Carson Block Says Stocks Will Sink, Valuations Make No Sense

(Bloomberg) -- Carson Block is predicting a plunge in stocks after they roared back from the coronavirus sell-off in March.

“The direction has to be sharply downward,” the renowned short seller and founder of Muddy Waters Capital said in a phone interview.

Block finds it hard to believe that equities are trading at their current valuations even though demand has been “crushed” by the pandemic and isn't likely to recover anytime soon. “It makes no sense,” he said.

After crashing into a bear market at its fastest pace on record, the S&P 500 Index has advanced about 27% from its March low. The U.S. equity gauge trades at about 20 times estimated earnings, more expensive than when the measure hit an all-time high in February.

“In the medium term, I just can't see equity values anywhere near where they are today,” Block said. “The underlying economy is on its knees and I just think that investors have yet to understand that and they have yet to see what it looks like when bankruptcies cascade through the economy.”

More than 30 million people filed jobless claims in six weeks as the virus outbreak shuttered businesses across America. The U.S. economy shrank at a 4.8% annualized pace in the first quarter, the biggest slide since 2008 and the first contraction since 2014. Technology giants Amazon.com Inc. and Apple Inc. made sobering comments about the pandemic's impact.

Current stock prices show how “incredibly complacent” investors have become about risk, according to Block. While fiscal and monetary stimulus measures were necessary to counter the economic effects of the pandemic, he hopes they'll be unwound “much sooner” this time. Still, he expects expansive monetary policy to be maintained for the “next roughly four years at least.”

‘Political Dysfunction'

“What caused the pandemic is not a policy failure,” Block said. But the fallout will be “much worse than it should be” due to “political dysfunction,” as was the case for the Iraq war and the global financial crisis, he said.

Block, who's best known as an activist short seller, has been making some short investments that don't fit his typical approach of rooting out financial fraud. He said he's betting against a cruise company that he declined to identify.

“I just don't think that cruise lines, that they're viable in a world in which we haven't conquered Covid-19,” he said.

In the meantime, he's watching how long the “muscle memory” of buying stocks whenever there's a dip will last in equity markets. To him, there comes a point where that will have to end.

“The underlying economy will bring the capital markets down and that will disabuse investors of complacency,” Block said. “I don't think that the capital markets can decouple from the underlying economy.”