Bernstein: Big Bond Investors Blew It

January 12, 2018 What would reverse your bullish outlook on equities at this point?

Bernstein: There are three things for us that we always look at. We look at profits. We look at liquidity and we look at sentiment/valuation.

Profit’s still accelerating around the world, so we think that’s OK. There’s a ton and a half of liquidity out there. And we know that because the VIX [Chicago Board Option Exchange (Cboe) Volatility Index] is telling us that. Right? The VIX is really more than anything else a reflection of how much liquidity there is.

It’s hard to get volatility when there’s a lot of liquidity, because people buy on the dip. Nobody ever asks, “Why don’t people buy on the dip in a recession?” The answer is because they don’t have any liquidity to do so. So we know there’s a lot of liquidity.

And sentiment and valuation—look, it’s not March of ’09. I’m not trying to overplay my hand on this one, but we’re nowhere near extremes.

What would make us change? Well, if profits rolled over, if liquidity dried up too much and people were truly euphoric about equities, that would do it for us. Do you think the tax reform package has given new life to the bull market in equities?

Bernstein: Yes. And it should. Whether it should for three years or not—getting back to the panel title—is another story.

Here’s why I say this: The short-term effect is what we call “unmitigatingly bullish” for the stock market. And the reason is that a cut in the corporate tax rate is specifically designed to aid the owners of capital. Who are the owners of capital? The shareholders. It’s called equity because you’re a partial owner of the company.

A cut in the corporate tax rate is specifically designed to help those people and to help investors. So on the surface you could say yes, this is very bullish. However, we’re a little skeptical that the secondary-, tertiary- and fourth-level effects of the tax cuts will actually come to fruition; in other words, creating jobs, building new factories, all this kind of stuff.

The reason goes back six, seven years ago, where I pointed out that, when you get a tax cut, there’s an inevitable leakage abroad. And it’s very difficult to measure. What I mean by this is, let’s say you’re a company and you’ve decided you’re going to go buy new computers. So we go and buy 25 new computers for the company.

Well, where are those computers made? They’re made in Korea, Taiwan or China. What’s happened is that some of the stimulus effects of the tax cuts has just aided Korea, Taiwan, China, someplace else. And has it really stimulated production here and job creation here? Or has it stimulated production and job creation in Korea?

Who would know? It’s very difficult to determine that. But given our trade balance, it’s a pretty fair guess that there’s going to be a fair amount of leakage.

My argument in the article that I wrote for The Financial Times was that, giving just blanket cuts would have a very muted effect on the economy longer term, would more likely just drive up the deficit because of these leakage effects.

Rather, what you should do is give tax cuts for good behavior. If you build the plant there, you get the tax cut. But you don’t get the tax cut hoping you’re going to build a plant.

Contact Heather Bell at [email protected]

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