The Covid-19 virus has required massive central bank policy intervention and raised our national debt to new highs. We also have racial protests, negative real interest rates, and an election with consequences just a few months away. Yet despite the uncertainties, investors have continued to pile into stocks pushing the S&P500 to all time highs. This commentary addresses why this is occurring, what we are doing confronted with markets with questionable remaining value, and the potential outcomes ahead.

Following a 32% correction in March over shutting down the economy, the markets have mostly recovered aided by $3 trillion stimulus programs from the US Treasury. Ever since, optimism has continued to outweigh fears despite a rebound in the spread of the virus and a divided electorate because of two factors: a less than one percent interest rate on 15 years bonds offering little competition for stocks and because there is a general investor conviction the Fed won’t let the markets fall before the election—aka the Fed put.

Indeed, five tech stocks—Apple, Microsoft, Amazon, Alphabet (Google) and Facebook—now make up nearly 20% of the S&P500 market cap. Apple and Alphabet + Google have each topped $2 trillion in market value; Amazon & Microsoft are above $1.7 trillion, and Facebook is nearly $1 trillion. Apple post-split is valued more than all the stocks in the Russell 2000! Price Earnings ratios are in the high thirties-to-forties on many companies, and Bonds offer a negative real return (return minus inflation) indicating they may have more risk than stocks.

We believe this is a time to be cautious. We have raised cash and may raise additional amounts ahead of the election to go to a neutral position. Our proven methodology is to increase stock exposure when risk is low and reduce it when risk is high. At present both stock and bond valuations appear to be considerably ahead of the economic recovery. Our judgement is the twain will meet at lower prices. When this happens, we will put side- lined cash back to work unless we see some notable opportunities arise like a shift in to value stocks.

Investing is not an exact science. Since 2008 we have had a spectacular rally even from a 14,000 Dow Industrials to today’s nearly 29,000 Dow. Asset values are based on the present value of expected future cash flows. The convention in valuing companies to compare current prices against five- & ten-year average valuations considering their growth prospects. At today’s prices the discounted cash flow model indicates near extreme valuations and the future returns on the S&P500 to be in the low single digits. That is because the higher price you pay today for a future cash flows, the lower you can expect long term returns to be. Market momentum favoring streaming and remote activities has given us a lop-sided market with rising volatility. We can’t say when the tide will shift, but we do know it will and with these certain prospects we are adding safety, trying to avoid tail-risk, and looking to add hedges. Current forward prospects are worrisome. Leverage is high and money is cheap. We want investments that are cheap.