The REAL smart money continues to head for the exits…

Billionaire Sam Zell

Although individually, shares can sometimes be difficult to value, collectively the market is so overvalued even my grandmother could point it out! As the billionaire investor Sam Zell rather prosaicly but nevertheless pertinently puts it, “the stock market is at an all-time high, but economic activity is not at an all-time high”. This type of disconnect is very rare indeed.

Given this observation, one can only explain the current situation through one of two possibilities: either the equity market is anticipating a long period of very strong levels of economic activity, or people are so blindly euphoric that the difference between stock prices and economic activity is fully explained by a behavioural phenomenon coined by no less a bubble blower than Mr Greespan, that is, by “irrational exuberance!”

While the first hypothesis is a plausible one, I believe the second is somewhat more realistic. As also stated by Sam Zell, “every company that’s missed has missed on the revenue side, which is a reflection that there’s a demand issue; and when you’ve got a demand issue it’s hard to imagine the stock market at an all-time high”.

As we have mentioned several times here at SBM, corporate America has been using the free cash handed down by the central bank to simply repurchase stock and thus pay a massive dividend to shareholders while maximising management’s stock option-based bonuses. In fact, there is a demand issue with the American consumer, as jobs aren’t being created and thus companies aren’t investing in new factories, products and technology. Without demand growth, corporates are forced to rely on cost-cutting and (more recently) capital reorganisation to drive the bottom line. These measures are unsustainable over the long term, which is why the lack of demand growth is so worrying.

Under such an environment it probably doesn’t hurt to hold cash instead of other investments. As Sam Zell posits, “this is the first time I ever remember where having cash isn’t such a terrible thing”.

Mr Soros in a somewhat contemplative mood!

Zell isn’t alone in his pessimism. Another worried smart investor is George Soros, who has been increasing his holdings of put options on the S&P 500 index. These options now represent a whacking 17% of his total portfolio holdings. While this can’t be considered a bear position, it is a real hedge for what Soros believes to be an increase in the risk of a serious drawdown.

Carl Icahn has also followed suit. He has been making a few comments on the current monetary policy stating that he is worried that the end game is approaching and Janet Yellen is quite simple “clueless”!

Meanwhile, Stan Druckenmiller fears that “our obsession with what will happen to markets and the economy in the near term is causing us to misjudge the accumulation of much greater long term risks to our economy.”

In very simple words, market participants are ignoring risk, period. Central bank intervention has been the only game in town and investors are moving (blindly!) in accordance with it. Europe, the US and Japan have been unable to deal with their long-term issues and to generate decent growth in their economies. With massive monetary packages failing to deliver the needed results and with those governments so heavily indebted, the smallest of problems can turn into very a big deal very quickly indeed.

With Sam Zell, George Soros, Stan Druckenmiller, and Carl Icahn all heading for the exit (or at least taking their last sips from the punch bowl), it is time to reflect a little. With NYSE margin debt near record levels ($460 billion) and Investor Net Worth at record lows (-$182 billion), the smallest of negative events could quickly turn the market into a blood bath…

Filipe R Costa