Cash will be King

- By Bill Bonner

Bill Bonner

Gualfin, Argentina

Dear Diary,

Where is that old, tattered, black and blue, "Crash Alert" flag?

Many times since '09, have we hoisted it. And many times has it failed to give us a useful signal.

But we will bring it out again...and let it wave, if a bit sheepishly, in the warm Argentine air.

Why? Do we know a crash is coming? No, of course not. Is our flag a good indicator of what will happen? No, apparently not.

But we regard it like the 'Shark Alert' flags you see on the beaches of Australia. (Down Under is the only country in the world to have a chief of state who was eaten by a shark.) The 'shark alert' flag doesn't mean you can't go swimming. But if a shark takes a bite out of you, it's your own damned fault.

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Why are we raising the flag again, now? John Hussman explains:

Last week, the cyclically-adjusted P/E of the S&P 500 Index surpassed 27, versus a historical norm of just 15 prior to the late-1990's market bubble. The S&P 500 price/revenue ratio surpassed 1.8, versus a pre-bubble norm of just 0.8. On a wide range of historically reliable measures (having a nearly 90% correlation with actual subsequent S&P 500 total returns), we estimate current valuations to be fully 118% above levels associated with historically normal subsequent returns in stocks. Advisory bullishness (Investors Intelligence) shot to 59.5%, compared with only 14.1% bears - one of the most lopsided sentiment extremes on record. The S&P 500 registered a record high after an advancing half-cycle since 2009 that is historically long-in-the-tooth and already exceeds the valuation peaks set at every cyclical extreme in history but 2000 on the S&P 500 (across all stocks, current median price/earnings, price/revenue and enterprise value/EBITDA multiples already exceed the 2000 extreme). Equally important, our measures of market internals and credit spreads, despite moderate improvement in recent weeks, continue to suggest a shift toward risk-aversion among investors. An environment of compressed risk premiums coupled with increasing risk-aversion is without question the most hostile set of features one can identify in the historical record.

The water is full of sharks, in other words. And that's why this is the best time to get out of the market in the next 8 years, says Hussman. Over the next 8 years, he says, the likely return from a balanced portfolio of stocks and bonds is zero.

Meanwhile, so nutty are valuations (in light of the underlying economic situation) that SocGen analyst Albert Edwards is afraid he may be going bonkers too:

"We are at that stage in the cycle where I begin to doubt my own sanity. I've been here before though and know full well how this story ends and it doesn't involve me being detained in a mental health establishment (usually). The downturn in US profits is accelerating and it is not just an energy or US dollar phenomenon - a broad swathe of US economic data has disappointed in February. One of the positive surprises, payrolls, is a lagging indicator. The $64,000 question is not if, but rather when will investors realise what is going on?"

Yesterday, we looked at something so counter-intuitive, so contrarian, so out-of-the-box that many readers thought the craziness must have gotten to us. They urged us to get back into the box as soon as possible.

But one of the advantages of being down here in Argentina, so cut off from civilization, is that we can't find the box. We are largely out of touch with the news and cut off from popular opinion.

On a typical day, we rise at 7am...we chat with the farm manager...eat breakfast outside in the sunny courtyard...and settle into our work. We read a few headlines and stories on our computer (yes, we have solar power and a satellite internet connection). Then, we read more...and answer correspondence. We have lunch. We read some more and we sit down to write.

Then, when we are tired of sitting, at 5pm, we saddle up a horse and go for a ride. The ride usually takes a couple of hours, simply because it is takes so long to get anywhere. Yesterday, for example, we rode up the river bed towards the old stone mill. A sluice brought water down from an irrigation canal and used it to turn a stone grinding wheel. We've spent time studying its primitive technology. And we pray civilization will not collapse; we don't think we could ever figure out how to make it work again.

The ride was gloriously beautiful, through huge clumps of pampas grass, across the marshes, up the side of the hill, along a stone wall that led to the mill. A few white puffs of cloud flew across an otherwise pure blue sky...yellow flowers covered the hillsides.

Having cleared our brain, we returned to our thoughts. Lately, we have been thinking about how we, and almost everyone else, misjudged the effect of central bank policies. As we mentioned yesterday, they are not "printing money." Nor are they stimulating the economy.

Instead, they are providing credit to the financial industry and to the richest part of the population. Chris provided some detail on how corporations use credit to buy back their own shares yesterday. February set a new record for share buy backs.

This is the effect of cheap credit - it gooses up asset prices. It encourages speculation and quick-buck gambling. It does not raise consumer prices or help the real economy.

That is why the rich get richer - because assets go up in price. And it is why the poor get poorer - because real investment, the kind that produces jobs and incomes, goes down.

Curiously, even Alan Greenspan, now at liberty to speak the truth, said so himself:

"The single biggest problem in our economy is a lack of real capital investment."

Instead of the kind of patient, sensible, capital investment that we would see in a genuine boom, the cheap money policies encourage bubbles. Hussman explains:

When investor preferences are risk-seeking, overly loose monetary policy can have a disastrous effect by promoting reckless speculation and enhancing the ability of low-quality borrowers to issue debt to yield-starved investors. This encourages malinvestment and financial distortions that then collapse, as we saw following the tech and housing bubbles. Those seeds have now been sown for the third time in 15 years

All bubbles burst. They burst whether the Fed is raising rates or lowering them. And all bubbles burst in a way that destroys credit, but raises up the value of cash.

This is the curious phenomenon that almost nobody but us sees coming - the Fed inflates the base money supply by trillions of dollars, but instead of a falling dollar, the greenback becomes so valuable that people cannot live without it.

Cash will be King. Emperor. Rock star. And Oscar winner.

Briefly.

Stay tuned...we're getting somewhere important...