Jim Paulsen, CNBC

The eternal masochist, I turned on CNBC yesterday morning while I was having breakfast. I usually watch the crawl and try to tune out the talking head chatter. This time, though, I listened to an interview with Jim Paulsen, a veteran market strategist now at the Leuthold Group.

Paulsen, whose work I’ve known for many years, is, a lot like me, typically bullish, so arguably his real information value comes during the infrequent times he’s bearish. Yesterday wasn’t one of the latter times. Still, I found the interview interesting. My takeaways:

–his view is that many retail investors are still bearish and have lots of money on the sidelines, something that will lend continuing strength to the market as these funds are gradually reinvested

–the big reason to be bullish is that things are so bad now that there’s lots of good stuff that could conceivably happen

–the CNBC resident “strategist” opined that today’s stock market is risky because it is being driven higher mostly by the FAANGs, a small number of mega-cap growth names. Therefore, if any of them falter, the market could drop a lot. This is about as factually incorrect as one can get (what a surprise). Paulsen pointed out in as polite a way as he could that since the bottom in March a whole diverse group of indices–growth, value, small cap, large cap–have made 50%+ gains. More informed questions might have been about valuations, or about the runaway gains made by mid-sized tech names, or about signs of a possible market leadership shift from tech to consumer discretionary

(There are very substantial performance differences between growth (good) and value (pretty awful) over the past 12 months and year-to-date. But not since March 23rd, which five minutes looking at the S&P website would confirm)

–no thoughts about the decline of the dollar or the significance of the upcoming election. These are important stock market issues, particularly as US government indebtedness threatens to put us in Italy/Greece/Lebanon territory (thanks, ironically, to a Republican administration that led off with a budget-breaking tax cut). Given that the customer base is likely right of center, however, no one sees any percentage in pursuing this topic

the fight over unemployment benefits

My cartoon version of US politics:

A generation ago the Democrats were the party of the working people and the Republicans the party of the wealthy, especially of inherited wealth.

The Democrats’ goal was to push for strong wage gains, to improve the lot of their supporters. They were also for wealth redistribution–taxing the rich to get the money for social welfare programs like Medicare or Social Security. High wage gains would also eventually create inflation, eroding the value of the assets supporting hereditary wealth–an added plus.

The aim of the Republicans was to defend the status quo, the value of their bonds and their industrial operations, by advocating low wages, low taxes (no redistribution) and low inflation.

Even though both parties have strayed far from their roots, this old picture has some relevance in explaining economic forces at work in the US today.

The Congressional Budget Office estimates that the federal budget deficit for 2020–the amount that government spending will exceed income–will come in at $3.7 trillion.

This is where the current debate on extension of unemployment benefits comes in. Democrats are calling for another $3 trillion in aid to out-of-work Americans; Republicans are arguing for $1 trillion. In simple terms, the difference is between continuing $600 a week in extra benefits vs. reducing that to $200.

In the former case, the federal deficit would come in at about $7 trillion and total government debt would rise to just under $30 trillion. This compares with GDP of about $19 trillion this year–with real GDP growth (even before the pandemic) reduced to close to zero due to Trump’s epic incompetence. That would put us higher than perennial poor soul Italy in terms of debt/GDP and into the same bracket with Greece and Lebanon. Only Japan, with debt of 2.5x GDP would be out of our reach–for now, anyway.

(An aside: hard to believe one man could do so much damage so quickly–and that’s not considering his white racism, environmental recklessness, the secret police roaming Democratic cities…)

Anyway, the question wealthy Republican backers seem to be asking is at what point will creditors balk at continuing to fund the Federal government. Their answer can be seen in the Republican negotiating stance–we’re already there. In my view, a lot depends on whether Trump is reelected despite his devastation of US aspirations and value. I think we’re already seeing the first indications of the world’s worries in the decline of the dollar vs the euro. For wealthy holders of dollar-denominated assets–real estate, industrial plants, fixed income securities–losses could be very large.

alternative investments, the SEC and Trump

My earliest experience with alternatives was as a rookie analyst in 1979. Among other things, I was covering small oil wildcatters who funded themselves by promoting oil and gas limited partnerships sold through retail brokers. The 1/2″-thick prospectuses laid out terms that were so unfavorable to limited partners that at first I couldn’t understand why anyone would buy them. So I asked the VP Finance of one of my coverage companies. He laughed, and said the offerings were not for people who wanted to make money. They were for people who wanted to tell others at a party that they were wealthy enough to have an income tax problem.

I remember a China-oriented private equity fund whose prospectus touted the promoters’ prowess through their extraordinary history of high returns. The returns were high–but, after fees, they matched almost exactly those of the Hang Seng index. Again, lots of sizzle but…

As part of the financial reform after the financial crisis, and because of widespread improprieties in the alternatives industry–like misstatement of returns, or professional credentials, or size of assets under management …or other stuff I’d call flat-out fraud–many alternatives providers were required to begin filing reports with the SEC, which has since prosecuted a number of high-profile cases of abuse.

Trump is now taking two actions in support of alternatives, both of which seem to me only to be pluses for dubious alternatives promoters. He’s proposing that ordinary investors be allowed to buy alternatives in 401k accounts (they’ve been barred as too opaque and risky). He’s also “solving” the issue of fraudulent reporting by ending the mandate that smaller alternatives firms to file their results with the SEC (removing the threat of Federal prosecution for, say, falsifying returns).

Neither makes any sense to me. Why do this? Maybe the same reason Trump has made no effort to keep his promise to eliminate the carried interest ploy private equity managers use to avoid income tax.

I’m raising a little cash

why not to do this

One of the earliest lessons I learned as a portfolio manager is not to raise cash. How so?

–it’s much harder to figure out whether stock A or stock B is cheap or expensive in absolute terms than it is to figure out that A is cheaper than B. This means the easiest way to beat the stock market is to keep fully invested and spend all of your time trying to find more As and eliminate any Bs

–the penalty for having a large cash balance and being wrong can be severe. One of my former work colleagues, running a high-profile value-oriented portfolio for pension clients, decided one day that the stock market was overvalued and that he would be a hero to clients by raising 40% cash. This is like professional suicide. He did it anyway. For the following two years the market went straight up. Nothing he did could offset the negative effect of that dead-weight cash. And after a short while he was so deep in the hole that he felt he couldn’t admit his mistake and reinvest the cash. It took a huge market downturn to give him an opportunity to buy in again. But all that did was more or less recoup the performance losses he had sustained by raising cash in the first place. Then he was fired.

–personally, I’m very bad at judging market tops. I’m pretty good at bottoms, I think. But I tend to think that the good times can go on longer than they actually can

why I’m doing it anyway

To be clear, I’m only selling about 10% of my portfolio, mostly paring back individual positions by that amount. That’s not enough to fundamentally change my portfolio composition–in other words, the gains/losses from this move may end up only as a rounding error in performance attribution. So it’s more security blanket than anything else.

What’s causing me to act is something I usually don’t like to talk about: performance.

performance

One of my early mentors told me he thought a good securities analyst could find a way to make a 20% yearly gain in almost any economic circumstances. In less folksy style, I’ve come to think of a good year as the market return (S&P 500) plus 5 – 8 percentage points; if the S&P 500 is up by 10%, I’d like to end up in the +15% – 20% range.

So far this year, however, my “capital flight” idea, envisioning the US today as like Mexico in the 1980s, has worked much better than I would have thought. That’s, unfortunately, because the Trump administration has been much more toxic than I could have dreamed. The result is that my portfolio is already many times ahead of my yearend relative performance target (I really dislike writing this last sentence. My experience is the minute you begin to pat yourself on the back, your performance begins to fall apart).

Still, I don’t think the epic wave I’ve been riding can go much farther. That’s probably my strongest belief right now. The only way I can see for present conditions to continue would be if we knew that Trump would be reelected. I don’t want to replace names I know with new ones that are basically the same thing. That’s just the anti-US pro-Trump bet all over again. But I don’t have a firm idea of where to go next.

Hence, 10% cash.