In the spirit of Justice Oliver Wendell Holmes’ remark that people need to be reminded more often than they need to be instructed, this is a reminder that my quarterly missives are called market commentaries and not market outlooks. I don’t have an outlook on the market as I think it more useful to try and understand what is going on than to try to predict what is going to happen. The future is about probabilities and the current situation is about facts and interpretations. No one has privileged access to the future and market forecasts tend to be about as accurate as calling a coin toss. There are, of course, analogies that can be drawn about how the current environment maps onto previous historical data, but success in that depends crucially on how the future will, in fact, resemble the past, and whether the cited analogies turn out to be the governing ones. The record seems to show that sometimes they will and sometimes they won’t and we are back at the coin toss.

None of this appears to have any impact or influence on people’s unending attempts to forecast the markets. As I was gathering some material today for this market letter, I came across this headline in a well-known business publication: “Michael Burry, Jeremy Grantham, and other top investors are predicting an epic market crash. Here are their gravest warnings so far. Jeffrey Gundlach, Leon Cooperman, and Stanley Druckenmiller expect a downturn too.” Without quoting every one of the eight investors’ views, here is a typical cross section: “greatest speculative bubble of all time” (Burry); “fully fledged epic bubble” (Grantham); saying the market was “anything other than very over-valued versus history is just to be ignorant of all the metrics valuation” (Gundlach). “I have no doubt that we are in a raging mania in all assets” (Druckenmiller). Then Stan added, “I also have no doubt that I don’t have a clue when that’s gonna end.” He pointed out that “I knew we were in a raging mania in mid ’99, but it kept going on, and if you shorted the tech stocks in mid ’99, you were out of business by the end of the year.” The others quoted in the story mostly did not appear to share Stan’s cautiousness about the risks of actually acting on predictions of a dramatic decline in stocks. I recall George Soros saying in 2008 that he had predicted that financial crisis. He then wryly noted that he had predicted many financial crises over his career that never materialized.

The always insightful Anatole Kaletsky of Gavekal wrote a piece a few days ago titled ‘’A Killer Wave in the Nasdaq Bubble?” He noted that he agreed that “many technology stocks were fundamentally over-valued, while many of the ‘meme stocks’, crypto-currencies and other ‘Covid winners’ will prove fundamentally worthless.” He correctly pointed out the critical issue from an investor’s decision about what to do:

“There is… nothing inconsistent about expecting further big gains in asset prices that are already fundamentally overvalued. This should be obvious to anyone who experienced the 1989 Japanese bubble, the 1999 dot-com bubble and the credit bubble of 2008.”

I would add the 1987 US stock bubble as well.

What is a bit curious about the bears predicting an “epic market crash” is that we had one only 15 months ago. The market went down the most in history in a 4-week period ending on March 23rd due to the panic over Covid-19 before beginning the remarkable recovery we are currently experiencing. Current consensus estimates for growth are around 7%, the fastest in over 30 years. Earnings estimates likewise are being raised dramatically. Household net worth has grown the most in history in the past year. Home prices rose 14.6% in the most recent reading and housing continues to be in short supply. Real interest rates are negative and 10-year treasuries have been declining and offer the prospect of almost certain real loss of capital. The point of most contention is the outlook for inflation. Since I am not in the forecasting business, I don’t have a view. I do observe that prices across a broad sweep of the economy are rising the fastest in decades, but we are already seeing sharp declines in some of the more sensitive commodities such as lumber. It looks like headline inflation this year is on track to hit 5% or more. It is important to realize that it is already well discounted. If inflation is going to be a problem, prices will have to continue to rise over the next few years at well over the Federal Reserve’s average 2% target. The bond market is forecasting longer-term inflation of around that target. A Goldilocks scenario if it comes to pass.

Inflation has been too low (as the Fed sees it) for long enough that most investors have forgotten the 1970’s and early 1980’s when it was a major problem. It is perhaps ironic that 50 years ago President Nixon took the US off the gold standard. During the post-war period through 1971 global banking crises were few. Since going to a system of floating exchange rates there have been many. Bitcoin was born out of the 2008 crisis and was designed to be free of government control and manipulation, to be the ultimate in an inflation proof asset. It is an open question if it will be an enduring store of value, with many strong opinions on both sides.

A recent study of inflation forecasts by economists, consumers, and the bond market found no significant ability to make value added predictions. “As far as major shifts inflation go, we are all in the dark, just as we are essentially clueless about where the stock market is heading or the price of oil in 2022, or the date of the next recession,” as The New York Times put it.

The worries that one reads about regularly in the press and in research reports are already priced into the market commensurate with the market’s assessment of their probability. The market looks broadly fairly valued to me, with most stocks priced to provide a market rate of return plus or minus a few percent. There does appear to be considerable optimism among individual investors about their expected returns from stocks. A recent study by Natixis Investment Managers found that US investors think they can earn 17.5% above inflation per year for the next 10 years. Over the past 10 years, of all stocks and ETFs that existed over that period only 14% of them did that well and 22% lost money. Taking the under on that bet seems pretty safe.

There are pockets of what look like appreciable over-valuation and pockets of significant undervaluation in the US market, in my opinion. We can find plenty of names to fill our portfolios and so remain fully invested.

Bill Miller CFA
July 5, 2021
S&P 500 4352.48