The Case for Caution

Yesterday: these 31 charts to restore your faith in humanity.  If you were off barbecuing, take a look!

Also, an item on SIGA.  If you own it, take a look at that, too.  Jim has now posted follow-ups:  SIGA: The Judge Is Boxed In and SIGA: The Judge’s Paradox and SIGA: The Parasite’s Dilemma.  His conclusion (loosely paraphrased): who the hell knows?  But neither he nor I nor my heavily invested institutional friend would be selling at anything like Friday’s $4.40 after-hours close.

Finally, there was Matt Yglesias’s The Case for Stocks, citing an argument by Joshua Brown that the S&P earnings and dividends have doubled since 1999, when the index was last so lofty . . . so in a sense, those 500 stocks are only half as expensive as they were then: you get twice the bang for the buck.

I called it all “perhaps a little blithe,” hoping to inject a note of caution, but my pal Chris Brown, of Aristides Capital — whose work ethic and rigor exceed mine in the same proportion as, say, chess exceeds checkers or bridge, go fish — responded with a case for caution:

While I like Josh Brown to the extent he swears a lot and may be a distant relative, there are two key errors in his piece:

(1) the words “profit margin” never appear.  Sure, earnings are high, but margins (and the closely related corporate profits as % of gdp) are also near record highs. Corporate profit margins are sustainable to the extent that both (1) we continue to run massive fiscal deficits, and (2) business fixed-investment and new business creation lag. Here’s a nice graph from Hussman:  [it shows corporate profits as a share of GDP rising from little more than 4% in 1974 to more than 10% now — in a pretty tight inverse correlation to the level of government and household saving, which was about 8% of GDP in 1974, compared with negative 5% or so now].

(2) Brown writes: “The marginal speculators are doing futures, currencies or some other sort of crack cocaine, and it’s almost impossible to find a regular person who has any interest in talking about the stocks they own.” This is flat out wrong. In the last month, I’ve seen university professors trading solar stocks at >30x next year’s revenue, and a recent dinner guest reported that he and 7-8 buddies had been trading in $10k chunks on such wisdom as “Ford is going up. We should get some.” The 52-week high list is peppered with day trader darlings. A broker told me Friday that hedge fund clients who would normally be 40% net long are 80% net long, just because they see the market going up so much and they want to participate. Some statistics show a lot of speculation as well—the last time there was this much margin debt out there as a % of the whole equity market was the last time the period surrounding the 2007-2009 crash.

There’s no reason this has to end tomorrow. Between the Fed printing $85 billion a month, and Japan printing nearly as much (and three times as much relative to the size of their economy), there is a lot of money that needs to go somewhere. We could be early in 1999, or even in 1998 at this point, with the denouement still in the distance. But 2Q 2009 was the time to be buying stocks with both hands; right now is a time to be tilted towards caution.