A steady barrage of economic and market news clogs both our airwaves and our minds on a continuous basis. This information is dissected and examined in a variety of different ways with no shortage of expert opinions about what is taking place today in investment markets and what is likely to happen next come tomorrow. As a result, it can become very easy for even the most expert market participant to become so twisted around in the details of their own views and biases that they lose sight of the more basic bigger picture. For it is these simple naked truths that remain most important in recognizing what has brought us to this point as well as what is likely to come.

The following are some important simple naked truths.

The U.S. and Global Economy Is Both In Poor Shape And Chronically Sick

It is a common refrain across the business media. The U.S. economy is growing! It is picking up steam! And it is going to enter a sustained breakout phase “in the second half of the year”. The “second half of the year” claim has become almost comical, for this is a promise from analysts that we have heard each and every year since 2010. But the only problem is that this sustained economic growth breakout never actually happens despite the fact that stocks have repeatedly priced in this outcome each and every year.

Here is the reality. The U.S. economy is in poor shape. And it is chronically sick. How can I make such ridiculous claims? After all, there is no shortage of generally strong U.S. economic data to flatly contradict these statements. But here’s the thing. If the U.S. economy was indeed healthy and “robust” as so many are describing, why then has the U.S. Federal Reserve kept interest rates locked at the zero bound for more than six years and five years longer than they originally intended (remember when the talk was around preparing for rising interest rates in the spring of 2010 with QE1 having drawn to a close)? If the U.S. economy has been so strong, why did the Fed feel compelled to double their balance sheet again in the “post crisis period” from 2010 to 2015 by purchasing another $2.3 trillion in assets? And if economic conditions are so sound, why is the Fed so hesitant to raise interest rates by even a quarter point off of this zero bound more than six years after the “end of the financial crisis”? The answer to all of these questions is that the U.S. economy remains in poor shape despite more than six years of extraordinary central bank policy actions. Put simply, any positive economic numbers today are a result of flooding the financial system with liquidity. And if these are the economic numbers that we have today after printing nearly $4 trillion in U.S. dollar currency, or roughly 25% of U.S. GDP, it is an indication of a lingering sickness underlying the U.S. economy.

The same principles hold true across the globe. Would Japan (NYSEARCA:EWJ) need to recently up the ante on the doubling of their yen money supply if they were steaming out of the deflationary spiral in which they have been trapped for more than two decades? Would Europe (NYSEARCA:EZU) need to violate the principles underlying the euro experiment by entering into their own quantitative easing program if all of their problems were solved? And would China (NYSEARCA:FXI) feel the need to shift their monetary policy stance on a seemingly weekly basis while having enough housing vacancies in their country to provide an empty bed to every single citizen in the United States if there were not some chronic imbalances in their economy? The answer to all of these questions is absolutely not. In fact, these economies are ailing even more than the U.S. economy.

Quantitative Easing Does Not Work

Quantitative easing (QE) was a great solution in rescuing the global economy from collapsing into the abyss. And global central bankers including the U.S. Federal Reserve and Ben Bernanke should be enthusiastically applauded for their swift and effective efforts during the 2008 and 2009 period. But what was a solution to prevent a global financial meltdown has not at all been a solution to generate a sustained economic expansion. Sure, it’s been great in artificially inflating asset prices including stocks, but if QE were going to generate the next great wave of economic growth, it would have already done so long ago. We are now long overdue for a new policy approach to an old problem that is simply not going away.

Central Bankers Are Not All Knowing

The perception exists among the business media that central bankers are omnipotent. And it is widely held that they have the insights and crystal balls to do no wrong and solve the world’s problems. But this is not the case at all.

Do not get me wrong. I have enormous respect for those that serve in leadership roles at the major global central banks including Janet Yellen and Mario Draghi and all of the individuals that serve in the major supporting roles. They have been presented with some exceptionally complex problems for which there are no easy answers. And they have been getting little to no help from fiscal policy makers in their ongoing efforts to combat the ongoing challenges they face. In fact, they have been able to accomplish what they have so far despite the obstacles that fiscal policy makers have placed in front of them. For all of these reasons, they have earned by continuous admiration and appreciation for their work.

But with that said, they have neither the answers nor the silver bullet to get economic growth back in their respective regions back on a sustainable path. Instead, they are experimenting with the limited and largely untested tools that they have and are hoping for the best like the rest of us. To this point, the European Central Bank did not engage in its own quantitative easing program that started in March because it has worked so well for the rest of the world. Instead, they launched into the program because they simply did not know what else to do.

One final point in regards to central banking as we know it today. We are only 44 years removed from the end of the gold (NYSEARCA:GLD) standard and the advent of the current fiat currency system in 1971. This is not a very long time in the grand scheme of things, and our path along this road has been marked by an initial period of high inflation in the first decade followed by a two decade period of prosperity and then two major asset bubbles over the past fifteen years. All of this has led us to a period in the last few years where central bankers are now stretching the fiat system to the limit by printing their currencies in a way that some might describe as reckless. These are unprecedented times, and the longer-term consequences of such extraordinary behavior are not yet known.

Stocks Are Expensive, And More Expensive Than Already Appear

It is no secret that many in the investment community now view stocks as expensive. Sure, some experts still can torture the data into confessing that stocks are still undervalued by certain measures – I can definitely make the case for it myself and may actually do so in an upcoming article for the sake of discussion – but such views should be taken with a healthy sized block of salt. For based on a straightforward measure, stocks as measured by the S&P 500 Index (NYSEARCA:SPY) are trading at nearly 21 times trailing 12 month as reported earnings. This represents a roughly 30% premium over the long-term average and is a multiple that has not been reached very often or sustainably throughout market history.

But what is often not mentioned is that current valuations likely understate by a considerable margin how expensive stocks actually are today. After all, the price-to-earnings ratio is a multiple derived from two variables in price per share and earnings per share. Yes, stock prices have gone up, which has increased the multiple. But what has also taken place in this environment of zero interest rates over the past six years has been widespread debt issuance along with record levels of share buybacks, which has the effect of increasing earnings per share in a meaningful way. Put more simply, the denominator “E” in the “P/E ratio” has been getting inflated by aggressive share buyback activity, and basic math tells us that making the denominator bigger when dividing will result in a smaller number in the answer to the problem. As a result, the P/E ratio in reality would likely be meaningfully higher than it is today without all of the post crisis share buyback activity, which is less than productive activity from an economic growth standpoint.

Beyond valuations, it is important to recognize why stocks have done so well in the post crisis period. They have not tripled from crisis lows over the last six years because of the economy. Instead, they have done so despite the economy. For if it were not for the continuously extraordinary monetary policy actions that have been carried out over the past many years, there is no telling where stocks might be trading today. But presumably, it would be meaningfully lower from where they are right now.

Bonds Are Also Expensive And Have Entered Into The Realm Of The Surreal

This one speaks for itself. Yes, U.S. Treasury yields (NYSEARCA:TLT) remain at historical lows below 2%, but these are levels that can at least be rationalized and some might argue they are actually attractive given all that is going on in the global economy right now. But the fact that we are now looking at negative interest rates meaningfully out the yield curve in many developed nations (NYSEARCA:BWX) has global investors slipping down the rabbit hole. Let’s look at this for what it is – you are being charged to lend money, as borrowers are charging you for the privilege to borrow money from you. Beyond the absurdity that exists at the surface of this arrangement, it also provides further support to the notion that the global economy remains chronically sick. For the fact that capital would rather be charged through owning bonds than finding another productive and presumably inflationary destination where a reasonable rate of return could be generated highlights how badly true underlying demand is lacking in the current economy.

Stocks And Bonds May Become Vastly More Expensive Before It’s All Over

Both stocks and bonds are expensive. But they have been expensive for a long time. And as long as global central banks remain intent on staying the course with their quantitative easing ways, global bond yields are likely to continue falling and stocks are bound to continue rising in response. For example, a 21 times earnings multiple on the S&P 500 Index implies an earnings yield of roughly 5%. In a persistently low and falling interest rate and bond yield environment, such an earnings yield may be attractive to many investors. And we may reach a point where a 4% or even a 3% earnings yield may be attractive to investors before it’s all said and done.

We Have No Idea How This All Will End

These are extraordinary times in which we are living as investors today. The policy prescriptions being carried out by global central bankers have never been done before, and we are now seeing distortions in asset prices that were unthinkable even just a couple of years ago. We have no idea how this is going to end. It may end well with everything eventually resolving itself, and I certainly hope that it does. But it also may end very badly. We simply do not know. But with this uncertainty in mind, investors should resist the temptation to simply assume that this will all end well.

More importantly, investors should use great caution in trying to apply traditional economic and market rules in the current environment. It’s not that this time is different. Instead, it’s that this time is so incredibly distorted that the standard data instrumentation may be providing readings that have gone haywire. For example, one cannot simply rely on waiting for an inverted yield curve to predict the next recession, for it is difficult to invert a yield curve when short-term interest rates are pinned at zero. Of course, one way for it to happen would be for longer term interest rates to turn negative, but that’s simply impossible. Oh yeah, that’s right. It’s not impossible anymore.

These Are Times For Caution, Not Panic

By now, some readers will be warming up their remarks in the comment section that I am presenting nothing but “doom and gloom” in this article. But I hope this is not your take away, as this is not my intent to deliver such a message. In fact, I am a believer in the natural resilience of the global economy and the free market system. And I am optimistic that once policy makers finally allow pent up corrective forces to take place that the next great secular bull market awaits in its aftermath. The U.S. and global economy have so many growth themes to support long-term prosperity, and I am excited about what lies ahead in the future if policy makers would ever allow us to actually get to the starting line. In time, I suppose.

It should always be noted that investing is not a black and white exercise. Instead, it is a nuanced art that is cast in varying shades of gray depending on the prevailing investment environment at any given point in time. Over the years, I have had my points where I have been very bullish such as March 2003 when valuations across the market spectrum outside of technology and utilities had become most attractive following the three year cyclical bear market. But I have been and continue to be far more bearish today, as I believe the policy solutions to the crisis that have been undertaken since the summer of 2010 will not only fall well short of achieving their intended economic goals but will also lead to negative spillover effects that have the potential to last for years once they finally take hold. But this does not mean that I think investors should simply evacuate capital markets and run for the hills. Far from it.

I remain net long both stocks and bonds and fully intend in the short to intermediate term to participate in the further asset inflation that is likely to continue as long as global policy makers remain on their present course and the global economy continues to plug along. This includes a concentration in those areas of the market that have tended to perform well during the latter stages of cyclical bull markets such as high quality, low volatility stocks (NYSEARCA:SPLV). This includes a concentration in defensive sectors such as consumer staples (NYSEARCA:XLP), health care (NYSEARCA:XLV) and utilities (NYSEARCA:XLU) including high quality individual names such Gilead (NASDAQ:GILD) as well selected REITs (NYSEARCA:VNQ). I also continue to own preferred stocks (NYSEARCA:PFF) in the current environment as well as intermediate-term (NYSEARCA:IEF) to long-term U.S. Treasuries.

But I also recognize longer term that a day may come where the current liquidity party may quickly come to an end and more decisive and evasive action is required. Thus, while I remain an active participant in these capital markets, I am also continuously watching and preparing for what may be the necessary action to not only evade the next downturn when it finally arrives but ideally to also capitalize, potentially in a meaningful way. In short, now is not the time for running away, but neither is it the time for the complacency, as the naked truths highlighted in this article simply should not be ignored.

Investors should always be actively evaluating the potential downside risks to their portfolio at any given point in time, and at present these risk levels are meaningfully elevated. This includes staying up on research and keeping a watchful eye as events unfold. Stay long, but also stay ready to take the necessary action if and when the time finally comes.

Disclosure: This article is for information purposes only. There are risks involved with investing including loss of principal. Gerring Capital Partners makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made. There is no guarantee that the goals of the strategies discussed by Gerring Capital Partners will be met.

Additional disclosure: I hold selected individual stock names as well as a meaningful allocation to cash at the present time.