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Analyst Warns - Be Cautious With Complacent Markets And Weak Fundamentals

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EDITOR NOTE: You can't fool mother nature. In time, the market will correct the current "disconnect." And when it does, the present chaos will seem like a walk in the park. When this happens, it will be far too late to purchase bargain precious metals
 
Protesters march across the Brooklyn Bridge as part of a solidarity rally calling for justice over the death of George Floyd, June 1, 2020, in the Brooklyn borough of New York.

All roads seem pointed in one direction at the moment. The S&P 500 SPX+0.7%  closed up on Tuesday for the third-straight session, extending the rebound from the March lows to nearly 38%. Investors continued to flock to the hard-hit cyclical sectors, including energy, industrials and materials.

Mike Larson, senior analyst at Weiss Ratings, said he has never seen anything like it.

“It’s the biggest disconnect I can remember in the almost-quarter century I’ve been active in the markets,” he said. “I can’t recall a time when we’ve seen a large disconnect between, not just what’s going on in Main Street versus what’s going on in Wall Street, but what’s going on in the underlying fundamentals that would normally impact Wall Street.”

Larson said it’s unlikely a V-shaped recovery in the economy will take place. Even situations that previously caused markets to gyrate — like U.S.-China trade tensions — are now largely brushed aside. “We’re seeing a clear and an obvious breakdown in that relationship and yet the markets have hardly blinked.”

The markets also have ignored the protests over the police killing of George Floyd and ensuing violence that has gripped cities nationwide. “It’s hard as an American, much less as an analyst or investor, to look at what’s going on on Main Street in the last week, and believe that this isn’t going to have serious repercussions, or shouldn’t be having serious repercussions, in terms of risk appetite or the trajectory of any economic recovery and/or longer-term sort of impacts on society.”

Via Bank of America, this chart shows flows into various segments of fixed income, commodities and currencies.

Via Bank of America, this chart shows flows into various segments of fixed income, commodities and currencies.

The biggest dislocation he sees is in the high-yield, or junk bond JNK+0.42% segment of the market.

 

“The instant the Fed began discussing buying and backstopping high-yield bonds, fallen angels and so on, through a couple of different means, we’ve seen enormous inflows into ETFs. We’ve seen enormous interest in buying the riskiest possible credits out there,” he said. Larson pointed out the Fed itself was warning about corporate lending less than half a year ago, as has the Federal Deposit Insurance Corp., the Bank for International Settlements and the International Monetary Fund.

But what about the move lower in interest rates, and the positive impact that has on valuations?

“I understand completely when you’re discounting future cash flows back to the present, lower rates help, and that contributes to the there-is-no-alternative trade, so I get the other side of the trade, and it’s hard to lean too hard against it in the short term,” he said.

“But when you look at whether, ultimately, the credit quality and the underlying fundamentals are going to support the asset values, you have to use some extraordinarily generous economic assumptions, and assumptions about the vigor of this rebound, to get from point A to point B. I think that’s the real danger here — I think that there’s a lot of complacency on what liquidity can accomplish when it comes to fixing solvency-related and asset valuation-related excesses.”

He recommends having a defensive posture in portfolios. “That includes things like carrying more cash than you did prior to the first quarter of 2018, focusing on more yield-oriented defensive sectors than you would have from 2009 through 2018,” he said. On a three-to-five year basis, safer plays from gold to longer-term Treasurys have outperformed, with the one exception being the technology sector, he said.

Originally posted on MarketWatch

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