows the Rules!” I outlined my view that when (motley) fools rush in most buyers’ are destined to have an opposed end result.

Indeed, the market silliness is now deafening at the finish of a speculative cycle. 

I see a pivot in financial coverage and disappointing (relative to consensus) 2022 S&P EPS. There can be risk for a broad valuation reset decrease for shares in the months forward.

I additionally anticipate Peak Portnoy, Peak Reddit/WallStreetBets and Peak Silliness in Speculation in the close to time period. Few shares meet my standards for choice as we speak.

Remember, historical past at all times rhymes…

Now I wish to first look again after which look ahead (and increase upon Monday’s views) in mild of the calendar and the close to end result of the first six months of the yr, and the launch of my new hedge fund, Seabreeze Capital Partners LP later this month.

— Forbes Magazine cowl (1998) – h/t Peter Boockvar

The First Half of 2021 In Review

  • Stocks moved steadily increased all through the first 5 1/2 months of the yr.
  • A bull market in hypothesis and in (motley) fools additionally characterised the first half of 2021.

Most equities steadily rose increased throughout the first 5 1/2 months of the yr — importantly abetted by the extra liquidity and stimulation supplied by fiscal and financial insurance policies geared toward countering an unprecedented international pandemic.

Retail inflows into funds had been conspicuous and sturdy.

The affect on an unprecedented stage of hypothesis have been profound. As an instance:

Traders spent **$11.6 billion** on choices premium for AMC (AMC) final week — greater than on (SPY) , (QQQ) and Tesla (TSLA) COMBINED “These traditional relationships between volatility and stocks have been turned on their heads” — Wall Street Journal

That extra liquidity discovered itself in each well-known giant capitalization equities and the speculative gewgaws (SPACs, meme names  (GME) , (AMC) , and so on.). The latter class was aided by the closure of many companies (many dealer/buyers had been compelled to remain at house), the proliferation of commission-free buying and selling, the rising recognition of buying and selling boards (Reddit/WallStreetBets), and the availability of credit score/loans/margins to commerce speculatively.

Both SPACs and meme shares skilled recognition and markedly increased costs early in the yr. The rise in meme shares ended abruptly a number of months in the past and plenty of of the well-liked speculative points fell dramatically quickly thereafter.

In current weeks, meme shares have reclaimed their management place and recognition. Though meme shares have regained their recognition in May/June, SPACs and different gewgaws ( (CAN) , (MARA) , (PLUG) , (PTON) , (MSTR) , and so on.) stay firmly in the dumps.

Unprecedented liquidity additionally discovered its method into different asset lessons — significantly cryptocurrencies — an asset class that erupted in value in early 2021 solely to fall by practically 50% in current months. Though meme shares have rallied bigly, cryptocurrency costs have didn’t recuperate from that consolidation/schmeissing.

Looking Forward

Key bullish macroeconomic options of the subsequent 12-18 months are prone to be:

  1. An spectacular yr over yr achieve in 2021 S&P EPS.
  2. Elevated and above secular historic financial progress.

Key bearish macroeconomic options of the subsequent 12-18 months are prone to be:

  1. A probable pivot from extreme financial stimulation to much less stimulation.
  2. A continuation of indicators of rising inflation and inflationary expectations.
  3. A moderation in the charge of enlargement in international and home financial and revenue progress starting in the second half of 2021 and intensifying subsequent yr.
  4. The failure of our political system (each side of the pew) to beat a sickening and intensified stage of partisanship – this has coverage implications.

Key Issues

There shall be quite a few different elements that can affect inventory costs in the 1-2 years forward.

Some extra questions I ask myself embody:

* Will the absurd hypothesis (in meme shares), NFTs and different gewgaws cool off?

* Will the absurd leverage supplied to merchants and gamblers (and even with some giant hedge funds) in plenty of asset lessons end in comeuppance to these property and a major drag on the broader markets?

* Will the emergence of issues of safety and the additional enhance of the provide of recent digital currencies produce an additional crash in cryptocurrencies?

* Will a cryptocurrency crash feed into different markets and asset lessons?

* Will the robust help of retail buyers cool off or fade away if any of the above happen?

* Will retail merchants/buyers – as they did in the early 2000s (following the dot.com bubble) and in 2007 (at the starting of The Great Recession) – flee the markets?

* Will rates of interest lastly rise on a sustained foundation?

* Will inflation get uncontrolled?

* Will the increased prices of supplies, labor, transportation and laws adversely affect U.S. company income and revenue margins?

* Will excessive valuations develop ever increased or lastly readjust to historic and even decrease ranges?

* Will the pressures to boost company and particular person taxes intensify – flattening financial and EPS progress?

* Will geopolitical points resurface with a brand new Administration in Washington, DC?

* Will extra, new and/or variant viruses floor?

There will not be sufficient time and house to take care of all of the points above — however I’ll briefly take care of a few of the main topics launched, and naturally observe up with the others over the subsequent few weeks.

Some Answers

Here are a few of my core expectations and temporary responses to the above. They kind the foundation for my unfavorable market(s) outlook.

In late 2021 I anticipate financial coverage to start to pivot from its aggressive stance in recent times. The trajectory of financial progress is now sufficiently to this point above trend-line that “panic policy” is now not acceptable. Moreover, as famous in my earlier publish, low rates of interest at the moment are dropping their effectiveness. As properly, there’s a perception that extreme ease has widened the wealth and earnings hole and is contributing to rising inflation and inflationary expectations, which additionally hits the have nots relative to the haves.

Stocks low cost the future and won’t essentially prosper despite the fact that financial progress is optimistic and properly above development line – as so many appear to insist on Fin TV. As I’ve written bear markets/consolidations are borne out of fine information (early 2000, late summer time 2007) and bull markets are borne out of dangerous information (March 2009, December 2018 and March 2021). So, a revaluation decrease in value earnings multiples, although counter-intuitive to some, has a foundation in funding historical past, particularly with rising rates of interest, increased inflation and increasing inflationary expectations. In different phrases, purchase the rumor, promote the information.

In phrases of inflation, it’s a bonafide menace – and, not in my judgement, a transitory occasion as, as soon as out of the bottle it can’t simply be put again in. Labor shortages and each day product value enhance bulletins at the moment are routine. Yesterday Sherwin-Williams (SHW) introduced the implementation of a +7% August 1 value enhance in its Americas Group, and Chipotle (CMG) has simply raised menu costs by virtually 4%.

We begin the second half of the yr with considerably elevated valuations – significantly in mild of a few of the dangers mentioned on this opening missive.

As famous, the ahead 12-month P/E ratio for the S&P Index is over 21x, above the 5 yr common of 18x and the 10-year common of 16x:

U.S. firm income and revenue margins at the moment are uncovered to increased prices. Though financial progress over the close to time period is a tail wind, the optimistic working leverage anticipated by my pal Thomas Lee and others could disappoint. Optimistic and heightened consensus 2022 S&P EPS estimates could also be many integers too excessive.

As to a continuation of inventory market hypothesis (in meme names), as famous by the 1998 Forbes cowl above, the dominance of inconsiderate retail playing is nothing new and, if historical past rhymes, and is our information, it at all times ends badly. The uniqueness of as we speak’s silliness is that some comparatively sober minded company executives and funding “talking heads” are pandering to them! It will possible finish badly for them as properly.

I see Peak Portnoy, Peak Reddit/WallStreetBets and Peak Silliness in Speculation.

In phrases of hypothesis in different asset lessons, notably cryptocurrencies, this too, I’m afraid – and have written volumes on – may finish badly. It is already dangerous as privateness, taxation and (close to infinite) provide points have just lately surfaced – producing a halving in value of some digital currencies. As to NFTs, that are neither an artform nor a platform, the outlook is even worse than for Bitcoin, IMHO.

Bottom Line

“I will be calm. I will be mistress of myself.”

– Jane Austen, Sense and Sensibility

As I’ve written, the market’s structural change from lively to passive investing has produced the least educated investor and buying and selling base in historical past.

Frankly, I see a lot foolishness and poor judgment being displayed these day — by market members and by “talking heads” — of their continued and spirited search for superior buying and selling and investing returns.

Indeed, the speculative silliness, to this observer, is now deafening.

Many of the usually accepted and upbeat consensus macroeconomic views appear to be threatened or may need a lowered chance of being achieved given the threats mentioned on this column.

As to equities, upside rewards are possible dwarfed by draw back dangers and few shares meet my standards or commonplace for choice today.

The premium between S&P money (4230) and my calculation of the “fair market value” (about 3300) is in extra of over 20% and at the widest overvaluation in years.

Given my issues, I’m a non-consensus bear on most asset lessons.

My funding conclusion and technique is to promote in June for the anticipated market swoon.

(This commentary initially appeared on Real Money Pro on June 9. Click here to study this dynamic market data service for lively merchants and to obtain Doug Kass’s Daily Diary and columns from Paul Price, Bret Jensen and others.)

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