The Fed Doesn't Have Your Back

A surprising (or maybe not) look at sentiment... Lemonade stands and mountain climbers... The Fed doesn't have your back... The rate cuts aren't over yet... Paging 'Cutty McCutterton'... A culture of larceny...

One of our marketing experts caught me off guard with her comment...

We were in a conference room at the Streamsong Resort in Florida last week for our annual Spring Editors' Conference.

I (Dan Ferris) don't remember the exact words. But essentially, she mentioned that our subscribers – and prospective subscribers – were enjoying bullish messages more than anything else.

It was a bit of a surprise. After all, the stock market had already sold off sharply in recent weeks...

The sell-off, of course, continued in a big way yesterday... with all three major U.S. stock market indexes dropping at least another 7%. The S&P 500 plunged into "correction" territory (10% decline) faster than ever... And it was mere percentage points away from "bear market" land (20% decline) before rallying about 5% today.

The spread of the deadly coronavirus is the primary culprit. As the number of folks infected with the virus around the world climbs, it's causing major worries about global growth...

So as you might expect, "official" measures of investor sentiment – like well-known weekly surveys from Investors Intelligence and the American Association of Individual Investors ("AAII") – show that investors are less bullish and more bearish today... but not by as much as you might think.

The latest Investors Intelligence's bull ratio fell to 41.7%, down from 54.7% two weeks ago. Bears rose from 19.2% to 20.4%. The AAII survey through March 4 – the most recent data available – showed a reading of 38.7% bullish... just 0.7 percentage points above average. Bearishness was 39.6%... well above the historical average of 30.5%.

But with more than two decades in this business, I've noticed that the Investors Intelligence and AAII surveys can gyrate a lot from week to week. For example, we'll see how much the AAII data has changed over the past week when it comes out on Thursday.

Because of these gyrations, it's hard for me to personally rely on these indicators as a true gauge of what people are doing with their money.

I'm completely biased, but I prefer to see the markets through our subscribers' eyes...

We hear from and talk to a lot of investors around here – through interactions at our conferences, e-mails, and calls to our customer service team. And because of that, I believe we capture the underlying sentiment among investors better than those surveys.

So if one of our marketing experts says our subscribers are enjoying the bullish messages more than anything else, then I believe it's true.

(To that point, we'd love to hear what you are thinking about the markets right now. Are you bullish or bearish today? Send us an e-mail at feedback@stansberryresearch.com.)

And after thinking about it at our conference last week, I realized that any bullishness among our subscribers shouldn't have been that surprising after all. At least for now, we're 11 years into an epic bull market... the longest-running one in history.

But we all know the good times can't last forever...

I've been bearish on future 10-year returns for U.S. equities for almost three years.

More than once, I've explained that U.S. stocks tend to generate poor returns for a decade or more after reaching sky-high valuations. As I wrote in the October 11, 2019 Digest...

When the benchmark S&P 500 Index is trading for more than 1.5 times sales, investors are taking some risk ("slowly dying"). But once it exceeds two times sales, investors' capital is set for a fall from the greatest height possible... In the words of Hackett, it's "dying much more quickly."

The S&P 500 trades at a price-to-sales ratio of about 2.2 right now. It has only traded above two times sales on one other occasion in history – the peak of the dot-com bubble roughly two decades ago.

Two times sales is the "death zone" for future equity returns. According to economist and asset manager John Hussman, the index's 10-year returns have been abysmal any time it has approached anywhere near this level in history.

Today, the S&P 500's price-to-sales (P/S) ratio is at roughly the same level as it was in September. But that's after the pullback... It reached an all-time high of more than 2.3 in December. The P/S ratio has historically correlated much more closely with subsequent 10- and 12-year returns than the price-to-earnings (P/E) ratio – likely because the P/E ratio contains so much "noise".

I don't need to predict a bear market. The simple arithmetic of returns tells me that investors are mostly overpaying for U.S. equities right now – and they've been doing so for years.

Here's a simplified example to show you what I mean...

Pretend you pay $1,000 for a lemonade stand that generates $100 per year in net income. That's a 10% return on your money. But if you were to pay $2,000 for the same stand, you would only get a 5% return on your money. The more you pay, the less you make.

These days, buying stocks is like paying $3,000 or more for the lemonade stand. It's too much money... And more important, it means that you're destined to make a much smaller return on your money – while exposing yourself to the same risks as everyone else.

Since U.S. stocks remain within spitting distance of their most expensive extreme in history, it makes sense to see investors still excited about bullish messages despite a correction.

It tells me that the complacent "buy the dip" mindset remains intact today... though it would make sense if yesterday's rout suppressed that desire.

We'll see in the coming days and weeks. Still, an obstinately persistent desire to buy is exactly what you would expect to see near the end of the longest bull market in history.

With that in mind, let's turn to the Federal Reserve's 'emergency' interest rate cut...

Last Tuesday, the Fed cut the target federal-funds rate by 50 basis points to a range of 1% to 1.25%. It was the first rate cut between regularly scheduled meetings since 2008. And as we showed in last Wednesday's Digest, these types of moves haven't always helped stocks.

I'll use another analogy to show why gold and bond prices shot straight up after the Fed's announcement during the day Tuesday... and why the S&P 500 closed down nearly 3%.

Let's say you want to get into mountain climbing...

You know nothing about it, so you hire a guide for this new endeavor... He's a well-known climber who has scaled some of the world's highest peaks. He has been there, done that, and gotten the T-shirt to prove it. You trust him. He has your back.

With your trusted guide joining you up on the mountain, you'll be fine. He seems to know what he's doing. Everything seems to be OK. So you head up the mountain behind him.

Now, imagine how you would feel if you were climbing up the mountain, totally confident that this guy has your back... and then, all of a sudden, he screams out: "Oh no!"

You don't want to hear that. Instantly, you feel like maybe he doesn't have your back. Maybe you have the wrong guy after all. Maybe you've made a big mistake.

For more than a decade, the market has believed the Federal Reserve had its back. After all, the Fed saved us all from the 2008 financial crisis, right? (Sure it did...)

Then, the coronavirus happened. And the Fed, your guide on this mountain, said, "Oh no!"

The Fed's rate-setting committee rushed to set up a teleconference...

And of course, the members of the Federal Open Market Committee ("FOMC") unanimously voted for the 50-basis-point cut.

Obviously, I don't know what was said during the meeting last Monday night. But I'm willing to bet real money that nobody said anything to Fed Chair Jerome Powell like...

"Hey, it seems like all those underfunded pension systems out there are going to have a real hard time making that 7% return they all plan for if we keep cutting rates to zero and beyond. Just sayin'."

Instead, based on the fact that everyone was on board with the move to cut rates this week, they're essentially conveying a message like this to the American public...

"Oh yeah, lower interest rates are a great substitute for all the economic activity that's not occurring now and won't occur over the next nine to 12 months as coronavirus wends its merry way around the developed world.

"Who cares if a meaningful portion of Italy's 63 million annual tourists stay home? Who cares if the cruise industry shuts down and airline revenues fall by a third or so? At least folks in the U.S. will be able to get a mortgage at 3%.

"And I think we've proven that when we destroy the mortgage market, we can pretty much put it back together again.

"So, hey... go for it, Jerome. I vote to cut. Cut, cut, cut. Cut like the wind. Cut a rug with a bug. Call me Cutty McCutterton. Cut right away."

In other words, the Fed governors – our perceived guides on this stock market mountain – aren't just incompetent. They're gleefully incompetent... with a certainty stemming from an ignorance so vast that it makes deep space look like a pack rat's garage.

The Wall Street Journal reports that the rest of the Group of Seven ("G-7") countries –Japan, Canada, the U.K., France, Italy, and Germany – stand ready to take similar actions.

The People's Bank of China already cut its benchmark rate last month. And now, the White House is considering fiscal policies to stem a possible recession.

The Reserve Bank of Australia cut before the Fed last week... lowering its benchmark interest rate from 0.75% to 0.5% – the lowest level in its history. The Australian government hopes to prevent the coronavirus from causing a recession in the country for the first time in 28 years.

Malaysia also cut its benchmark interest rate for the second time this year.

The Fed quickly began staging a pathetic attempt to support its panicked decision...

In an interview last Wednesday, St. Louis Fed President James Bullard said investors shouldn't expect that another rate cut during the FOMC's March 18 meeting is a done deal.

Let me help you interpret Bullard's statement...

It's just like when some third-world finance minister makes a grand announcement that, "We will not devalue the currency." When that happens, astute investors should go ahead and sell the currency short... because devaluation is around the next corner.

When Bullard says another rate cut isn't necessarily in the cards, he's really telling us...

"You're an idiot if you think we won't push interest rates through the floor... the Earth's crust... the mantle... and into its molten core... to try to goose this market back to life."

You only tell the world you're not panicking when it becomes obvious to all that you... our expert mountain-climbing guide... our "ace in the hole"... the one who has supposedly had our backs for the past decade... are actually sweating bullets.

Bullard tried to play it cool, too. He dropped some fancy lingo, saying, "We took out some insurance against the possibility [that the virus] will cause a growth slowdown in the U.S."

As I mentioned earlier, it was the first time the Fed cut rates between scheduled meetings since October 2008 – when the worst crisis since the Great Depression was unfolding.

And yet, this guy wants us to believe he and his pals just "took out some insurance." Bullard and the Fed governors just expect us to keep thinking everything is cool. Yeah... right.

The government-bond market knows panic when it sees it... The Fed's unplanned rate cut pushed the 10-year U.S. Treasury yield below 1% for the first time ever.

It hadn't ever happened since Alexander Hamilton invented the Treasury market by scribbling notes on the back of a Denny's napkin during the Revolutionary War. The yield on the 10-year U.S. Treasury note is down to about 0.75% today.

The futures market knows it, too... As we go to press, the April federal-funds futures contract implies a federal-funds rate around 0.50% by next month – another 75 basis points lower.

Everybody knows another rate cut is coming...

Bullard's attempted denial seals the deal.

The Fed isn't merely taking out insurance against a virus-induced recession. It's panicking because everybody at the central bank thinks the market can't be trusted without their intervention.

It feels like our mountain-climbing guide is lecturing us on safety. But at the same time, he's slipping off the rock... And soon, he'll fall to his death, pulling us along with him.

It sure seems like the Fed is leaning heavily on the "wealth effect." That's the tendency of folks to spend more freely when their brokerage accounts and 401(k)s have risen in value.

The Fed's utter panic and the resulting ultra-low 10-year Treasury yield do not suggest a vigorous economy, in which demand for money pushes up its price.

Rather, they suggest panicky demand for safe havens and an economy teetering on the brink of recession... or maybe one already sliding down that side of the mountain.

You'd think, too, that the Fed would have glanced at the financial news sometime in the last decade or so. If it did, it would have noticed that both Japan and Europe failed to stimulate their struggling economies with ultra-low – and even negative – interest rates.

In other words, when economic activity slows, you can't even pay people to borrow and spend. Folks smell the panic in your "emergency" rate cuts... and behave accordingly.

But wait, there's more...

Based on what I've seen, many folks believe something else is making the market crazy, too...

And yes, it's as crazy as everybody believing that the Fed has their backs... Politics.

A recent Bloomberg article showed how stocks fell when so-called "progressives" – like Elizabeth Warren and Bernie Sanders – were seen as front-running Democratic presidential candidates. And when former Vice President Joe Biden, who is perceived as a "moderate" candidate, charged into the lead... the market, especially health care stocks, rallied.

It's hard for me to believe any candidate – moderate, progressive, or otherwise – would be much better or worse than any other. In the end, the progressives are all frauds, anyway...

They work for their Wall Street masters. (Yes, including Bernie, the millionaire "socialist" with multiple real estate properties). If Bernie never used the word "socialism," he might still be in the lead. But the word carries a stigma that turns many Americans away.

The so-called "conservatives" are equally fraudulent...

They act like they're protecting the American way of life. But they seem to forget it was forged by people who violently revolted against a tyrannical king... and who didn't want government telling them what to do every minute of the day.

If you think things have changed a lot in 300 years, I disagree... Human beings haven't changed in 200,000 years.

Politics is an unpleasant subject, no matter how you slice it...

And it's mostly because debate today has degenerated to a combination of virtue signaling and larceny.

You'll rarely meet anyone who says, "Hey, let's start by not infringing on one another's person or property and go from there." Nowadays, you're much more likely to hear...

"I'd steal half of everybody's money to save the country."

"Oh yeah? Well I'd steal 75% of it."

"Oh yeah, well I'd steal $100 billion from Bill Gates and make it illegal to be a billionaire."

"Oh yeah? ..."

You get my point: It's a culture of larceny...

All the politicos' schemes are based on stealing more money from those who know how to make it... or in some cases, stealing services from capable, highly skilled people who provide them (like doctors and nurses)... and anything else they can get away with.

Government is supposed to be about as exciting as watching paint dry. It's supposed to be about making sure nobody – including itself – infringes upon your person or property. We all pitch in a little to pay its bills. And most of the time, we shouldn't need to think about it.

But now, it's more about waging war against you for being productive and figuring out how to divide the spoils. Around and around it goes, loudly and pointed in no direction that reasonable men and women would tolerate if the discussion were in their own living rooms.

We all have to pitch in to make our society work, but you would never tell your next-door neighbor that you have a right to anything he owns. Yet somehow, when you pull the lever in the voting booth, it magically becomes OK to do that.

You might think I sound like a pessimistic curmudgeon...

But if we ever met, you'd know that isn't the case.

It's insane to be anything but optimistic about the human condition... We're living in the greatest moment in history. More people are living longer and enjoying a higher standard of living than ever before. We have no reason to believe that won't continue.

You can't really be a long equity investor without being an optimist at heart.

However, criticism is necessary... That's especially true when it comes to the government, an institution whose hubris and overreach makes Bernie Madoff look like a petty thief.

But life doesn't move ahead with constant criticism. It moves ahead thanks to people who take calculated risks. That sums up investing, too...

It's about knowing how to take risks... how to recognize, understand, and control them... and most important, how to get behind a good idea with your hard-earned capital.

If I weren't an optimistic investor, how else could I afford the luxury of ranting about the Fed and the government?

The more I can afford to indulge in the luxury of a good rant, the more I realize how good I have it, and from where that bounty originates.

I hope you feel the same way.

New 52-week highs (as of 3/9/20): SPDR Gold Shares (GLD), iShares 1-3 Year Treasury Bond Fund (SHY), and the short position in Interpublic Group of Companies (IPG).

In today's mailbag, one of our subscribers "reverses roles" on us... and another shares what he has learned about trailing stops amid the recent volatility. Do you have a question or comment? Send us an e-mail at feedback@stansberryresearch.com.

"Dear Porter, Steve, Doc and Dan: In the spirit of 'what you'd want to hear if our roles were reversed,' I wanted to write and express my thanks for your outstanding suite of services.

"After taking big losses in the market in both 2000 and 2008, I decided what I was doing wasn't working. So I began looking for investment advice I could trust, and that led me to Stansberry.

"I not only bought the recommended stocks in several categories, but added the discipline of applying trailing stop losses (using TradeStops VQ) to all my positions. I basically put my portfolio on auto-pilot and went on with life.

"In the past three weeks, 29 of 35 trailing stop losses executed. My net gain was several thousand dollars, and while I 'lost' some unrealized gains, I'm still holding on to some significant gains in gold, bonds, Treasurys, an S&P short position, and a ton of cash. I'm UP about $10,000 today as panic selling grips the markets. I'm sleeping well at night.

"Porter says 'there is no teaching, only learning.' After not learning twice before, this time is different, thanks to you and the exceptional work your team does every day. With much gratitude..." – Paid-up subscriber Joe C.

"I am a small investor and was shocked the first time the stocks dropped drastically. I checked my portfolio and most of my trailing stops had been passed, with those that didn't being my ultra-small investments (with 'loose change').

"I wondered if I should have sold all of the shares I had, but felt I was being emotional about the drop, so I waited and the next day, the market dropped again. By then, most of my unrealized gains had dwindled to hardly anything, compared to what they were just a couple of days before.

"I just read Dr. Steve [Sjuggerud]'s message about using the trailing stops, but a day too late, and a dollar too short. I now know that I should have been disciplined and sold my shares the first day I saw the drop, instead of thinking that the thought was an emotional one.

"Emotion is something different to different folks, I guess. Stops are there for strict adherence. I learned, the hard way; back to square one." – Paid-up subscriber Rodney Y.

Corey McLaughlin comment: If you missed Steve's message about trailing stops in the Masters Series on Sunday morning, you can still read it right here. With all the volatility in the markets right now, it's as important as ever to remain disciplined as an investor.

And if you'd like a better way to maximize your portfolio's potential, we urge you to check out a recent interview with Steve. In it, he details what you can do to make sure you're ready for the next "Melt Down"... whenever it occurs. Watch the full interview right here.

Good investing,

Dan Ferris
Vancouver, Washington
March 10, 2020