I'm not bearish...I just don't trust it

I'm not bearish.

I really think the US economy is coming out of its slumber. Most of the signs are pretty good.

The problem is I don't trust the market.

After such a big run over the last year, I can see the market continuing higher. With a little bit of earnings growth (9% projected this year...which could be a stretch, but maybe it isn't) and a little more multiple expansion (say from 15.5x to 18x) the market could easily deliver another 26% return - and even then would not be overly valued. I find myself making these rationalizations. It is easy to do.

The problem is the higher it goes, the less margin for error there is and the more I don't trust it.

When you know you are playing a con(fidence) game, you are always looking to be the first to exit the party (which can make for some bad - kneejerk - decisions). 

Notes From November 19, 2009

Here are some notes I made toward the end of 2009.

Why is everything right again?*

The belief that we are past the worst. We are.
The belief that better days are ahead. Unclear.
The belief that the "crisis" was more a psychological phenomenon than something real. Who knows, but it has had real effects.
The belief that it is reasonable to take risk(s) again. Seems to be the case.
The belief that Fed tightening is still a long way off. Stokes the bullish fires.
Evidence that the economy is moving forward again. Confirmation.
Evidence that profits are better than expected. Positive impetus.
The strength in the market provides courage and confidence. Reflexivity.
Momentum trumps fundamentals. The same old game.

So what has been the trade?
Long equities, bonds, commodities, energy, and precious metals. Short the dollar.

Believe we need a super-squeeze in order clear the market.


Why did everything fall last year?
Financial crisis of confidence predicated on a financial system collapsing under a burden of bad debts feeding into a large recession.
The fear that everything was just a con game, a house of cards.

Where are we vulnerable

The seas appear to be calming, but the quiet reflects the passing of the storm, and rocks lie just beneath the surface.

So, where are we vulnerable. And, what are we vulnerable to.

Given the amount of debt outstanding, we are vulnerable to a rise in interest rates.

Given the fragility of the recovery, we are vulnerable to a rise in oil prices.

Given the trade imbalances in the global economy, we are vulnerable to a trade war.

Given the level of confidence in China, we are vulnerable to an asset collapse there.

Given the fickle nature of financial markets and the risks outstanding, we are vulnerable to a generalized decline in confidence.

Given a host of structural issues (prospective new wave of defaults, unemployment, monetary/fiscal exit) we are vulnerable to a double dip.


As we found out so painfully in 2008. Confidence is fleeting. We know and can see the vulnerabilities in the system. What we don't know is when the positive will turn to negative.

Vacuous mouthpieces

I feel sorry for the likes of anyone who heads-up a confidence game (financial CEOs, central bank chairman, country heads), because they have to compromise their integrity in order to maintain confidence.

When the system/company/country's wellbeing is predicated upon maintaining confidence, then they reason that it is worth compromising their personal integrity (or belief) for the greater good, and the potential of getting through the crisis du jour.

However, after calamity strikes, they are seen to be vacuous mouthpieces.

Even though I think there is some truth to this, I think it is also somewhat unfair. We knew they were compromised, but we chose to turn the other way, because it also served our purposes as well.

A risk you've got to take

Ever since the govt decided to be fully committed to "solving" the crisis, the key has been to re-boot growth. Failure to do so, means you end up in a worse position than when you started.

The paradox, or the dilemma, is that in order to re-boot the economy you must cover the growth shortfall by creating demand (in the hope that this artifical stimulus will get you across the growth divide). Unfortunately, given the weak starting position of the govt's balance sheet, options are limited and running out, and any failure to re-ignite growth poses serious risk to the economy and the financial system (again).

In other words, having already committed to the current course of action, the government has no choice, but to go for it (it is already "all in"). Conversely, if it fails and the markets lose faith, then we have a bigger problem on our hands.

With each lapse or fault in the market/economy, the government will continue to bail with all its might. It has no choice. But in so doing, it raises the chance of bringing about a collapse in the system (markets call their bluff...an emperor with no clothes). Confidence is a psychological phenomenon. It is transitory. The general stability of the markets/economy to which we are accustomed, mask a more fragile reality.

Sadly, the risk you've got to take increases the chance of failure.