Results 151–200 of 324 found.
An Imminent Likelihood of Recession
Since October, the economic evidence has shifted from supporting a growing risk of recession, to a guarded expectation of recession, to the present conclusion that a U.S. recession is not only a risk but an imminent likelihood, awaiting confirmation that typically only emerges after a recession is actually in progress.
Complex Systems, Feedback Loops, and the Bubble-Crash Cycle
Our expectations for a global economic downturn, including a U.S. recession, have hardened considerably in the past few weeks, with a continued expectation of a retreat in equity prices on the order of 40-55% over the completion of the current cycle as a base case. The immediacy of both concerns would be significantly reduced if we were to observe a shift to uniformly favorable market internals. Last week, market conditions moved further away from that supportive possibility.
The Next Big Short: The Third Crest of a Rolling Tsunami
At speculative extremes, recent history always temporarily belongs to the reckless herd that has ignored concerns about valuation and risk at every turn. Fortunately, the future has always belonged to those who take discipline, analysis, and the lessons of history seriously. On the basis of the valuation measures most strongly correlated with actual subsequent market returns (and that have fully retained that correlation even across recent market cycles), current extremes imply 40-55% market losses over the completion of the current market cycle.
On the Completion of the Current Market Cycle and Beyond
As we look forward to 2016, to following through on our investment discipline over the completion of the current market cycle and beyond, a few recent market comments will serve as a detailed review of our present market and economic outlook.
Reversing the Speculative Effect of QE Overnight
In recent quarters, I’ve remained adamant that the immediate first step of the Federal Reserve in normalizing monetary policy should have been to reduce the size of its balance sheet. The Fed’s failure to prioritize that first step, in the apparent desire to maintain an aggrandized role in the U.S. financial markets, has significantly increased the risk of a collapse from the speculative extremes the Fed has created in recent years. Given the increasing risk-aversion evident in market internals, we doubt that even a reversal of last week’s rate hike would materially reduce that prospect.
Deja Vu: The Fed's Real "Policy Error" Was To Encourage Years of Speculation
Over the past several years, yield-seeking investors, starved for any “pickup” in yield over Treasury securities, have piled into the junk debt and leveraged loan markets. Just as equity valuations have been driven to the second most extreme point in history (and the single most extreme point in history for the median stock, where valuations are well-beyond 2000 levels), risk premiums on speculative debt were compressed to razor-thin levels. By 2014, the spread between junk bond yields and Treasury yields had fallen to less than 2.4%.
From Risk to Guarded Expectation of Recession
In the presence of obscene valuations, deteriorating market internals, widening credit spreads, and tepid economic activity on the most historically reliable measures, we presently observe the same essential syndrome of risk factors that allowed us to accurately anticipate the 2000-2002 market collapse and recession, as well as the 2007-2009 global financial crisis. Emphatically, a return to risk-seeking behavior among investors, as evidenced by a clear improvement in market internals across a broad range of individual stocks, industries, sectors and security types (including debt securities
Rarefied Air: Valuations and Subsequent Market Returns
The atmosphere is getting thin up here, and every ounce counts triple when you're climbing in rarefied air. While near-term market dynamics are more likely to be impacted by Friday’s employment report than any other factor, our broad view remains that stocks are in the late-stage top formation of the second most extreme episode of equity market overvaluation in U.S. history, second only to the 2000 peak, and already beyond the 1929, 1937, 1972, and 2007 episodes, not to mention lesser extremes across history.
Two types of dispersion are increasingly apparent in market dynamics here. The first type of dispersion is between leading measures of economic activity and lagging ones. The second is dispersion in market internals, particularly observable in a continued narrowing of leadership to a handful of “winner-take-all” stocks, while broader measures of market action across individual stocks, industries, sectors, and credit spreads show persistent divergence that suggests increasing risk-aversion among investors.
Investors have experienced a great deal of whiplash in recent months. After a rapid but relatively contained retreat in August and September, the stock market has rebounded to within 2% of its May record high. Only weeks ago, investors were concerned about economic deterioration. As of Friday, strength in nonfarm payrolls has suddenly convinced investors that a December rate hike by the Fed is all but certain.
Last Gasp Saloon
Historically, when the stock market has deteriorated internally following a recent period of overvalued, overbought, overbullish conditions, we know that market outcomes have been negative on average. But what if the S&P 500 Index falls below its 200-day moving average, and then recovers above it again? Doesn’t that recovery signal a resumption of the bull market? The answer largely depends on market internals.
One of the central themes I’ve emphasized over the past year is the critical importance of using market internals as a gauge of investor risk-seeking and risk-aversion. Over the long-term, investment returns are driven by valuations – particularly on a 10-12 year horizon. Over shorter horizons, and more limited portions of the market cycle, the primary driver of investment returns is the preference of investors to seek or avoid risk.
Not The Time To Be Bubble-Tolerant
One of the important investment distinctions brought out by the speculative episode of recent years is the difference between the behavior of an overvalued market when investors are risk-seeking, and the behavior of an overvalued market when investors shift to risk aversion. The time to be tolerant of bubbles is when the uniformity of market internals provides clear evidence of risk-seeking among investors.
A Growing Risk of Recession
With the S&P 500 within about 8% of its highest level in history, with historically reliable valuation measures at obscene levels, implying near-zero 10-12 year S&P 500 nominal total returns; with an extended period of extreme overvalued, overbought, overbullish conditions replaced by deterioration in market internals that signal a clear shift toward risk-aversion among investors; with credit spreads on low-grade debt blowing out to multi-year highs; and with leading economic measures deteriorating rapidly...
Valuations Not Only Mean-Revert; They Mean-Invert
Risk-seeking among investors can often defer the immediate consequences of extreme valuations, while vertical losses can suddenly emerge when extreme overvaluation is joined by increasing risk-aversion among investors (as evidenced by deterioration in broad market internals). In any event, investors should expect market overvaluation or undervaluation to be reliably “worked off” within a period of about 12 years, on average.
When an Easy Fed Doesn't Help Stocks (and When It Does)
Investors who wonder why the stock market failed to advance on the Fed’s decision to leave interest rates unchanged would do well to understand that the market is following a script that has played out repeatedly across a century of market history. The short explanation is straightforward. When investors are risk-seeking (which we infer from the behavior of market internals), Fed easing tends to be very favorable for the stock market, because risk-free, low-interest liquidity is a hot potato to risk-seeking speculators.
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.
Results 151–200 of 324 found.