“Actually, throughout my life, my two greatest assets have been
mental stability and being, like, really smart.”
President Donald J. Trump
As 2017 came to a close, global stock markets continued to surge higher, thanks in large part to the passing of the Trump led Republican Tax Bill that was signed into law just before the Christmas break. This was the most ambitious overhaul on the US tax code since Ronald Regan’s White House back in the 1980’s. The most significant benefit accrues to corporations with a reduction in corporate taxes from 35% to 21%. Corporations have been building large sums of idle cash outside of the United States to avoid the previously onerous American tax rates but now these sums are going to be repatriated home. Apple alone is planning to bring home well over U$200 billion in cash held overseas and in so doing, will pay around U$38 billion in repatriation taxes. Of course it remains to be seen how these repatriated dollars will be redeployed but certainly the market is expecting lots of stock buybacks, dividend increases and mergers over the next couple of years.
Every Wall Street analyst and every company CFO came back to work after the holidays and began reflecting lower taxes in their earnings projections. Many companies have also announced one time employee bonuses (which President Trump has been quick to take credit for!) although more permanent wage increases would have more of a beneficial impact on consumer spending. On the surface, the U.S. tax changes have been a positive catalyst for the markets causing stock prices to grind relentlessly higher. However, as markets reach new all-time highs on the back of tax changes, many question if the increasing stock price targets set by analyst’s may lead to a “stock market melt-up”. While I suspect that “the grind higher” will most likely continue for a while or at least until earnings season ends, I do believe caution is warranted at these prices!
The other important development that is driving stock markets higher is that for the first time in almost a decade, practically every major global economy is growing at the same time! This so-called “synchronized global growth” is self-reinforcing and is also helping to carry the global stock markets higher. Europe, Japan, Latin America and pretty much all emerging market economies are all doing better at the same time. This means the US economy is no longer the only source of global growth. And it bears mentioning that for all the worries over the years about China’s unsustainable growth rate, talk of its impending doom has stopped! China today is almost 4 times larger an economy than it was before the financial crisis and its growth rate has actually turned higher recently as it transitions to higher-valued manufacturing and services.
As we have a broadening of global growth, the US dollar has almost paradoxically been weakening just when the overwhelming consensus was that it would continue higher. After all, the US is raising interest rates and is also gradually unwinding its central bank balance sheet (stemming from 3 rounds of Quantitative Easing) which fueled the expectation that money would continue to flow towards the U.S. and keep the US dollar going strong. Again, beware the “consensus view” because it is usually wrong at extremes. Another consensus view is surrounding inflation as many remain convinced that technological productivity gains and the move towards automation will forever hold inflation in check. I continue to think inflation is the next big thing (pardon the pun!).
Global central banks have created well over $10 Trillion of liquidity over the last 10 years and I think this liquidity is smoldering. Commodity prices (as measured by the Goldman Sachs Commodity Index) are at a multi-decade low when compared to the level of the S&P500 stock index. The last time we saw commodity prices this undervalued compared to US stocks was 1971. So we have global growth picking up, the U$ trending lower and commodities (which are all priced in U$) at almost a 50 year relative low to US stocks. Sounds to me like we may be setting up for an inflection point and perhaps better days on the horizon for commodity producing countries like Canada. That would be welcomed since the Canadian stock market remains overwhelmingly weighted in financials and resources. Oh and marijuana companies, we have lots of pot stocks now!
Canada has set its sights on becoming a global leader in marijuana production (well it is a resource after all!). The sector has grown to have a market capitalization of close to U$30 billion, with just 4 of the largest stocks accounting for about C$18 billion of market value. Now for fun, let’s compare that to the market cap of Molson Coors Brewing Co at about U$18 billion. Molson Coors generated about U$13.4 billion in sales over the past 12 months, compared to C$148 million in revenue from these 4 companies combined. Certainly sales will greatly increase this summer when Canada legalizes the sale of recreational marijuana and yes California’s legalization is a huge opportunity for this nascent industry as well. But it seems like we have some excessive optimism in this market. Every time an emerging industry catches the public’s imagination, it goes through these “bubble valuations” at the beginning. When we marry optimism and abundant capital to a new market opportunity such as the aforementioned marijuana industry, “irrational exuberance” often follows. This phrase was coined in 1996 by Alan Greenspan, halfway through his tenure as the head of the US Federal Reserve, when he thought stock markets were getting ahead of themselves. Interestingly, markets did not top out until almost 4 years later so timing tops is never easy and best done only with the benefit of hindsight! Bubbles often get bigger than anybody can possibly predict.
Another “bubble” in formation is all things to do with the “cryptocurrency craze” with the total value of all outstanding “currencies” rapidly approaching U$1Trillion. With seemingly no barriers to entry, every day new currencies come to market by way of “initial coin offerings” which are almost completely unregulated as they don’t list on established stock markets. The market expression “feed the ducks when they are quacking” comes to mind as companies are also trying to get in on the cryptocurrency craze by putting out press releases stating they will focus on “blockchain” initiatives. As blockchain is the technological backbone of cryptocurrencies the mere mention of the word in a press release by a publicly listed company often flocks together euphoric “investors” driving share prices higher. Fresh in our memory is the incredible price action of beverage company Long Island Ice Tea as investors sent the stock up nearly 300% within a single trading day due to the company rebranding itself as Long Blockchain Corp and refocusing its efforts on blockchain. It is very reminiscent of the late 1990’s during the tech boom when companies announced websites and their stock prices climbed in response. The fear of missing out (FOMO) may very well lead people into decisions that are followed by years of regret. As an illustration, if you bought into the semiconductor index at the peak of the technology bubble in 2000, you are just about to break even now, 18 years later! Valuations matter and bubbles are best observed safely from the sidelines.
In general, I have a pretty constructive view on how this year will play out but remain mindful of the pockets of euphoria and excessive valuations which suggest we are long overdue for a meaningful market correction that can happen for any reason and without much notice. Many pundits keep highlighting how long in the tooth this economic cycle has already been, implying that it will end at any moment. Since WWll, the average US expansion has lasted 64 months producing 24% cumulative GDP growth. At 95 months, the current expansion is longer than average but has produced just 17% cumulative GDP growth rate! So it seems the expression that was coined for interest rates, “lower for longer” may actually apply to the current economic expansion with a longer but lower growth rate. And it bears mentioning that expansions don’t just die of old age, but rather they are usually assassinated by central banks when monetary policy is tightened excessively to curb imbalances such as inventory buildups or inflation.
There is that “i” word again!