Results 1–50 of 136 found.
If You Need to Reduce Risk, Do it Now
The single most important thing for investors to understand here is how current market conditions differ from those that existed through the majority of the market advance of recent years. The difference isn’t valuations. On measures that are best correlated with actual subsequent 10-year S&P 500 total returns, the market has advanced from strenuous, to extreme, to obscene overvaluation, largely without consequence. The difference is that investor risk-preferences have shifted from risk-seeking to risk-aversion.
We Learn From History That We Do Not Learn From History
Market conditions presently match those that have repeatedly preceded either market crashes or extended losses approaching 50% or more. Such losses have not always occurred immediately, but they have typically been significant enough to wipe out years of prior market gains. Our present views are not built on the forecast that stocks must decline immediately, or that we wont go through some additional discomfort if the market pushes to a higher peak. Still, a century of history strongly warns that whatever transitory gains the market achieves from present levels will be wiped out in spad
How to Build a Time Machine
With industrial production, capacity utilization, real disposable income, real personal consumption, real sales retail and food service sales, and real manufacturing and trade sales uniformly declining in their latest reports, coincident economic indicators having generally peaked in July are now following through on the weakness that weve persistently observed in leading economic measures. We continue to believe that the U.S. economy joined a global economic downturn during the third quarter of this year.
The Third Law of Randomness
Proper investing doesn't rule out randomness and unpredictability, particularly when it comes to individual events. It instead diversifies against randomness both across holdings at each point in time, and across time by repeatedly acting on the basis of averages instead of individual forecasts.
What if the Fed Throws a QE3 and Nobody Comes?
When we look around the globe, we find that the impact of quantitative easing is rarely much greater than the market decline that preceded it. Investors seem to be putting an enormous amount of faith in a policy that does little but help stocks recover the losses of the prior 6 month period, with scant evidence of any durable effects on the real economy.
Anatomy of a Bear
The unusually bad outcomes of similar historical precedents help to convey why we retain such a durable sense of doom, even after last weeks scorching risk on advance. A moderate continuation of constructive market action would likely be sufficient to move us to soften our presently hard defense by retreating from a staggered strike option hedge. At present, conditions remain aligned with those that have preceded some of the most negative consequences in market history.
Enter, the Blindside Recession
The joint evidence suggests that the U.S. economy has entered a recession that will eventually be marked as having started presently. In recent months, our measures of leading economic pressures have indicated the likelihood of an oncoming U.S. recession.
A Brief Primer on the European Crisis
Europe has repeatedly been successful at addressing its recurring liquidity crises with the help of other central banks, but its still an open question whether they can durably solve the solvency crisis without more disruption and more restructuring of both government debt and troubled banks. In my view, the hope for an easy solution is misplaced, and the likelihood of recurring disruptions from Europe will remain high.
The Heart of the Matter
The ongoing debate about the economy continues along largely partisan lines, with conservatives arguing that taxes just aren't low enough, and the economy should be freed of regulations, while liberals argue that the economy needs larger government programs and grand stimulus initiatives. Lost in this debate is any recognition of the problem that lies at the heart of the matter: a warped financial system, both in the U.S. and globally, that directs scarce capital to speculative and unproductive uses, and refuses to restructure debt once that debt has gone bad.
Run of the Mill
The awful behavior of the market in recent weeks is very run-of-the-mill in terms of how similarly unfavorable conditions have usually been resolved historically, and there is no evidence that this awful prospective course has changed much. Investors should expect no easy solutions to the fiscal and global challenges ahead. They should instead expect market valuations that adequately reflect the fact that there are no easy solutions. In my view, those valuations remain miles below present market levels.
The Reality of the Situation
If one steps back from the trees to observe the forest, the reality of the situation is that Europe is already largely in recession, the global economy is slipping quickly toward the same outcome, and in my view, the U.S. is also entering a recession that will ultimately be dated as beginning in May or June of 2012 (i.e. now). The economic headwinds already in place are likely to make any meaningful budget progress virtually impossible in the Eurozone, and without meaningful budget progress, the likelihood of continued bailouts to peripheral European states is slim.
Presently, the market remains richly valued on normalized earnings, and is coming off of a speculative peak with an abrupt and persistent initial decline. All of this reflects what might be called a "liquidation syndrome" that is selective for awful drops that began in 1969, 1972, 1987, 2000, 2007, and the more moderate but still steep losses in 1998, 2010, and 2011.
Dancing at the Edge of a Cliff
Our recession concerns remain intact, as do our separate concerns about extreme stock market risk. I've emphasized that our estimate of prospective market return/risk in stocks has slipped into the most negative 0.5% of historical data. Last week that estimate actually deteriorated, but I am reluctant to make comments on such a small sample, as the only more negative estimate in post-Depression history was on September 16, 2000. Even in the conditions that match the worst 2% of our return/risk estimates, the market has lost an average of 20-25% just in the following 6-month period.
Maybe our present concerns won't amount to as much downside as we expect. But if investors were to choose a point to test the hypothesis that this time will be different and risk will be well-rewarded, I hardly think a worse moment could be found.
Run, Don't Walk
One way to gauge your speculative exposure is to ask the simple question - what portion of your portfolio do you expect (or even hope) to sell before the next major market downturn ensues? Almost by definition, that portion of your portfolio is speculative in the sense that you do not intend to carry it through the full market cycle, and instead expect to sell it to someone else at a better price before the cycle completes. With respect to those speculative holdings, and when to part with them, my own view is straightforward. Run, don't walk.
No... Stop... Dont
In the classic version of Willy Wonka and the Chocolate Factory, Gene Wilder watches one child after another ignoring every cautionary warning, with predictably bad consequences. His deadpan appeals become increasingly halfhearted and emotionless because he knows they won't listen anyway.
Is the Fed Promoting Recovery or Merely Desperation?
What we've observed in the employment figures is not recovery, but desperation. Having starved savers of interest income, and having repeatedly subjected investors to Fed-induced financial bubbles that create volatility without durable returns, the Fed has successfully provoked job growth of the obligatory, low-wage variety. Over the past year, the majority of this growth has been in the 55-and-over cohort, while growth has turned down among other workers. All of this reflects not health, but despair, and explains why real disposable income has grown by only 0.3% over the past year.
A False Sense of Security
As we examine the present evidence relating to both the financial markets and the global economy, the aspect that strikes us most is the extent to which Wall Street continues to emphasize superficially positive data in preference for deeper analysis, to extrapolate short-term distortions as if they were long-term trends, and to misconstrue freshly printed wallpaper and thin supporting ice as if they were solid walls and floors.
An Angry Army of Aunt Minnies
The steepest market plunges on record (e.g. those following the 1973-74, 1987, 2000 and 2007 peaks, among others) have generally followed an overvalued speculative blowoff coupled with divergent interest rate pressures. This is why we take the "overvalued, overbought, overbullish, rising yields" syndrome so seriously. Indeed, the outcomes are usually negative on average even without rising yields, but the yield pressures tend to add immediacy. Notably, the emergence of this syndrome has provided accurate warning of oncoming losses both historically, and also as recently as 2010 and 2011.
Warning: A New Who's Who of Awful Times to Invest
Last week, the estimated return/risk profile of the S&P 500 fell to the worst 2.5% of all observations in history on our measures. This is not a runaway bull market. Rather, it is a market that again stands near the highs of an extended but volatile trading range. Importantly, the market is again characterized by an extreme set of conditions that we've previously associated with a Who's Who of Awful Times to Invest.
Unusual Drawdown Risk
Presently, the investment opportunity set remains one of the most unfavorable in history - we estimate a 4.4% annual total return for the S&P 500 over the coming decade, corporate bond yields are now at just 3.3%, the 30-year Treasury yield is at 3.2%, the 10-year Treasury yield is at 2.0%, and Treasury bill yields are at 0.1%. We would view a significant change in the investment opportunity set as a very welcome development, but we remain unwilling to accept significant risk for insignificant or negative prospective return simply because of the temporary absence of better opportunities.
A hot potato has been repeatedly passed from speculatively overvalued, overbought, overbullish market conditions driven by massive central bank interventions, to credit strains and emerging economic weakness nearly the instant those interventions are even temporarily suspended. The same speculators who have historically accompanied major and intermediate market peaks have emerged, followed by the emergence of credit strains, economic pressures, and a flight to safe-havens. The market is in an extended game of hot potato which will be resolved by the eventual removal of both conditions.
Notes on Risk Management - Warts and All
Presently, there seems to be an unusually wide gap between hindsight and foresight, both in the financial markets and in the economy. In both cases, forward-looking evidence suggests weak outcomes, but recent trends encourage optimism and risk-taking. Rather than sugar-coat these uncertainties and minimize the messy divergences in the data, I think the best approach is to review the evidence, warts and all, including economic risks, market conditions, and the strengths and limitations of our own investment approach.
Warning: Goat Rodeo
We're observing an "exhaustion" syndrome that has typically been followed by market losses on the order of 25% over the following 6-7 month period (not a typo). Worse, this is coupled with evidence from leading economic measures that continue to be associated with a very high risk of oncoming recession in the U.S. - despite a modest firming in various lagging and coincident economic indicators, at still-tepid levels. Compound this with unresolved credit strains and an effectively insolvent banking system in Europe, and we face a likely outcome aptly described as a Goat Rodeo.
Dodging a Bullet, from a Machine Gun
The interpretation best supported by the data is that recession risk remains very high based on the leading evidence and the typical outcomes that have resulted, but that the rate of deterioration has eased significantly, and it is simply unclear whether this is a temporary pause or a reversal. Rather than overstating the case one way or another, we remain strongly concerned about recession risk, but recognize the recent stabilization and the potential for a low-level continuation of that.
Dwelling In Uncertainty
When unseen states of the world have to be inferred from imperfect and noisy observable data, there are a few choices when the evidence isn't 100%. You can either choose a side and pound the table, or you can become comfortable dwelling in uncertainty, and take a position in proportion to the evidence, and the extent to which each possible outcome would affect you.
Leading Indicators and the Risk of a Blindside Recession
The balance of leading evidence continues to indicate a very high likelihood of an oncoming recession. We respect the various marginal improvements in the data in recent months, which do take the probability to less than 100%, but that is a far cry from suggesting that recession risk is anywhere close to being "off the table." Recession is not a certainty, but it remains the most probable outcome at present.
The Right Kind of Hope
We enter the year with great hope. But our hope is not for continued speculation and the maintenance of rich valuations (that only look reasonable because long-term cyclical profit margins are at a short-term peak about 50% above their historical norms). Our hope this year is for a return to a proper investment opportunity set - where saving is encouraged and rewarded by sufficiently high prospective returns, and the cost of capital is high enough to discourage high-risk, low-return investments and unsustainable fiscal deficits.
Brief Holiday Update
As I noted last week, there is a typical "sentiment cycle" in economic surprises, which we would expect to roll over to an increasing number of economic disappointments in the weeks ahead, but we'll respond to the data as it emerges. Given that we're in a typically low-volume, slightly positive seasonal period, I expect that day-to-day movements over the next several sessions may be more influenced by those factors than by meaningful economic or international developments.
When "Positive Surprises" Are Surprisingly Meaningless
How much importance should we put on the fact that economic data has delivered positive surprises in recent weeks? Don't all these surprises significantly short-circuit the risk of probable recession? As economist John Williams observes, "starting in October, a divergence developed: Whereas year-to-year change in BLS estimated payroll earnings continued at a more-or-less constant, positive level, tax receipts fell quite markedly. Where the Treasury numbers reflect full reporting, the BLS data are sampled..modeled and..revised...the BLS has overstated average earnings..in recent months."
The present market environment warrants unusual concern, in my view. Based on a wide variety of evidence and its typical market implications over an ensemble of dozens of subsets of historical data, the expected return/risk profile of the stock market has shifted to hard-negative. This isn't really a forecast in the sense that shifts in the evidence even over a period of a few weeks could move us to adjust our investment stance, but here and now we observe conditions that have often produced abrupt crash-like plunges.
Have We Avoided A Recession?
Recent U.S. economic reports have improved modestly from the clearly negative momentum that we saw in late-summer. Unfortunately, the underlying recessionary pressures we observe are largely unchanged. When we take the present set of economic evidence in its entirety, we see very little evidence of a meaningful reduction in recession risks. Indeed, the evidence from the rest of the world, both developed and developing, reinforce the expectation that the global economy is approaching a fresh contraction.
Are Corporate Balance Sheets Really the Strongest in History?
At an aggregate level, corporate balance sheets look reasonable, but are certainly not "stronger than they have ever been in history." Cash levels are elevated, but this is at best a second-order factor (with excess cash representing only a few percent of total assets), while debt remains near record levels relative to total assets and net worth.
Why the ECB Does Not Bail Out Distressed Debt
Investors are not likely to be treated with a "surprise" announcement that the ECB is going to expand its purchases of distressed European debt. Any significant ECB intervention would likely follow a formal revision of EU treaties that trades greater ECB flexibility in return for more centralized fiscal control.
Nearly every traditional asset class is priced to achieve miserably low long-term returns. Meanwhile, our leading economic measures are negative, and the global economy has already begun to show overt signs of a new downturn. We can understand that investors are inclined to hold off any concerns until an economic downturn can be seen and touched in actual (not just leading) U.S. data, but that inclination comes with the prospect of trying to reduce risk when a hundred million other investors suddenly become interested in doing the same thing.
Current market conditions cluster among a set of historical observations that might best be characterized as a "whipsaw trap." Though last week's rally triggered several widely-followed trend-following signals, the broader ensemble of data suggests a high likelihood of a failed rally. In this particular bucket of historical observations, less than 30% of them enjoyed an upside follow-through over the next 6 weeks. So while the expected return/risk profile of the market remains negative here, we have to be somewhat more tentative about taking a "hard" defensive position.
Penny Wise and Euro Foolish
The bottom line is a) Euro leaders will likely initiate a forced bank recapitalization within days; b) Greece will default, but the new hold-over funding may give the country a few more months; c) the EFSF will not be "leveraged" by the ECB; d) banks are likely to take haircuts of not 21%, but closer to 50% or more on Greek debt; e) much of the EFSF will go toward covering post-default capital shortfalls in the European banking system following writedowns of Greek debt; f) the rest will most probably be used to provide "first loss" coverage of perhaps 10% on other European debt.
Europe: Just Getting Warmed Up
At present, the S&P 500 is again just 10% below the high it set before the recent market downturn began. In my view, the likelihood is very thin that the economy will avoid a recession, that Greece will avoid default, or that Europe will deal seamlessly with the financial strains of a banking system that is more than twice as leveraged as the U.S. banking system was before the 2008-2009 crisis.
Talking Points for the "Occupy Wall Street" Protesters
The proper way to address the present economic imbalances is pursue policies that encourage the restructuring of bad debt, the allocation of public funds and private savings to productive investment and new research, the accumulation of education and labor skills ("human capital") to allow workers to capture a greater share of their own productivity, and the continuation of social safety nets to ease the economic adjustments that are necessary in a deleveraging economy. In my view this requires a number of steps which not everyone will like.
Recession, Restructuring, and the Ring Fence
We are headed toward a recession because our policy makers never addressed the underlying problem in the first place, which was, and remains, the need for debt restructuring. This is an issue that I suspect will re-emerge to the forefront of public debate in the next year. Hopefully, the response of our policymakers will be at different. In Europe the only real option is to allow peripheral defaults; to allow distressed and insolvent countries to exit the euro; and then for those countries to redenominate their own national currencies and peg them to the euro at a gradually depreciated level.
Not Over by a Longshot
Unless we observe a robust improvement in market internals from current levels, which appears doubtful given further confirmation of oncoming recession, the broad ensemble of data we observe doesn't offer much latitude to establish a constructive position based on, say, weak technical reversals or other scraps that the markets might toss out in the near term. The first 13 weeks of a recession are among the most predictably hostile periods for equities in the data. We'll take our evidence as it comes, but the primary risks - recession, default and global credit strains - continue to increase.
Preparing for a Greek Default
The yield on 1-year Greek government debt ended last week at 110%, down slightly from a mid-week peak of 130%. Even with the pullback, the Greek yield structure continues to imply default with certainty. All the markets are really quibbling about here is the recovery rate. That figure was still hovering near 50% as of Friday, but was a bit higher than we saw a few days earlier. A bailout today does not avert default, but at best defers it to a later date, and squanders funds that could otherwise be used to stabilize the European banking system once that inevitable default occurs.
Fed Policy: No Theory, No Evidence, No Transmission Mechanism
One of the main factors prompting a benign response to what is now a recession and virtually certain Greek default is the hope that the Fed will launch some new intervention. Many view the present weakness as a replay of 2010, however, the evidence tells a different story. While we have to allow for the possibility of a knee-jerk response in the event of further Fed intervention, it is also much clearer now than it was in 2010 that quantitative easing does not work. To a large extent, the only basis for further Fed action here is superstition in the absence of either fact or theory.
An Imminent Downturn: Whom Will Our Leaders Defend?
The global economy is at a crossroad that demands a decision-whom will our leaders defend? One choice is to defend bondholders-existing owners of mismanaged banks unserviceable peripheral European debt, and lenders who misallocated capital by reaching for yield and fees by making mortgage loans to anyone with a pulse. Defending bondholders will require forced austerity in spending of already depressed economies, continued monetary distortions, and the use of public funds to recapitalize poor stewards of capital. It will do nothing for job creation, foreclosure reduction, or economic recovery.
A Reprieve from Misguided Recklessness
Over the past three years, Wall Street and the banking system have enjoyed enormous fiscal and monetary concessions on the self-serving assertion that the global financial system will "implode" if anyone who made a bad loan might actually experience a loss. Because reversing this mantra is so difficult, policy makers are likely to continue fitful efforts to "rescue" this debt for the sake of bondholders. The justification for those policies will therefore have to be coupled with rhetoric that institutions holding these securities are too "systemically important" to suffer losses.
What did I think of Rick Perry's comments about Ben Bernanke? Frankly, I thought they were unfortunate. Perry suggested that monetary intervention would be "playing politics," which implies that Perry believes the Fed actually has the power to benefit the Obama Administration by improving the economy with its interventions. We certainly differ on that point. In my view, QE2 was an economically baseless attempt to distort the financial markets and force the prudent into taking risk in hopes of substituting speculation for innovation. Perry gives Bernanke far more credit than I do.
Results 1–50 of 136 found.