“Money amplifies our tendency to overreact, to swing from exuberance when things are going well to deep depression when they go wrong.”
– Economist and historian Niall Ferguson
Future bull. Let me admit up front that this EVA has been rolling around in my mind for quite awhile. Its genesis may be directly related to the fact that I’ve been desperately yearning to write a bullish EVA – besides on Canadian REITs or income securities that get trounced by the Fed’s utterances. In other words, I want to return to my normal posture of being bullish on the U.S. stock market.
It wasn’t long ago, like in 2011, that clients were chastising me for believing in what I formerly referred to as “the coiled spring effect.” By this I meant that corporate earnings had been rising for over a decade, and yet, stock prices were much lower than they there were in 1999. Consequently, price/earnings ratios were compressed down to low levels, though certainly not to true bear market troughs. My belief was that stocks were poised for an upside explosion once the inhibiting factors, primarily extreme pessimism on the direction of the country, were removed. I even remember one long-time client dismissing my “Buy America” argument on the grounds that in my profession I had to be bullish (regular EVA readers know that is definitely not the case).
Well, a funny thing happened to my “coiled spring effect” – namely, it became a reality. Additionally, the upward reaction was much stronger than I envisioned. But what really caught me by surprise was that it played out with virtually no improvement on the “extreme pessimism on the direction of the country” front. Perhaps I’m wrong, but I don’t think there has ever been a rally that has taken stocks to such high valuations (time for my usual qualifier – based on mid-cycle profit margins, not the Fed-inflated ones we have today) concurrent with such pervasive fears America is on the wrong track.
Undoubtedly, the pros among you who just read that last sentence are thinking: “That’s great news. All that pessimism will keep this market running. We’re not even close to the peak.” Not so fast, mon amis (and amies). We’re not talking market pessimism here. As numerous EVAs have documented, U.S. investors are as heavily exposed to stocks as they have ever been, other than during the late 1990s, when stocks bubbled up to valuations that made 1929 look restrained.
Further, please check out the chart below from still-bullish Ned Davis regarding investment advisor sentiment. The bearish reading is the lowest since the fateful year of 1987, while bulled-up views are in the excessively optimistic zone. (See Figure 1.)
It is my contention that there are currently millions of fully invested skeptics. They aren’t bullish long term – in fact, they believe the underlying fundamentals are alarming (with the usual perma-bull exceptions) – but they feel compelled by the lack of competitive alternatives to remain at their full equity allocation. Disturbingly, professional investors are increasingly doing so even with money belonging to retired investors who need both cash flow and stability.
Okay, with all that history out of the way, let’s go the other direction – into the future, to a time several years from now, when conditions are nearly the polar opposite of where they are today.
The Evergreen Virtual Advisor (EVA)
November, 201?
At long last, reforms. Do you remember back in 2014 when the stock market was as hot as napalm? When it just never went down? When millions believed the Fed could control stock prices by whipping up a trillion here and a trillion there?
Looking back from the vantage of today, it all seems so obvious. We should have known better than to believe that the S&P 500 had years more of appreciation left in it after having already tripled by the fall of 2014 from the 2009 nadir. The warning signs were there. But, before we rehash what went wrong, let’s focus on the upside of what some are calling “The Great Unwind” – the hangover after years and years of the Fed recklessly driving asset prices to unsustainable heights.
First of all, let me start with what I think is the biggest positive of all: the end of the central banks’ era of omnipotence. While that might sound like a major negative, you may have noticed that with the crutch of binge-printing taken away, our nation’s leaders are finally getting around to implementing reforms that should have been enacted years ago. The history of our country is that we are energized by crises, and the latest is no exception. Our most recent financial convulsions have galvanized a bipartisan coalition to attack an array of long-festering problems that have hobbled our country since the start of the millennium.
Arguably, the most important was the recently enacted tax reform legislation. Skeptics believed the U.S. could never move toward the type of simple tax system that has long been used in countries like Singapore, Hong Kong and even Estonia. It took the realization by both parties that lower tax rates with almost no deductions would actually produce more revenue. Moreover, the elimination of incalculable and massive “friction costs” for millions of businesses and individuals, trying to adhere to and/or game that beastly labyrinth known as the tax code, is quickly catalyzing real economic growth. This is in contrast to the 2010 to 2014 counterfeit version that rolled off the Fed’s printing press.
By 2014, the U.S. was ranked a lowly 32nd out of 34 countries in terms of tax fairness and efficiency. Yet now, thanks to last year’s drastic tax reform, U.S. corporations are no longer fleeing in droves to other countries, using such tax dodges as inversions (buying out foreign companies and assuming their country of corporate citizenship to access lower tax rates). They have even begun to repatriate their trillion or so of offshore profits since the formerly onerous tax rate of 35%, the highest in the developed world, has been reduced. And, thanks to the eradication of the aforementioned legalized tax dodges, corporate tax receipts are actually beginning to rise sharply, despite the fact that our economy is in the early stages of recovering from the latest recession.
As we all know, the rationalization of our national business model involves much more than even the essential aspect of tax code simplification. At long last, meaningful tort reform has been enacted. No longer will the rule of lawyers be allowed to dominate the rule of law. The enormous, but insidiously hidden, costs of a subsector of the legal system whose chief mission is to squeeze unjustifiable sums from the private sector is finally being reined in.
Similarly, regulatory overkill is also being addressed by the very entity that created this monster in the first place: the government itself. Absurd, overlapping and often conflicting directives that hobbled the most essential element of the private sector – small businesses – have been abolished, replaced by a much simpler and unified set of rules.
Even America’s dysfunctional and wasteful healthcare system is being revamped using rational economic solutions, rather than by piling on more incomprehensible rules, requirements, and panels. Consumers can now easily compare prices among service providers thanks to technology as instituted by for-profit providers. Along with significantly improved visibility, they also now have far greater control over how their healthcare dollars are spent. Medical outlays are now in a decided downtrend.
Incredibly, Congress is actually beginning to behave like a representative of the people rather than an ATM dispensing taxpayer money to the most politically connected. The intense implosions of the multiple bubbles the Fed intentionally inflated triggered a backlash of voter ire toward its legislative enablers. Since then, we’ve seen a dramatic House – and Senate – cleaning. This new “coalition of the thinking” is now following the proven path to recovery that numerous countries – such as Germany, Sweden, and Canada – blazed when their economic and financial systems hit previous roadblocks. As in those nations, moving away from excessive socialism, while simultaneously supporting the business community, rather than vilifying and hindering it, is already beginning to elevate America out of its long stagnation.
Collectively, these sweeping reforms are as dramatic as those seen in the 1980s and promise to unleash a growth boom equally as powerful as the ones that followed those overhauls. Yet, despite these dramatic and highly promising changes, investors remain hunkered down in their bomb shelters.
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