How to Invest in a Bizarro World

Not only are markets overvalued, so we’re in buyer beware territory, the laws of economics seem to have been suspended for the time being. 

The cyclically adjusted P/E, a valuation measure created by the Nobel Laureate Robert Shiller, now stands at over 27, a level topped only during the 1929 market peak, the 2000 dot-com frenzy, and the 2007 equities and housing bubble.

And top economists and asset managers have started to sound the alarm. Larry Summers, the former U.S. Treasury Secretary, wrote that he thinks both the markets and the economy “are most likely enjoying a sugar high that will not last a year.” He’s not a big believer in the current administration, and noted that the best post-election, pre-inauguration performance of the stock market in the last 100 years occurred during President Herbert Hoover’s transition, the same year as the 1929 market crash and the beginning of the Great Depression.    

And though no one is calling for 1929-sized crash, the markets have been propelled on little more than the Trump administration’s proposed tax cuts, proposed deregulation and proposed infrastructure spending.  Not only have those yet to be enacted, even if they are, their success is far from guaranteed.  Tax cuts—mainly to the wealthy—may not produce more jobs and infrastructure spending may not be as large as expected.

On the bright side, the economy has strengthened. Retail spending is strong, unemployment is low, and even inflation is finally rising. But higher rates and a stronger dollar, and a potential trade war could stall economic growth, especially as the U.S. economy has been weak overall.

Meanwhile, asset managers such as those at PIMCO, have been warning that there is a risk that the Federal Reserve could make a mistake and tighten monetary policy faster than markets expect; a situation eerily similar to what the Fed did in 1937 that worsened the Great Depression.

And then there’s the bond market, or rather, the bond bubble. Bond prices have been inflated for years, and the only question is if the air will be let out slowly and less painfully, or quickly in a painful bond crash, that might drag down stocks.

Bizarro Economics

Ever since the 2008 financial crisis, we have crossed over into a financial Bizarro World (Superman comic readers will know the reference), where the laws of economic gravity that were once in place pre-2007 are the exact opposite.

Now inflation is being bolstered on expectations of fiscal policies that have yet to become reality. Meanwhile policy makers are arguing for moves that could cause a trade war and stifle those very same economic growth policies, which is the policy equivalent of a circular firing squad.

Goldman Sachs economists, after running simulations, found that President Trump’s policies, while they could boost growth slightly in 2017 and 2018, are likely to weigh on growth thereafter if trade and immigration restrictions are enacted.

So the future doesn’t look rosy. Income investors should pick only the most stable of investments, such as those we recommend in the Personal Finance Income Portfolio. Particularly, we have created a REIT portion to help subscribers protect against inflation while delivering income and growth. We also hold some top electric utilities names that would deliver stable income in the event of a recession.