For the first time in almost three years in the markets, I have witnessed a president try to intentionally talk the stock market lower.
President Obama has told Wall Street that this time they should be worried. During an interview on CNBC this week the president said, “This time’s different. … When you have a situation in which a faction is willing to potentially default on U.S. government obligations, then we are in trouble.”
It was a warning shot from an administration who many believe would like to see the markets much lower to reflect what they say is a looming crisis — and you’d be wise to be prepared.
The Treasury Department got in the mix on Thursday by releasing a report saying that failing to extend the debt limit could have catastrophic consequences for the economy. In a statement, Treasury Secretary Jacob Lew added, “As we saw two years ago, prolonged uncertainty over whether our nation will pay its bills in full and on time hurts our economy. … Postponing a debt ceiling increase to the very last minute is exactly what our economy does not need — a self-inflicted wound harming families and businesses.” The report warns of frozen credit markets, a plunging dollar and skyrocketing interest rates, none of which would be favorably received by the equity markets.
Investors need to pay attention to what is going on in D.C. more than ever right now. I hate the mess we’ve made of the system with these idiotic and brutal partisan fights, but they’re just part of our existence right now. If this goes on for too long, the markets will react negatively — look at today’s market action as a harbinger of things to come.
Now more than ever “margin of safety” should be at the top of mind. Given the run stock prices have had, and amid continued weakness in the economy and corporate earnings, the potential upside in the market appears limited. And looking at economic comparisons like the ratio of market capitalization to GDP and the Tobin’s Q Ratio, the market looks to be at best fully valued and at worst overpriced right now — so there is some pretty serious potential downside.
This a good time to review your portfolio and assess the valuations of your stocks and the risk of a serious decline. If you own safety stocks trading well below book — such as Resolute Forest Products (RFP), Arcelor Mittal (MT) and Swift Energy (SFY) — you really don’t have to worry too much about market movements. The business value is in excess of the stock price, so any reversals should be temporary in nature. But if you own a bunch of betting slips with triple-digit P/E ratios — I’m looking at you, Tesla (TSLA), Netflix (NFLX) and Facebook (FB) — you might want to take some money off the table. The stock prices here are many multiples of the business value, and declines could become permanent in nature.
They may not ring a bell at market tops, but the president and Treasury have fired a warning shot. Ignore it at your own peril.
At the time of publication, Melvin was long MT, SFY and RFP.
