Mellon on the Markets: “Now is the time to be cautious on equities”

Inside the mind of the Master Investor: Jim Mellon updates his readers on his latest thoughts on the markets and investing activities. 

I have to say, now is the time to be cautious on equities. Below is a chart of a fear and greed index and it’s not looking good. We seem to be back into complacent behaviour by investors, who are seemingly intent on believing that there will be a v-shaped recovery everywhere and that the good times are going to roll pretty quickly.

Although I think that this deflationary shock we are in will lead to an inflationary boom, which will result in competitive devaluations and debasement of fiat money, we are not there yet. In the meantime, the old practice of burying bad news on a Friday has been extended to every day of the week. Everyone is kitchen-sinking their results with the excuse of COVID-19 and I am not as convinced as some that there is a vast amount of liquidity swilling around on the sidelines.

I have felt that the brokers (you know who you are!) who have consistently called this bounce wrongly, were over pessimistic, especially in the face of the biggest stimulus in history – $14 trillion and counting worldwide.

But money takes time to circulate – the so-called velocity – and although there is plenty of newly created money, it needs conscience for it to cause economic booms, and thereby, especially now, inflation.

This will happen, which is why I am so bullish on gold and have been for over a year, and on silver too! But from a stock market point of view, there are multiple headwinds which make me cautious.

1. Valuations, particularly of tech stocks, are far too high.
2. Dividends are being slashed, and many will take time to come back. The attached chart suggests S&P dividends may not be back until 2027.
3. There is a very heavy concentration of ownership in a few stocks, particularly in the US, and this is bad.
4. Ditto the influence of ETFs which could yet prove to be an unravelling point.

I have been reading a book on the Atlantic Convoys in WWII, and one of the interesting things is that the Allies in the latter part of the war started targeting the milch cows, the supply boats that allowed the U-boat fleet to range far and wide. Once these had been sunk, the whole edifice crashed. By the end of the war, more than 75% of U-boat submariners had been killed, the highest percentage of any service arm anywhere in the world.

I feel that the FAANG stocks are going to be the milch cows of the next few years, and that they will be taken down, piece by piece and separated from at least a goodly part of their cash balances. Watch this space.

Here are some other thoughts.

The Oxford vaccine will likely work, but we need to prepare for the next pandemic – NOW.

Bond yields will go up over time, but it is possible that there could be a move to negative interest rates in the UK shortly, though it will be very quick.

The damage to GDP will not be as great as the direst forecasts suggest, but still substantial.

The healthcare industry will grow faster over the next ten years, and fast food/restaurants will be in secular decline. Retailing already was and that will carry on.

Good stocks to buy now include anything related to gold, silver, cleaning materials, immunoresilience in human health, and some finance, which is not the proximate cause of this debacle and very beaten up.

Oh, and I hate companies that begin their communications (mostly asking for more money) with insincere enquires about family and health. As if they care. They will not get my money.

Those that clearly lay out what they need money for, why the returns on an investment now are going to be spectacular and how they are adapting to new conditions are the winners.

Happy hunting!

Jim Mellon