Low Return World

The S&P500 crept up 0.7% last week, once again proving how far Wall Street is separated from Main Street. Why? Because last week, Detroit—a perfect example of Main Street, and once America’s fourth largest city—filed for bankruptcy, the largest municipal bankruptcy in the history of the United States. Meanwhile, on Wall Street, stock markets were hitting new highs.

Sustainable? In the long run, it seems hard to believe that this divergence can continue. But in the short run, it most certainly is continuing.

At the same time, equity volumes were anemic. In other words, the buyers were not rushing to get in. It’s only during sell-offs that volumes seem to surge. This is not a good sign; it suggests that the foundation of this latest bull market surge is built on sand. Also, complacency returned to historically low levels, also suggesting that investors have been lulled into a false sense of security, once where they believe that stock prices can only move in one direction…..up.

Other hard data on the US economy is not encouraging, as usual. Retail sales, ex-autos, missed badly; instead of rising 0.5% as expected, they came in completely flat. Headline retail sales, including autos, also missed badly. Consumer prices rose more than expected, on the back of higher oil and fuel prices. Industrial production, on the other hand, slightly beat consensus estimates, as did initial jobless claims. On the other hand, housing starts plunged, as soaring mortgage rates filter through the housing industry. Leading economic indicators also disappointed.

Technically, the S&P500 is now overbought on the daily and the weekly charts. Investors have come to believe that all dips must be bought and that nothing can really stop this market from rising more. So the markets have returned to a severely over-bullish condition. According to Investors Intelligence, over 52% of advisors are bullish, while only 20% are bearish. And the Shiller PE ratio is now about 24 times, a level associated with major market tops over the last 100 years.

Howard Marks, a 40 year investing veteran cited here in prior posts, has recently reminded us that we, courtesy of the Fed, currently live in a “low return world”.

He makes the point that the US 30 year Treasury is a critical benchmark that sets the benchmark for long-term risk-free returns.

In prior years, when the 30 year yielded 6% risk free, investors could reasonably make 11% if they accepted moderate amounts of risk and bought high-yield bonds or equities.

But now that the 30 year Treasury yields something closer to 3%, investors are making a terrible mistake if they insist on ‘making’ the same 11% total return.

Why? Because the only way to reach for that 11% return is not by accepting the same moderate amount of risk, which would yield them only about 6-7% today. Instead, an investor would have to accept a HUGE amount of risk to reach for that older and higher 11% of yield.

The point he’s making is that investors are NOT aware of the huge amount of risk they’re taking on when they reach for those older, higher yields today. They’re blindly taking on this risk to earn the returns they ‘expect’ and ‘deserve’.

But because they’re doing this in a low return world, the much higher risk they’re naively accepting will very likely lead to much higher losses, permanent losses, of their capital.

And this will come as a rude shock to those who are are rejecting reality by not lowering their expectations.

The market, he says, is not an ‘accommodating machine’. It will not ‘give you’ the consistently high returns that most people think it should give them.

Thanks for the words of wisdom Mr. Marks.

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