Is it Wrong to be Bearish?

 

My bearishness about stocks is merely is in context of saying let’s not get over excited about the recovery and overvalue it and let’s follow Shiller PE10 and Tobin’s Q and thus accept that stocks are overpriced, so until the price comes down one must be bearish. I believe that diversification between risk assets is of minimal use especially when most needed in crashes. During crashes correlations rise until risk-on assets become highly correlated. I am not bearish in terms of thinking there will be a recession or the world will run out of oil or hyperinflation or true deflation will occur. References to deflation merely refer to that as a deflationary pressure which is offset by other factors to at least keep growth from going negative. What I am concerned is that people assume since the Fed bailouts did work for failed banks that therefor the crash was an unnecessary panic and thus there is no need for substantial reform. Instead the Fed’s stimulation and debt restructurings by banks merely gave debtors some breathing room. Also the lost GDP gap was a waste of some workers’ productive capacity since they can’t work forever. If they can only work another 20 years and wasted 7 years they lost a third of their remaining work years which substantially reduced their opportunity to fully save for retirement.

   Ultimately financial planning for retirement is a game of careful avoidance of excessive, ruinous uncompensated risk, so one should hold plenty of “near cash” or short term bonds as reserves, hold a portfolio with a high expected Sharpe ratio and avoid hidden bubbles. In today’s bubble market the best practice is to avoid the risk of overpriced risk-on assets.

  Ultimately the hard core unemployed will learn that they need to change and let their house go into foreclosure so they can move to where jobs are located and then push hard to learn a new skill and push hard to find an employer that will accept a rookie trainee.

  The inhibitions on consumer confidence and purchasing power, the continued extremely low volume of new home sales (when adjusted for population increase over 50 years the volume has dropped by an astonishing amount), the low growth rate of corporate sales, the stagnant real wages for middle and lower income people support a theory of a low growth world where corporate profits will go down and stocks will go down. This can happen even if the economy is growing because stocks prices have gone up way too far, too fast.

It is an amazing world we live in: a huge increase in global debt in the past 7 or 15 years and all we have to show for it is a world full of low growth countries. In other words, the debt proceeds were spent irresponsibly, yet the world economy is still obligated to service the debts. This is a recipe for a global slow growth, low profit economy, which means stocks will come down.

These are unprecedented times of globalization acting to keep wages and inflation low, and increase unemployment in developed countries, all while people everywhere are burdened with a record high amount of debt. The combination of excess debt and downward pressure on wages and thus downward pressure on demand is truly a “this time it is different” scenario that can lead to global secular stagnation. This phrase usually applies to people who wrongly approve of tech bubbles, but in this case the phrase is a legitimate way to describe the situation, although it is a negative rather than a positive situation.

Regarding my bearish views I feel that life is wonderful and America’s long run prosperity is a sure thing; I just want to avoid getting ripped off by overpriced stocks, even if that means waiting a very long time to buy stocks. The risk of loss in bonds from rising interest rates and duration risk is much smaller than the risk of an equity crash.

Investors need independent financial advice about the risks of a stock market bubble.

 

About the author

Don Martin, CFP®

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