Ignorance Is Peril, Not Bliss: Mistaking the Present for the Permanent

Economic headwinds abound, storm clouds are gathering, and thunder can be heard rumbling. Yet the stock market is still blithely skipping along, beach umbrella in hand, preparing for a day in the sun.

You can tell when a thunderstorm is coming. But you can decide to ignore the mounting and obvious evidence all around you and say “Well, it isn’t raining right now, so it probably isn’t going to rain!”

It’s not smart and it’s not the right decision. But it’s what risk market participants are doing en masse right now. They’ll end up all wet. It’s just a question of when, and nobody has that exact answer no matter what they tell you. The best strategy is to prepare for what you know is coming, and wait.

• Interest Costs Are Climbing. The Federal Reserve is raising interest rates and reducing its balance sheet’s size The European Central Bank will soon follow as it tapers its own quantitative-easing program.
• Energy Costs Are Making New Highs. Rising oil prices are a tax on consumption.
• Commodity Prices Are Rising. Lumber and steel are just two of the commodities that are bolting higher.
• Labor Costs Are Growing. A November midterm-election “blue wave” of Democratic congressional victories might only accelerate the trend.
• Trucking/Transportation Costs are Exploding. Every single good that’s transported is costing much more to deliver.
• A Strengthening U.S. Dollar. This weighs on U.S. trade, as well as on multinationals who export products.
• Regulatory Expenses Are a New Threat to Technology/Social Media. There’s little doubt that Alphabet/Google (GOOG) , (GOOGL) , Facebook (FB) , Twitter (TWTR) et al. will have to accelerate hiring of compliance people and others who monitor and supervise the dissemination of personal data. This will place a new drag to profits.

Valuations are higher than most recognize when measured against feeble economic growth and too-optimistic EPS forecasts. Gluskin Sheff’s David Rosenberg last week delivered an interesting report which shows that investors are paying more for less U.S. economic growth. He concluded that U.S. stocks have only been so expensive only 9% of the time in history.

Add it all up and this might be a good time to derisk, as the possibility of stagflation looms ever closer. The bottom line: Investors are paying too much for stocks given slowing economic and corporate-profit growth, coupled with the pressure of rising costs of all kinds.

ORIGINAL SOURCE: Kass: Rising Costs And Suffering Profit Margins by Doug Kass at Real Investment Advice on 5/21/18