Complacency

“THE STRIKING PRICE” is a weekly feature in Barron’s magazine. It has a few charts that I find informative. Here are last week’s charts:

ON-CD549_bCBOE0_NS_20170526193030

from the Barron’s article:

http://www.barrons.com/articles/its-time-for-investors-to-pounce-on-banks-1495858728

Here’s why I find this interesting. The top right chart (EQUITY ONLY PUT-CALL RATIO) is showing the lowest value I have seen in recent years. People generally buy PUT options to protect against rapid stock market declines. This is a 21-day weighted PUT-CALL ratio, as explained here, which is to say that, in the last 3 weeks, investors have reckoned that the chance of a crash is pretty low. Low volatility has also made the news is recent weeks (see the top left chart above).

Yet, investors are not bullish. In fact, the AAII sentiment survey shows that very few investors (just 27%) expect a rise in the overall stock market in the next 6 months. Rather, investors feel “neutral”.

I sense complacency, which is a sign that there’s probably an unpleasant surprise around the corner.

Warren Buffett vs. the bond king

I came across two news items today. In one, Warren Buffett said that US stocks are not expensive. In the other, Jeff Gundlach trashed the S&P500 (deprecating passive investing in  general) and suggested buying emerging markets instead. On the surface the opinions seem to be at odds, but the two gurus are providing pieces of a jigsaw that makes sense if we find and put together the missing pieces.

Buffett was responding to a question on the overvaluation of US stocks as measured by the “Market Cap to GDP ratio” and the “Cyclically Adjusted PE ratio”. His answer was that ratios are informative without being absolute. Further to Buffett’s point, early signs of a recession are conspicuously absent. Buffett no doubt sees this through the reports Berkshire Hathaway receives. Granted this could change quickly, but for now the economy is doing well. Buffett prefers stocks because their expected return is much higher than that of treasuries. Two points struck me as essential to complete the picture, yet not clearly stated:

  1. Buffett is a stock picker. I’m not surprised he is finding good value in US stocks, because there are enough companies whose stocks are cheap in relation to their future cash generation potential. However, the US stock market also has plenty of companies that will do far worse (many will go bankrupt) than treasuries. Investing in a stock market index may not be a good idea because one ends up buying the good and the bad.
  2. Which is what Gundlach (google “bond king”) was saying at the SOHN conference: Investing in a stock market index (such as the S&P500) is a bad idea. His point is that stock pickers (like Warren Buffett) will do much better than a market index. But he is also implicitly saying something else: that we are not constrained to invest inside the US alone. It’s not “do we invest in US stocks or US treasuries?”. There’s an entire universe of securities that we have access to. Gundlach sees good returns – even without stock picking – in emerging markets.

It would be fair to say that those with the talent for picking stocks globally will do quite well.