On behalf of our Chief Investment Officer Tim Travis…
Hello Everyone,
I stumbled upon an article on MarketWatch that said we are in the 3rd biggest stock market bubble in history. Firstly, I don’t agree with that premise, although I do believe that the market is quite expensive. The analysis is based on a combination of metrics, including a measure that looks at how much it would cost to replace corporations’ assets from scratch. I find it very hard to believe that a realistic analysis could occur using this measure on the broad market, as assets such as patents, trademarks and real estate bought in the past are extremely hard to measure by any basic metric.
More importantly, I decided to take the author’s three major bearish arguments and relate them to how we have structured our clients’ portfolios to display how we are preparing for the future.
1) The Fed could be the cause of a sell-off if it winds down on quantitative easing.
There is no doubt that the Fed’s easy money policies have bolstered risk assets, including stocks. At T&T Capital Management, we have invested heavily in financial stocks such as banks and insurance companies. These companies will benefit when interest rates go up as their net interest margins and investment income will go up dramatically, bolstering earnings and returns on equity. This is a big reason why I expect significant divergence between our portfolios and the performance of the overall market.
2) Companies could stop borrowing money to buy their own stocks.
The financials are going through a period in which they face the most restrictive and damaging regulatory environment in the history of the United States. Part of these regulatory changes has been an obsessive restriction on stock buybacks and dividend increases, unless the companies pass through a Byzantine review process. The positive aspect of these regulations has been that most of the big banks and insurance companies are now overly-capitalized. As regulations eventually normalize, these companies should be able to aggressively buy back stock and increase dividends.
3) There could be a return to 1970’s-style stagflation.
This is probably the biggest threat, but I believe that all it would take are more effective fiscal policies to promote the pent-up growth that has not occurred since the Financial Crisis. Easing on regulations, less uncertainty relating to healthcare costs and a simplification of the tax code would all be positives for the economy, in my opinion.
I’m not saying that all of these things are likely to occur, but if one or two of them do, I believe it is possible that GDP growth could normalize to 2.5-3.5%, which would be a very solid improvement. These changes might take 3-5 years to occur, if not longer, but I’m confident that things aren’t likely to get much worse and any positives could go a long way. I’m not trying to make a political statement one way or the other as I believe that most of us feel that there has been dysfunction on both sides, but my point is that the economy has been facing tremendous fiscal headwinds that at some point should be overcome.
We utilize a strategy where we sell long-term cash-secured puts to provide a large cushion before we would start taking losses assuming we hold the options till expiration. We only do this on stocks that we want to own anyways for the long-term, so we believe we that have a great deal of protection from the volatility that can occur when markets do take a turn for the worse, which of course they inevitably will do.
Thank you very much and please don’t hesitate to give us a call if we can help with anything at all!