Some Like It Hot

But Not Everyone

I was intrigued by billionaire hedge fund manager David Tepper’s comments on CNBC Thursday morning.

A legend in the hedge fund industry with an estimated worth of nearly $24 billion, over $16 billion under management, and the owner of the Carolina Panthers to boot, Tepper is well-known for making some very astute calls on markets from here to China and amassing a rather large fortune in the process.

Thursday, on CNBC’s “Squawk Box,” Tepper had this to say about the Fed’s first rate cut since last year, noting that they could cut rates a bit more but …

“If they go too much more on interest rates, depending what happens with the economy ... it gets into the danger territory.” You’ve got to be careful not to make things too hot.”

He said inflation, and other risks, could arise from an overly stimulative interest rate policy.

Tepper was more judicious in his risk assessment than I am going to be … his words carry more weight in the markets, given not only his success but also his scale!

From my vantage point, while acknowledging that a quarter point cut in the Fed’s policy rate appears warranted, I would also note that the Fed has rarely, if ever, engaged in a full-scale easing cycle when the unemployment rate was just a tick above what is believed to full employment; when inflation was rising rather than falling; and when asset prices, of all kinds, were at, or near, all-time highs.

By virtually every valuation measure we know of, stocks are expensive in historic terms.

I will offer one caveat in addition to the difficulty of using valuation measures as market timing tools … the NASDAQ in 1999/early 2000 may well have been the most overvalued index in the history of the U.S. market with a price-to-earnings ratio that was virtually immeasurable.

Having said that, let’s review the valuation metrics today, all of which are at historic highs for the S&P 500.

*The forward price-to-earnings on the S&P 500 is above 23, well above its historic norm of 16-18 and sitting at, or just below, a record high.

*The price-to-sales ratio has topped 3.4X … an all-time high.

*Market capitalization to GDP (the Buffett indicator) is 217 … in other words, the value of U.S. stocks is 217% or 2.17X the size of the overall economy … also a record.

*The 10 largest stocks in the S&P 500 comprise nearly 38% of the market value of the index … a level of concentration never seen before.

Again, while markets can remain overvalued for quite a long time … or as is often said on Wall Street, “the market can remain irrational longer than an investor can remain solvent,” it’s prudent to note that any major stimulus could lead to a market melt-up and subsequent collapse.

This is just part of my early warning system test, like the TV warnings we used to get every so often when I was a kid.

It’s not necessary to do anything yet but it is imperative to become increasingly aware of these and the additional risks that may arise if an “easy money” environment emerges in the months ahead.

I’ve witnessed, reported, or commented on, every major market event since the 1987 stock market crash on October 19th of that year.

This does not yet quite “feel” like the period that immediately precedes a crash.

Usually, the Fed is raising rates, not lowering them … or there is some shock to the system here at home, or emanating from abroad, that topples the market.

The ingredients are not there as yet.

If the Fed were to aggressively cut interest rates, driving up inflation just as the economy is rebounding, it could then be forced to change course, stop cutting and, perhaps, begin to take back the rate reductions and start raising them all over again.

That would be a trigger for a serious market downturn.

Again, we’re not there yet and possibly not close to that point.

But, I agree with Tepper that the Fed may not want to do too much going forward for reasons all my own.

Throwing gasoline on a flame, even one that is not blazing hot, can lead to a five-alarm fire … and then, once again, the Fed will be the institution forced to stamp it out.

Let’s hope that cooler heads prevail.