I just watched an interview on CNBC where hedge fund manager David Gerstenhaber of Argonaut Management discussed his investment outlook and current positioning. In a nutshell, he is “lightly” long equities, short short-dated Treasuries and apparently long the U.S. dollar or at least positioned in a manner that would benefit from a higher dollar. As it relates to being aggressively long stocks here, he mentioned (I’m paraphrasing) that the U.S. stock market is in the 9th or 10th decile as it relates to valuation, making the risk reward to committing new capital to stocks less than attractive.
Just prior to Gerstenhaber’s commentary, the new Treasury Secretary Steve Mnuchin told CNBC’s Beck Quick that he does view the market’s strength since the election as a referendum of sorts of the proposed economic agenda stating that “this is a mark to market business, and you see what the market thinks”. But without the disclaimer that past performance is not indicative of future returns that view seems too rosy looking forward. We’ve seen the market already price in way more than the new tax policy it is anticipating, and there will be no shortage of obstacles to achieving merely the base case of the new administrations proposed pro-growth agenda. Here’s an interesting statistic from our friend Peter Boockvar’s Boock Report:
Much of the ebullience is being driven by hopes over a large cut in the corporate tax rate. To put numbers to this, the Bloomberg US exchange market capitalization has increased by $2.5 Trillion since the day of the election. According to the CBO estimate, the US will take in $320 Billion in fiscal year 2017 in TOTAL corporate income taxes. Thus, if the entire corporate tax was eliminated, we’ve priced that in by 8 times and some of those corporations are privately held. I know that we’ll get regulatory relief and capital spending tax incentives that the market is celebrating but you get my point.
At this point it feels like the U.S. stock market is trading way past the mere promise of pro-growth policies being implemented this year and more of a perfect storm of everything going right and nothing going wrong. If we were to get tax reform without the adverse affects of a border adjustment tax, slow pace of interest rate increases keeping the U.S. dollar and inflation in a slowly rising stable range, fiscal stimulus and smart de-regulation, minimal adverse affect on the deficit, then I would fully expect an all out melt-up in risk assets in 2017, kind of like the parabolic move in U.S. stocks in 1999 into early 2000, or the 2006-2007 run up in stocks, both which preceded 50% peak to trough declines in the S&P 500 (SPX).
I think it is safe to say some of this will occur in 2017, but predicting the potential headwinds from rising rates, dollar and commodity prices on U.S. corporate earnings will be a tad harder, and that is what stocks should trade on. All of that with the backdrop of very low levels of implied volatility, high levels of complacency, rising positive market sentiment and historically high valuations.
At this stage of the game, there may be more room to go. But it might entail picking single stocks to play catch up, where there is some sort of secular story, or the potential of the reversal of prior negative trends. And it makes even more sense to do so by defining ones risk in the options market. Capturing any further gains in the market while knowing exactly what you can lose if it all reverses sharply. We have highlighted a few of these set-ups of late in stocks like Cisco (CSCO), General Electric (GE) and Oracle (ORCL) just yesterday. So maybe lets not just buy everything, but there are certainly some stocks to buy.
My Fast Money co-panelists had a little debate on the topic Tuesday night. I think it was fairly measured, most of the crew has been positively disposed to continued higher highs in the market, but also knowing what we’re dealing with here so a dash of caution sprinkled from time to time. For those who like to be contrarian on headlines, the one on this post, pulled from the chyron during Fast Money was a gem. And it’s gotten some criticism. But I’ll remind you just how difficult it can be on a mark to market basis to commentate on daily market moves. And a tv chyron headline isn’t necessarily reflecting the nuance of short and longer term views.