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Unio Capital is an asset management firm—oriented to publicly-traded equities, global in scope, and equipped to manage hedged and long-only portfolios as funds and separately-managed accounts.

The Bull & the Risks

In Perspective

Unio's "In Perspective" short-form series covers the Unio team's views on topics ranging from investing to business to economics.  

 

The Bull & the Risks

John Allison

Yes, a bull

If it looks like a bull, snorts and paws like a bull, and charges like a bull, it is a bull. And this is a bull market.

Absolutely, no doubt about it. It is one of the great bull runs in history—already 5 ¼ years old. On March 6, 2009, the S&P 500 was 676.53; on May 31, 2014, it was 1923.57. Total price appreciation: +284%. Compounded annual price appreciation: +22%!

These are astonishing numbers for any era, for any market, but especially for a big, developed market like the United States.

A unique bull

However, keep in mind that this is a bull market like no other. It is truly one of a kind.

Never in the past few hundred years—and we can start with the founding of the Bank of England in 1694—has any equity market rally been accompanied by as massive and long-lived a monetary stimulus as this one. Put another way, never in the past few hundred years has an economic recovery and stock market boom been as clearly attributable to the stimulative actions of monetary authorities, starting with our own Federal Reserve.

In fact, when trying to size up this bull market in the context of previous bull markets, we find ourselves in uncharted territory. There has simply never been a bull so pumped up with adrenalin injected by monetary authorities.

Thus, when people marvel at the extraordinarily low stock market volatility as measured by the VIX index—see the accompanying chart—they are simply marveling at a symptom of central bank actions. They should be marveling at an image of the Federal Reserve in Washington.

VIX Index 1990–2014

The good bull

Without doubt the bull market has done good things:

  • It has made stock-owners wealthier.
  • It has lowered costs dramatically for all sorts of debt holders—from the homeowner to the private equity owner.
  • It has played some role in raising the good old animal spirits which in turn has given an assist to GDP demand, employment and mergers and acquisition activity.
  • It has helped to heal the most traumatic effects of the financial system’s 2007–09 breakdown.

The unstoppable bull market

Once bull markets get going, they enter a phase I describe as “we can’t believe this, but it’s true.”

That’s the phase when people are astonished by the magnitude of the bull; can barely believe it; but can’t see anything to get in the bull’s way. In other words, people see a bull whose historical run they can’t deny and see no credible risks to slow down its future charge.

We are there now—there where the bull is beginning to look unstoppable.

One symptom is that more people than ever are throwing in the risk towel. Inflation worriers have given up. Bubble watchers see mini-bubbles but nothing big. Bond bears are slinking off.  Hedge funds are un-hedging. Another symptom: more people are offering more reasons—or rationalizations—for joining the party.

It is completely unknowable how long any bull market will last. This one could have weeks or years left in it.

Weeks if, for example,  inflation just creeps up to the 2½% to 3% range triggering a jerk upward in interest rate expectations.

Years if the world economy huffs and puffs well below what central banks think is its potential, giving them the self-perceived latitude to be as accommodative as they wish.

A historical Rubicon. A gargantuan take-over.

However, what is nowhere near sufficiently appreciated by investors is that the Fed—and other central banks following its lead—crossed a historical Rubicon in 2007–09:

Central banks largely took over the stabilization and stimulation of the economy from those who pull the Keynesian fiscal levers of government (in this country, the President and Congress).
This represents the most profound takeover in economic management since Keynesianism itself took over the keys to the economic castle around 1945.

Risks of the Rubicon

When we take our eyes off the bull and try to peer through the dust it is kicking up, at the risks all around, what do we see? In order of smallest overall impact to biggest, we see four outsized risks:

  • In 4th place: Mini-bubbles that grow into bigger, stronger adult bubbles—bubbles ranging from junk bonds to long-term governments to emerging-market corporate debt to modern art and   selective valuation bubbles in equities throughout the world.
  • In 3rd place: Political and social instability around the world, which will grow in frequency and size for a variety of reasons, ranging from slack leadership over the world economic and political system; to power vacuums filled in by groups ranging from tribes to nations; to opposition by social groups, which believe they are not getting their fair share of the pies that divide up wealth and power.
  • In 2nd place: Major China stress from a country believed to be the growth engine for the world economy. Past performance is expected, through the cleverness of the political leadership, to be a harbinger of future results—until it becomes evident that, despite its financial strength, China’s misallocation of resources, and the debt funding that misallocation, cannot be finessed away without serious pain and disruption.
  • In 1st place: the biggest risk of all: The one-trick pony bull market—to seriously mix a metaphor—engineered by central banks that believe the good they are doing more than outweighs the risks they are creating, and who are believed by investors to have full control over economic reality—until the day comes when the tricks or the control end or abate.

Two stadiums. One strategy.

Right now, we as investors are like fans with tickets to two different championship games in two different stadiums.

One is the bull-market contest where, fortunately, we still like what we own and have plenty of ideas in reserve.

The other is the risk contest where risks are growing.

Our strategy is not to prefer one stadium over the other but to deal with each so that, when the day comes and there is one game in one stadium, we are ready.

– John A. Allison