Results 151–200 of 306 found.
The Beauty of Truth and the Beast of Dogma
When you examine historical data and estimate actual correlations and effect sizes, the dogmatic belief that the Fed can “fine tune” anything in the economy is utter hogwash. Truth, on the other hand, is beautiful. Economic relationships that are supported in real-world data are a sight to behold.
That Was Not a Crash
To call the recent market retreat a “crash” is an offense to informed discussion of the financial markets. It was merely an air-pocket of the sort that typically emerges once overvalued, overbought, overbullish conditions are joined with deterioration in market internals. It was probably just a start.
Risk Turns Risky: Unpleasant Skew, Scale Dilation, and Broken Lines
Over the years, I’ve observed that overvalued, overbought, overbullish market conditions have historically been accompanied by what I call “unpleasant skew” – a succession of small but persistent marginal new highs, followed by a vertical collapse in which weeks or months of gains are wiped out in a handful of sessions.
Debt-Financed Buybacks Have Quietly Placed Investors On Margin
When corporations and even developing countries experience debt crises, one of the primary means of restructuring is the debt-equity swap. This sort of transaction involves canceling out debt of the company or government in return for equity of the company, or privatization of some of the assets of the country. Corporate debt-equity swaps typically result in severe dilution of the equity claims of existing shareholders, and in some cases, can wipe those claims out as creditors take control of the company.
Thin Slices from the Top of a Bubble
“You need to know very little to find the underlying signature of a complex phenomenon…. This is the gift of training and expertise – the ability to extract an enormous amount of meaningful information from the very thinnest slice of experience.” Malcolm Gladwell, Blink
A Bad Equilibrium & How Speculative Distortion Ends
In economics, we often describe “equilibrium” as a condition where demand is equal to supply. Textbooks usually depict this as a single point where a demand curve and a supply curve intersect, and all is right with the world.
Memorize This, Earn a Dollar
As a kid growing up in the 1960’s, I earned my allowance the usual way; cutting grass and raking leaves. When there was no grass to cut or other work to do, my parents – who deeply valued education – would give us things to commit to memory. I figure I squeezed more than 30 bucks out of memorizing the multiplication tables up to 12. My brothers were better at memorizing poetry, but I was pretty good at song lyrics, which put me in good position to learn the words to countless 70's songs (e.g. "This really blew my mind.
Two-Tier Markets, Full-Cycle Investing, and the Benefits and Costs of Defense
“The Nifty Fifty appeared to rise up from the ocean; it was as though all of the U.S. but Nebraska had sunk into the sea. The two-tier market really consisted of one tier and a lot of rubble down below. What held the Nifty Fifty up? The same thing that held up tulip-bulb prices long ago in Holland - popular delusions and the madness of crowds. The delusion was that these companies were so good that it didn't matter what you paid for them; their inexorable growth would bail you out.” Forbes Magazine during the 50% market collapse of 1973-74
Greece and the King of Asteroid 325 (and The One Lesson to Learn Before a Market Crash)
Last week, the price of Greek government debt soared on hopes of an 11th hour stick-save bailout by the European Union. Unfortunately, that price jump still left Greek bonds priced to reflect a default probability of 100% at every maturity. The jump only reflected an increase in the amount that bondholders evidently expect to recover in default, raising the implied recovery rate from the recent low near 30% to something closer to 50%. Put another way, the bond market has fully priced in the likelihood of a default coupled with a major haircut on Greek debt.
Judging the Future at a Speculative Peak
With valuations still extreme and deterioration in market action continuing to indicate a shift toward risk-aversion among investors, we are less concerned about specific factors such as Greece than about much more general pressures that threaten to force an upward spike in compressed risk-premiums. We’ve often noted that a market collapse is nothing other than that phenomenon: razor-thin risk premiums that are then pressed abruptly to higher levels.
Durable Returns, Transient Returns
Over the course of three speculative bubbles in the past 15 years, I’ve often made the distinction between “durable” investment returns and transient ones. At any point in time, the cumulative long-term return of the stock market equals the gain that investors can reasonably assume will be durable (in that it is unlikely to be surrendered in the future), plus whatever market gain investors should assume will be entirely wiped out over the course of the present or future market cycles. As it turns out, those two components can be identified with surprising accuracy.
All Their Eggs in Janet's Basket
The financial markets are establishing an extreme that we expect investors will remember for the remainder of history, joining other memorable peers that include 1906, 1929, 1937, 1966, 1972, 2000 and 2007. The failure to recognize this moment as historic is largely because investors have been urged to believe things that aren’t true, have never been true, and can be demonstrated to be untrue across a century of history.
When You Look Back On This Moment In History
There are moments in time when durable history is made; history that others observe much later, shaking their heads, at a loss to understand how the events that followed could not have been obvious at the time. When you look back on this moment in history, remember these things. When you look back on this moment in history, remember that spectacular extremes in reliable valuation measures already told you how the story would end.
Why Stocks are Not "Cheap Relative to Bonds"
One of the constant refrains we hear at present is that while stocks may be richly valued on an absolute basis, they are “cheap relative to bonds.” At least one professor recently told students that valuations are meaningless because the P/E on cash is 100. Technically, with T-bill yields at just 0.01%, the P/E on cash is more like 10,000, but let’s not quibble. Using simple P/E ratios or inverted interest rates as a standard of value only makes sense if you have no appreciation for how securities are valued.
When Paper Wealth Vanishes
As in equal or lesser speculative bubbles across history, there’s a common delusion that elevated stock prices represent wealth to their holders. That is a fallacy, and we can hardly believe that given the collapses that followed the 2000 and 2007 extremes, investors (and even Fed policymakers) would again fall for that fallacy so readily. The actual wealth is in the cash flows that are ultimately delivered into the hands of shareholders over time.
Voting Machine, Weighing Machine
The fact is that valuations drive long-term returns, but over shorter horizons, stock prices are the result of whatever investors collectively believe, however reckless or detached from historical evidence those beliefs may be. As long as enough market participants are attached to the idea that risk is their friend (or enemy) regardless of the price, there is no natural limit to how overvalued (or undervalued) stocks can become. There is only one way to address this: measure investor risk preferences directly through observable market internals.
The "New Era" is an Old Story
It’s not monetary easing, but the attitude of investors toward risk that distinguishes an overvalued market that continues higher from an overvalued market that is vulnerable to vertical losses. That window of vulnerability has been open for several months now, and the immediacy of our downside concerns would ease (despite obscene valuations) only if market internals and credit spreads were to shift back toward evidence of investor risk-seeking. Meanwhile, there’s no evidence to suggest that historically reliable valuation measures have somehow become irrelevant.
Recognizing the Risks to Financial Stability
Our hope is that Chair Yellen’s growing recognition of speculative risks will continue, and for the sake of the U.S. economy, that the rather baseless hope of manipulating a “Phillips Curve” or a “wealth effect” will fade. If one believes in these things, it is tempting to think that more monetary easing could be “good” for the economy. If the FOMC recognizes how weak those empirical relationships actually are, and how extreme the financial distortions have become, we might still avoid another financial crisis.
Two Point Three Sigmas Above the Norm
If you’re waiting for stocks to become overvalued by 2 standard deviations, we’re already past that, and we would not be at all surprised to observe another decade of negative total returns on the S&P 500, as we observed the last time valuations were similar on the most reliable measures.
Fair Value on the S&P 500 Has Three Digits
We continue to classify market conditions among the most hostile expected return/risk profiles we identify. The current profile joins rich valuations with continued evidence of a subtle shift toward risk aversion among investors, which we infer from market internals (a variant of what we used to call “trend uniformity”), credit spreads, and other risk-sensitive measures.
Profit Margins - Is the Ladder Starting to Snap?
Since mid-2014, the broad market as measured by the NYSE Composite has been in a broad sideways distribution pattern, with an increasing tendency in recent months for advances to occur on weaker volume and declines to follow on a pickup in volume. While capitalization-weighted indices have done somewhat better since mid-2014, the S&P 500 Index is unchanged since late-December.
Valuation and Speculation: The Iron Laws
If you genuinely want to learn something from our experience during the recent half-cycle, it’s not to discard the Iron Law of Valuation, but to couple your awareness of valuation with an understanding of where investor preferences toward risk are from the standpoint of the Iron Law of Speculation. I had very vocal concerns about valuation during the tech bubble and the housing bubble, well before they burst.
Stock-Flow Accounting and the Coming $10 Trillion Loss in Paper Wealth
The failure to recognize that stock-flow consistency must hold in the economy and the financial markets is the basis for an enormous amount of misunderstanding in both fields. That omission of clear thinking about the link between economics and finance contributes to misguided policies that ignore the impact of financial distortions on the real economy, and invite speculation, malinvestment, and ultimately financial crisis.
Eating Our Seed Corn: The Causes of U.S. Economic Stagnation, and the Way Forward
The U.S. has become a nation preoccupied with eating its seed corn; placing consumption over investment, outsourcing its jobs, hollowing out its middle class, and accumulating increasing debt burdens to do so. What our nation needs most is to adopt fiscal policies that direct those seeds to productive soil, and to reject increasingly arbitrary monetary policies that encourage the nation to focus on what is paper instead of what is real.
Monetary Policy and the Economy: The Case for Rules Versus Discretion
Deviations in monetary policy from what one would have predicted (using past non-monetary variables alone) have zero correlation or ability to explain subsequent GDP growth (versus the levels that would have been predicted by past non-monetary variables alone). In other words, once we allow for the component of monetary policy captured by a fixed linear rule (the Taylor Rule comes close – and currently indicates an appropriate Fed funds rate of about 3% here), one can find no evidence in the historical record that additional activist monetary policy is useful.
What Does That Difference Mean?
The difference between actual market returns over a given time period, and the returns that one would have projected earlier based on reliable valuation measures, is extremely informative about where current valuations stand, and about where future market returns are headed.
Plan to Exit Stocks Within the Next 8 Years? Exit Now
Unless we observe a rather swift improvement in market internals and a further, material easing in credit spreads – neither which would relieve the present overvaluation of the market, but both which would defer our immediate concerns about downside risk – the present moment likely represents the best opportunity to reduce exposure to stock market risk that investors are likely to encounter in the coming 8 years.
Expect a Decade of 1.7% Portfolio Returns from a Conventional Asset Mix
The problem for investors here is that risk premiums are compressed in equities at a time when bonds offer no way out. When risk premiums are compressed across the board, conventional asset allocations are very much like trying to squeeze water from a stone. We project a 10-year nominal annual portfolio total return averaging only about 1.7% annually for anything close to a standard portfolio mix of equities, bonds and cash, regardless of how much diversification one has within each of those asset classes.
Market Action Suggests Abrupt Slowing in Global Economic Activity
The combination of widening credit spreads, deteriorating market internals, plunging commodity prices, and collapsing yields on Treasury debt continues to be most consistent with an abrupt slowing in global economic activity.
QE and the ECB: "Authorize" is a Slippery Word
The ECB will authorize a large QE program this week, but my impression is that the details will leave the ECB itself responsible for executing only a fraction of the announced program, with the remaining majority of the program (perhaps 60-75%) being nothing more than the option for each national central bank to purchase its own country?s government bonds, at its own discretion, and its own risk. Moreover, that option is likely to be limited to something on the order of 25% of the outstanding government debt of each respective country.
A Better Lesson than "This Time is Different"
The near-term outcome of speculative, overvalued markets is conditional on investor preferences toward risk-seeking or risk-aversion, and those preferences can be largely inferred from observable market internals and credit spreads. The difference between an overvalued market that becomes more overvalued, and an overvalued market that crashes, has little to do with the level of valuation and everything to do with investor risk preferences. Yet long-term investment outcomes remain chiefly defined by those valuations.
The Line Between Rational Speculation and Market Collapse
Current equity valuations provide no margin of safety for long-term investors. One might as well be investing on a dare. If we observe an improvement in market internals and credit spreads, it would not make valuations any less obscene, but it would significantly ease our immediate concerns about market losses. A safety net would be required in any event, but there is a range of possible outlooks between hard-negative and constructive with a safety net.
Iceberg at the Starboard Bow
Market history, including the series of bubbles and crashes over the past 15 years, does not teach that valuation is irrelevant, but instead that a key distinction affects whether stability or instability is likely to prevail. When rich valuations are coupled with tame credit spreads and uniform strength across a broad range of market internals and security types, one can infer that investors remain tolerant toward risk. In that environment, risk premiums may be low, but theres no particular pressure for them to normalize, even if the speculation is driven by mindless yield-seeking.
A Sensible Proposal and a New Adjective
The FOMC is well-served by Richard Fishers proposal to consider terminating the current policy of reinvesting proceeds from Fed balance sheet holdings as those securities mature. That shift would not imply any rush to raise the federal funds rate or otherwise normalize policy rates.
In my view, we are likely witnessing the peak of the third equity valuation bubble in the past 14 years, the first two which saw major indices plunge by at least 50%. Its important to recognize that market peaks are a process, not an event. Internal deterioration has actually been developing since early July, and became measurable in early August. This process has been quite like what we observed in 2007, when deterioration became measurable in July of that year. Despite an initial selloff, the major indices recovered to a marginal new high in October 2007 before continuing lower.
Hard-Won Lessons and the Bird in the Hand
The S&P 500 is more than double its historical valuation norms on reliable measures (with about 90% correlation with actual subsequent 10-year market returns), sentiment is lopsided, and we observe dispersion across market internals, along with widening credit spreads. These and similar considerations present a coherent pattern that has been informative in market cycles across a century of history including the period since 2009. None of those considerations inform us that the U.S. stock market currently presents a desirable opportunity to accept risk.
A Most Important Distinction
Quantitative easing only works to the extent that default-free, low interest liquidity is viewed as an inferior holding. When investor psychology shifts toward increasing risk aversion which we can reasonably measure through the uniformity or dispersion of market internals, the variation of credit spreads between risky and safe debt, and investor sponsorship as reflected in price-volume behavior default-free, low interest liquidity is no longer considered inferior. Its actually desirable, so creating more of the stuff is not supportive to stock prices.
These Go to Eleven
We have entered an environment in which extraordinarily thin risk premiums have been joined in recent weeks by a subtle shift toward increasing risk aversion. Present conditions couple every essential component of historically extreme and vulnerable market environments. The market has been dodging boomerangs, not bullets, and they are likely to come back harder for it.
Do the Lessons of History No Longer Apply?
Without permanent changes in the way the world works, on valuation measures that are best correlated with actual subsequent market returns, stocks are wickedly overvalued here. Meanwhile, the stock market re-established overvalued, overbought, overbullish conditions last week that mirror some of the most precarious points in the historical record such as 1929, 1937, 1974, 1987, 2000 and 2007. Notably, that syndrome is now coupled with continued evidence of a subtle shift toward more risk-averse investor psychology, primarily reflected by internal dispersion and widening credit spreads.
Losing Velocity: QE and the Massive Speculative Carry Trade
What central banks around the world seem to overlook is that by changing the mix of government liabilities that the public is forced to hold, away from bonds and toward currency and bank reserves, the only material outcome of QE is the distortion of financial markets, turning the global economy into one massive speculative carry trade. The monetary base, interest rates, and velocity are jointly determined, and absent some exogenous shock to velocity or interest rates, creating more base money simply results in that base money being turned over at a slower rate.
Fast, Furious, and Prone to Failure
Though we remain open to the potential for market internals to improve convincingly enough to at least defer our immediate concerns about market risk, we should also be mindful of the sequence common to the 1929, 1972, 1987, 2000 and 2007 episodes.
On the Tendency of Large Market Losses to Occur in Succession
We may wish to believe that a 25-30% market plunge has zero probability since we know that the probability of a one-day loss of several percent is quite low, making a whole series of them seemingly impossible. But that view overlooks the tendency of large losses to occur in succession. It also overlooks the tendency for monetary easing to support stocks only when low- or zero-interest risk-free assets are considered inferior holdings in comparison to risky ones.
Air-Pockets, Free-Falls, and Crashes
Once overvalued, overbought, overbullish extremes are joined by deterioration in market internals and trend-uniformity, one finds a narrow set comprising less than 5% of history that contains little but abrupt air-pockets, free-falls, and crashes.
Dancing Without a Floor
As I did in 2000 and 2007, I feel obligated to state an expectation that only seems like a bizarre assertion because the financial memory is just as short as the popular understanding of valuation is superficial: I view the stock market as likely to lose more than half of its value from its recent high to its ultimate low in this market cycle. In my view, speculators are dancing without a floor.
The Ingredients of a Market Crash
Market peaks often go through several months of top formation, so the near-term remains uncertain. Still, it has become urgent for investors to carefully examine all risk exposures. When extreme valuations on historically reliable measures, lopsided bullishness, and compressed risk premiums are joined by deteriorating market internals, widening credit spreads, and a breakdown in trend uniformity, its advisable to make certain that the long position you have is the long position you want over the remainder of the market cycle.
The Ponzi Economy
When the most persistent, most aggressive, and most sizeable actions of policymakers are those that discourage saving, promote debt-financed consumption, and encourage the diversion of scarce savings to yield-seeking speculation rather than productive investment, the backbone that supports a rising standard of living is broken.
Results 151–200 of 306 found.