Trumpophobia to Trumpophoria & Central Bank Lessons
David R Kotok
Cumberland, December 12, 2016
Zimbabwe competes with Venezuela for first place in the contest of the most poorly governed regimes that have hyperinflation policies. Here is the latest chapter in dictator Robert Mugabe’s attempt to destroy what remains of any capital in that country.
In Venezuela, Hugo Chavez’s successor, Nicolás Maduro, has presided over a hyperinflation of the Venezuelan bolívar that is most reliably measured by an index operated by a former Venezuelan army officer who now works at a Home Depot in Hoover, Alabama. Bottom line: the people of Venezuela are struggling to find food and to pay for it when they do. Just this week, the Venezuelan government introduced six new banknotes in denominations ranging from 500 to 20,000 bolívares. In the hyperinflationary environment, the new 500 bolívar banknote replaces the 5; the 10,000 replaces the 100, and so on. (See havanatimes.org.)
There are other cases we can cite in the world, but these two are enough to verify that all is not perfect in the global paradise celebrated by stock market highs.
Meanwhile, Islamic countries now have the religious imprimatur to add gold holding under (Shariah-compliant) Islamic law. (See Bloomberg.) How this religious policy will evolve to monetary policy depends on substitution effects.
Right now the US dollar trumps (pun intended) everything else, and rising interest rates in the US are drawing flows into our currency. How long this trend lasts is anyone’s guess, but it seems solid for the moment.
Trumpophoria is a wonderful salve for stock market participants. We have had a marvelous year in our US ETF accounts. But there comes a time to take some off the table and leave the excesses to others.
Last week, as the markets made new highs, we did some selling and raised a cash reserve. We lowered our stock allocation in steps. And we seized opportunity in the tax-free bond sector, where yields backed up to over 130% of taxable Treasury bonds at the same time that Treasury yields have risen dramatically. Munis are now cheap.
At best, stocks are fully priced. There is little margin for a stumble now. Trumponomics has its limits, and a 2250 starting point on the S&P Index gives us reason to no longer be fully invested. Three flat years of earnings at $118 are expected to be replaced by about $123-4 in the coming year. Let’s call it an 18-19 p/e and an earnings yield of 5.5%. With treasury interest rates up and heading higher, the equity risk premium says the stock market is no bargain.
It has been an extraordinary year in the stock market. Earlier this year the equity risk premium was a full point higher and we were fully invested. A little profit in the bank now feels good.
Two decades ago Alan Greenspan gave his famous “irrational exuberance” speech. The link to its text is below. Note his historical references.
We think Greenspan warned early but accurately. Trumpophobia has morphed to Trumpophoria. But investment decision making is not a reality TV show that always comes on at 8 PM on Tuesday. In the investing world timing is always uncertain.
Reality TV is different than reality investing. We have a cash reserve in place in our US ETF portfolios.
Here is Greenspan’s warning.
David R Kotok
Chairman and Chief Investment Officer