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CONCLUSION: We see downside risk in the US equity market over the intermediate term as the structural bull thesis is riddled with shortcomings.

According to Dr. Richard Peterson, renowned behavioral psychologist and author of the highly-acclaimed book, Inside The Investor’s Brain, an asset class needs to two features to be correctly identified as a bubble: 

  1. A good story; and
  2. Price confirmation. 

While we don’t care enough to argue whether the US equity market is or is not a bubble at the current juncture, we can confirm that this market does indeed satisfy the previous criteria. In reverse order, the S&P 500 remains in a Bullish Formation on our quantitative factoring – albeit amid some of the most worrisome volume and volatility signals in years.


In line with Keith’s remarks on our Morning Call yesterday, we continue to be unsurprised to see prices jammed higher due to the sheer level of performance chasing and “short low/cover high” strategies being employed across the oversupplied asset management industry. In spite of this, we continue to side with our proprietary Global Macro GROWTH/INFLATION/POLICY fundamental research process that continues to auger bearishly for global equity markets (including domestic stocks) with respect to the TREND duration.

To address the former of the aforementioned criteria, below we debunk what we see as three of the most deeply ingrained arguments in the structural bull thesis on US equities:

“Investors are massively underweight equities, therefore the market should continue to trend higher as both investors and fund managers chase performance.”

On a variety of measures, there is a bit of truth to this statement. At the fund manager level (excluding money market mutual funds), investors ended 2011 with a 61.5% allocation to equities (per the 2012 ICI Factbook), which is -0.2 standard deviations from the long-term average (yearly data starting in 1990). At the broader mutual fund investor level, which has been shown to be even more sensitive to forward-looking economic variables than the asset allocation strategies of fund managers (many of whom may be constrained from a mandate perspective), equities represented 44.8% of total net assets of the mutual fund industry. That is 0.2 standard deviations from the long-term average (yearly data starting in 1975). Net-net, at -0.2x and 0.2x standard deviations from their respective historical means, we’d argue that neither fund managers nor mutual fund investors are grossly underexposed to equities.




Given the understanding of the aggregated prescience of mutual fund investors as indicated in the previously hyperlinked article, we decided to run the analysis a bit deeper. We regressed the broad allocation to money market funds against the broad allocation to equity funds, finding exactly what we expected to find: an obvious and statistically tight negative relationship (i.e. “risk on/risk off”). Furthermore, we looked at the residual of the latest data point (2011) to see if A) it implied whether equities were over/under allocated to with respect to the model and B) by how much. In short, this analysis suggests that according to the weight of mutual fund investors’ allocations to money market funds (i.e. cash), they are underweight equities by -730bps in their portfolios – a fair amount (-0.9 standard deviations to be exact), but not nearly as underweight as they were in the late ‘80s/early ‘90s ahead of that bull market in US stocks.





All told, while there is certainly room to return to prior peaks in equity allocations, the notion that investors and fund managers are massively underweight equities and, thus, are poised to materially ramp up their exposure to this asset class is more than likely a gross overstatement.

“The US is not headed for a Japanese-like financial market outcome(s), largely because we continue to have favorable demographics, whereas Japan does not.”

***We attribute much credit for the following analysis to our Healthcare team, led by Managing Director, Tom Tobin. To the extent you like what you see below and would like to trial their research, please email .

While perhaps not as acute as the gaping bi-partisan leadership void in Washington D.C., the US’s demographic headwinds can be considered equally as problematic as it relates to the long-term health of the US economy. To arrive at this conclusion, we initially source a 2007 paper from The Review of Economics and Statistics that strongly demonstrates a consistent pattern of consumption throughout the human life cycle – specifically the presence of a steep hump with peak consumption typically occurring in the mid-to-late 40s due to changes in household size and makeup. Not surprisingly, we were able to document similar humps in the latest US census data, from both an income and expenditures perspective.





As it pertains to the most economically important cohort (i.e. people at/near peak earnings and peak consumption), YoY growth rates in this segment of the US population are set to remain negative through 2019 – after having turned negative for the first time since 1975 in 2008 (coincidence?). Needless to say, contraction here will continue to weigh on the US and global economy for quite some time. Specifically, by applying a demographic overlay (i.e. # of people per age bucket) to the income and expenditure data from the two charts above, we have created metrics that project total after-tax income and total consumer expenditures; YoY growth rates in both series are set to continue slowing though 2022.





In summary, we would agree with the view that the US does not have as negative a demographic outlook as has been repeatedly documented in Japan. That said, however, the US economy does have its own demographic challenges to contend with over the next 5-10 years, making a return to persistent rates of +2-3% real GDP growth an unlikely scenario over the long-term. Perhaps the trailing 10yr average of +1.6% is just about right. If that is, in fact, the most probable scenario, we’d argue that investors are NOT missing a generational opportunity to allocate funds to the equity market, as many perma-bull marketers would have you believe.

“Corporate profits – which have been outstanding of late – will ascend to even greater heights when the economy bounces back, rendering US equities substantially undervalued on a broad basis.”

This is arguably the easiest tenet of the long-term bull thesis to debunk and we’ve already completed a compendium of thoughtful work on the topic. In short, we certainly do commend the efforts of US corporates for being able to consistently generate margins at/near peak during such a challenging economic environment. Inclusive of this tipping of the hat, we’ve walked though the steps they’ve taken to achieve such lofty results in great detail and, needless to say, we are not completely impressed. Specifically, the broad-based trend of cost-cutting and negligible investment sets US corporate revenue growth to remain sluggish for the foreseeable future.

This is on top of incessant capital misallocation out of central planners across the globe, which is likely to perpetuate muted top line (i.e. GDP) expansion from a macroeconomic perspective for the foreseeable future.

In short, we find it unreasonable for investors to expect anything but weak sales growth, given that instead of investing in their businesses, companies are using capital to buy back stock with the hopes of juicing earnings. We don’t see how that is sustainable from a long-term perspective. By all means, email us if you disagree.

The following research notes provide the analyses upon which we have formulated these conclusions: 

  • HAVE US CORPORATE EARNINGS GONE TOO FAR? (JUL 20): “When analyzed outside the vacuum of short-termism associated with quarterly reporting, US corporate profit margins appear particularly overstretched – from both an operational and a social perspective. This has potentially dire implications for corporate earnings growth over the long term.”
  • ARE  US EQUITIES SUFFERING FROM COGNITIVE DISSONANCE? (AUG 8): “We see a similar see a similar pattern in consensus storytelling and a similarly-asymmetric price setup as we did in the previous occurrences of our being bearish at cyclical tops in the US equity market and “risky assets” broadly (1Q08, 1Q10, 1Q11, 1Q12).”
  • THINKING OUT LOUD RE: GLOBAL GROWTH (AUG 10): “New data points, including negative revisions to the official growth forecasts out of Singapore and Hong Kong, affirm our bearish conviction on the slope of global growth with respect the intermediate-term TREND duration. Applying a longer-term lens, would argue that the incessant policy responses out of the global central planning cartel over the last ~5yrs have set us up for broadly weak economic fundamentals for the foreseeable future.” 

All told, while you may not agree with our ultimate conclusion that the US and other global equity markets are likely to head south over the intermediate term, we do think it’s important to help you contextualize the key top-down economic debates as you ponder the bottom-up exposures in your portfolios. In that regard, we find that three of the most central tenets of the structural bull thesis on US equities are substantially weaker than they are likely being perceived by popular consensus.

Darius Dale

Senior Analyst