Update On My Market View

I remain surprised that the market continues to be accepting and forgiving of disappointing top- and bottom-line corporate sales and profit growth, which has, as its lead, subpar domestic and worldwide economic growth. Failed consensus expectations of self-sustaining growth has, arguably, still not reached "escape velocity," as real GDP growth in the U.S. has averaged only about 2.4% growth per year over each of the last three years. "Outside influences" have replaced healthier nominal GDP growth as a catalyst to expansion of earnings per share. Per-share profits have been buoyed by "financial engineering" -- a continued reduction in companies' fixed-cost basis coupled with aggressive buybacks, fueled by a zero interest rate policy (ZIRP) backdrop. I had thought that corporate share buybacks and a lean management policy (ingredients for a lower quality of earnings) would be re-agents to lower price earnings multiples, not higher price-earnings ratios. The response by investors has almost been nonchalant. The renowned invesment professional from Raymond James, Jeff Saut, highlighted the marked lowering in consensus S&P 500 earnings expectations (over the last nine months) yesterday morning...and yet stocks have continued to move slightly higher What shocks me is how readily most investors have accepted this sharp drop in expectations; judging by the steady rise in the U.S. stock market, they have barely blinked! Here's where I erred in my market view over the past year: While I was materially correct that global economic growth would be subpar and that corporate profit expectations were far too high, I was wrong in my investment conclusion that stocks would suffer because liquidity has trumped and overwhelmed the reduction in profit expectations. That being said, the markets have to continued to rise... Let me close this morning's missive by noting that, historically, if such a meaningful downward shift in profit expectations was to evolve in the last nine months to 10 months, stocks would not likely have moved so strongly in a northerly fashion and valuations might have suffered! Some might argue, and rationalize, the rise in stocks and multiples as normal, as the halving in oil prices (and its damaging effect on energy sector earnings) could be viewed as a "one-off". This is no more of a "one-off" than taking out food and energy from the CPI "consumer price index" (as these are costs of the necessities of life). Or in 2007-09 taking out weakened profits from the financial sector from aggregate profits because of the magnitude of the economic downturn. Until 2014-15, many, if not most, strategists failed to see the valuation rise clearly, though many have swept their views under the rug as if they were never made! Nor did they expect still sluggish economic growth (as world GDP has been much lower than consensus expectations for three straight years), but their vision has grown much clearer in hindsight. Certainly few would have expected, based on history, price-earnings ratios to rise so meaningfully in the face of aggregate profit disappointments. It remains my view that central bankers' showering of liquidity has played a much more important role than many believe in the market, and valuation has climb since the generational low in March 2009. Neither I nor anyone else can rewrite investment history. But as we look at 2015-16, it seems to me that aggregate profits must grow into valuations in order to justify current stock price levels (which are well overpriced), as the expansion in P/Es (earnings) in the face of subpar economic and profit growth seems extreme relative to the corresponding fundamentals. We are now in a "wait and see" moment where stock prices have continued to rise in the face of dissapointing economic news and lowering corporate profits... For example: - The Philly Fed Index (which monitors manufacturing growth) hit its lowest point in a year this month - Insider buying at U.S. corporations has dried up - The Baltic Dry Index (which monitors shipping/tankers cargo and the demand for them) recently hit a 3 year low - The Federal Reserve said two days ago that they were concerned about the continued growth in the economy if interest rates were to start to rise (which they have begun to which is also mortgage applications have slowed to a crawl of late) I'm definitely not "chicken little" as my father always quotes but I will once again mention how we are in a period of investment "no mans land" where the risk/reward profile is more skewed towards being risky. Buyer beware...