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Comstock Partners, Inc.
April 28, 2018
In our last posting “The Elephants In The Room”, we outlined the reasons we remain as bearish on the US stock market as we have ever been, if not more so.  Briefly, those reasons centered around the negative effects of Zero Interest Rate Policy in the U.S. , Negative Interest Rate Policy in Europe and Japan, and the FED’s transition from Quantitative Easing to Quantitative Tightening.    In addition, Debt to GDP ratios inexorably are moving higher in the US and most of the rest of the world.  We have discussed the negative effect on growth that is the result of excess debt many times, (so that should come as no surprise to our readers).  The poor economic growth since the end of the Financial Crisis of 2008 is also related to the state of labor force demographics, productivity, and entitlements that we have discussed in the past.
We have noticed over the last few weeks that many prominent individuals are saying similar things as us, in whole or in part.  Let’s start with Jim Grant, of Grant’s Interest Rate Observer.  Mr. Grant recently appeared on CNBC and stated that the most important price in a free economy is the price of money, i.e., interest rates.  Given the fact that the price of money has been effectively determined by fiat, and has, in fact, been too low, financial assets of all types are mispriced, and in most cases, overpriced.  Another way of saying that stocks and bonds are overpriced, is stating that they have more risk than is appreciated by the marketplace.  We have been saying for the last many years, that stocks were overpriced and would soon enter a bear market.  Though we were admittedly early, it appears quite possible that the bear market we have been looking for is beginning to unfold.
Another prominent voice is that of Christine Lagarde, Head of The International Monetary Fund (IMF).  Ms. Lagarde recently stated, in reference to a report by the IMF, that worldwide debt is now $164tn, which amounts to 225% of worldwide GDP.  Two thirds of this debt is in the private sector while public debt in the advanced economies is the highest since WWII.  We have been saying for years that excess debt, not only implies excess risk, but also tends to slow economic activity.  This is because capital must be used to service the debt, rather than be used for new investment.  Ms. Lagarde is also very concerned that a possible trade war between the two largest economic superpowers, the US and China, would be very negative for the world as a whole.  We share Ms. Lagrde’s concern, and would further add, that there were lots of negatives even before the trade tensions that we are now concerned about.
It has been seven years since The National Commission On Fiscal Responsibility and Reform (AKA The Simpson-Boles Commission) published its report.  Former Senator Alan Simpson recently pointed out the U.S. government has added $7tn in debt over the past 7 years.  Senator Simpson feels that both parties have abdicated their responsibilities and that no one is coming to the table to attack the problems of Social Security and other entitlements.  Without reform, these entitlement programs will ultimately crowd out discretionary government spending.  In addition, we agree with the Senator’s thinking that the interest rate exposure to the government, should rates rise, is enormous.  By our way of thinking the logical conclusion is that the government will continue to print money to fund these deficits, and thus debase our currency.  As the commission pointed out, by 2028 the national debt is likely to be at least $29.4 tn if entitlements are not addressed in an aggressive fashion.  This may mean increasing the age of beneficiaries, but not attacking the problem will almost guarantee that the national debt will skyrocket.
As Jesse Felder, of The Felder Report, wrote recently “The U.S. Stock Market’s Impressive Outperformance May Be Coming To An End”.  Mr. Felder points out that the U.S. stock market is not only the most expensive it has ever been relative to GDP, but it is also far more expensive than the major emerging markets. We fully agree. For years we have talked about how expensive U.S. stocks are relative to trailing 12 month (TTM) GAAP (Generally Accepted Accounting Principles) earnings.  Even with the earnings growth in the first quarter, the TTM GAAP P/E is over 22 in the S&P 500.  If this were early in a cycle, as in coming out of recession, this would not be as egregious as late in the cycle and BEFORE what we believe is a likely recession.  Thus, given that we expect economic growth, due to the tax cut and repatriation to be a flash in the pan, we think at 22 times earnings and with diminished growth prospects, stocks are very expensive. We are great believers in cycles, and believe a period of much lower PE’s will be symptomatic of the coming bear market.
We were surprised to see how many people are on the same page as us regarding the markets, the economy, and the debt situation.  This gives us more confidence that our conclusions will soon come to fruition.

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