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To the Moon Or to the Sun?
Submitted by Leo Kolivakis, publisher of Pension Pulse.
In his November investment outlook, Midnight Candles, PIMCO's Bill Gross tells us that assets are way overvalued:
Let me start out by summarizing a long-standing PIMCO thesis: The
U.S. and most other G-7 economies have been significantly and
artificially influenced by asset price appreciation for decades.
Stock and home prices went up – then consumers liquefied and spent the
capital gains either by borrowing against them or selling outright.
Growth, in other words, was influenced on the upside by leverage,
securitization, and the belief that wealth creation was a function of
asset appreciation as opposed to the production of goods and services.
American and other similarly addicted global citizens long ago learned
to focus on markets as opposed to the economic foundation behind them.
So
far I am with you, Bill. We basically forgot that real wealth comes
from real production not from trading stocks, bonds, and
commodities on-line. Forget the clowns on CNBC where you regularly appear talking up your book, and focus on real work.
Bill goes on to write:
PIMCO
long-term (half-century) chart comparing the annual percentage growth
rate of a much broader category of assets than stocks alone relative to
nominal GDP. Let’s not just make this a stock market roast, let’s
extend it to bonds, commercial real estate, and anything that has a
price tag on it to see if those price stickers are justified by
historical growth in the economy.
This
comparison uses a different format with a smoothing five-year trailing
valuation growth rate for all U.S. assets since 1956 vs. corresponding
economic growth. Several interesting points. First of all, assets
didn’t always appreciate faster than GDP. For the first several
decades of this history, economic growth, not paper wealth, was king.
We were getting richer by making things, not paper. Beginning in the
1980s, however, the cult of the markets, which included the development
of financial derivatives and the increasing use of leverage, began to
dominate. A long history marred only by negative givebacks during
recessions in the early 1990s, 2001–2002, and 2008–2009, produced a
persistent increase in asset prices vs. nominal GDP that led to an
average overall 50-year appreciation advantage of 1.3% annually.
That’s
another way of saying you would have been far better off investing in
paper than factories or machinery or the requisite components of an
educated workforce. We, in effect, were hollowing out our productive
future at the expense of worthless paper such as subprimes, dotcoms, or
in part, blue chip stocks and investment grade/government bonds.
Putting
a compounding computer to this 1.3% annual outperformance for 50 years,
produces a double, and leads to the conclusion that the return from all
assets was 100% (or 15 trillion – one year’s GDP)
higher than what it theoretically should have been. Financial leverage,
in other words, drove the prices of stocks, bonds, homes, and shopping
malls to extraordinary valuation levels – at least compared to 1956 –
and there could be payback ahead as the leveraging turns into
delevering and nominal GDP growth regains the winner’s platform.
WHOA!
Did you all get that? Bill says assets are $15 trillion overvalued! The
game is over and now we face a protracted period of deleveraging and
asset deflation.
He goes on to write:
At
the center of U.S. policy support, however, rests the “extraordinarily
low” or 0% policy rate. How long the Fed remains there is dependent on
the pace of the recovery of nominal GDP as well as the mix of that
nominal rate between real growth and inflation.
My
sense is that nominal GDP must show realistic signs of stabilizing near
4% before the Fed would be willing to risk raising rates. The current
embedded cost of U.S. debt markets is close to 6% and nominal GDP must
grow within reach of that level if policymakers are to avoid continuing
debt deflation in corporate and household balance sheets.
While
the U.S. economy will likely approach 4% nominal growth in 2009’s
second half, the ability to sustain those levels once inventory
rebalancing and fiscal pump-priming effects wear off is debatable. The
Fed will likely require 12–18 months of 4%+ nominal growth before
abandoning the 0% benchmark.
I
am with you on this, Bill, but I look at it from a jobs perspective.
The Fed won't dare raise interest rates until U.S. unemployment falls
well below 10% and even then, they'll think twice about it. But what
you don't get Bill is that the Fed is convinced they can create another
asset bubble and they're betting this will lead to real economic
inflation down the road.
Importantly,
when confronted between two evils, the Fed will always choose inflation
over deflation. And therein lies the kink, we need asset bubbles to
keep the fantasy alive.
But not everyone is as pessimistic as Bill Gross. On Monday, James Altucher was interviewed on Tech Ticker, telling us that the economy and the stock market were going to blast off from here:
Ever since the market bottomed in March, a parade of bears have warned about all manner of coming calamities:
- An end to the "sucker's rally"
- A collapse of the financial system
- A double-dip recession
- A commercial real-estate collapse
- A decade of "deleveraging" as consumers recover from a drunken debt binge
Ridiculous, says James Altucher, managing director at Formula Capital.
The
economy is recovering nicely, says Altucher, and 2010 is going to be a
huge year. Companies that stopped making things and fired thousands of
employees last winter out of fear of a second Great Depression will
restock their shelves and start hiring like mad. The federal stimulus,
which has barely kicked in yet, will really get cranking.
Consumers
will find jobs much easier to get, and the resulting optimism (and
income) will prompt them to start spending again.
And the market?
It's going to the moon, says Altucher.
In
fact, the biggest thing Altucher is worried about is another monster
bubble, which the Fed will have to stomp out by raising interest rates
too quickly. But that's a year away. In the meantime, he's confident
the recovery will knock your socks off.
I
think Mr. Altucher is getting ahead of himself. However, as I stated
before, there is an unprecedented amount of liquidity in the global
financial system that can easily lead to another bubble sooner than you think. Is the market "going to the moon"? You can call me crazy, but my bet is still that the market is going to the sun and it will melt up faster than it takes Bill Gross to blow out his midnight candles.
So while Mr. Gross worries about a cold
wind from the future blowing into his bedroom, I worry about the next
bubble in stocks and how many people are going to get burned chasing it
higher.
»
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the stock market can stay disconnected from reality for inordinately long periods of time
“The market can stay irrational longer than you can stay solvent.”
- JM Keynes
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“The market can stay irrational longer than you can stay solvent.”
- JM Keynes
The financial industry is trying to push a wet noodle with all this liquidity and promotion but can they fool the masses twice? My bet is the mindset of the average investor with retirement savings will be less inclined to buy stocks "going forward" after the big scare. Until then risk meant big gains. Now it includes big losses. Unemployment, large mortgages, over extended credit cards, and more risk averse boomers nearing retirement will have a long term dampening effect on any new prolongued rally.
Never underestimate greed. People's memories are short and if they think they can make money, they'll buy risk assets.
Yes, its all about doing some real hard work, as opposed to making a quick buck trading (other people's hard work ) stocks.
So stop staring at your computer screen Leo, waiting for a line to turn green and get out there and do some real work!!!
I work full time and risk my own money. I would never manage other people's money the way I manage my money because I am a big risk taker. When I have conviction, I go in heavy. I would never manage a hedge fund because I'd have to answer to investors. I do not want to answer to anyone when it comes to making money in markets.
Agreed Leo.
Gross is the most overrated fixed income manager in the buisness.
He spent 5 years calling for a bear market in bonds that never happened and screwed his clients out a huge rally . He called for inflation while we deflated.
Someone is kicking back soft dollar or hard dollar execution commissions under the table.
You can feel the market is going up if
you like, but don't use Altucher - the
guy is an arrogant douchebag and
former Cramer lackey who
stated the other day that "insider
trading shouldn't be illegal."
He's a quirky guy who thinks he's a big time hedge fund manager. I just used him to make a point.
The Japanese threw a boatload of liquidity into their financial system as well. You might want to take a peek at the Nikkei over the last decade or so to see how that worked out.
No matter how much liquidity is thrown into the markets, there has yet to be any meaningful credit expansion. Banks are still protecting their balance sheets because they continue to see deliquencies/foreclosures on their assets piling up. The process of liquidating bad assets has been postponed, and subsidized, for the most part.
The government is throwing ad-hoc program onto ad-hoc program, but now are faced with the challenge on how to finance the next one. They can't without increasing the budget deficit even more. We will likely get that increase in the debt ceiling-- but Congress knows people are watching-- and bitching.
The Federal Reserve can certainly print money to infinity if they so choose, but are running into constraints on dollar devaluation. Their problem is compounded, as countries with stronger currencies are hiking interest rates-- as well as the coupon they are willing to pay on government issued debt. The Treasury needs the underlying cost of debt as low as possible, and too much reflation will take away that puchbowl in a hurry.
While I do think the argument you make has some merit, I think the plan here in the U.S. is to cycle between reflation and flight to quality trades. With the phasing out of serveral Fed programs and asset purchases, we are likely to see the beginning of a "cool" period-- allowing the Treasury to find spooked buyers at low issue rates, as the stock market will fall during the flight.
Once we dip back toward deflation (and we certainly will), the printing presses will be switched back on to full bore. Icarus will be let loose again and ride whatever bubble (thermal) is available.
We can probably do this for as long as it is needed-- meaning this will be a long and nasty process that will likely be just as bad as Japan's "lost decade". Given that we've made only marginal strides in asset liquidations, I'd say we're off to a slow start.
Assetman,
I do not like comparisons with Japan because the U.S. economy is a lot quicker to adjust to downturns. Companies cut costs fast and they wait for an entrenched recovery before hiring. Moreover, U.S. demographics are nowhere near as bad as Japanese demographics.
But your point on debt deflation is one that I have considered many times in the past. This can happen but the Fed and government will throw everything but the kitchen sink to avoid this scenario. Will they succeed? Too early to tell.
In the meantime, unprecedented global liquidity is driving risk assets much higher. One or many bubbles are percolating around the world. This is more of my concern in the near term.
I think the correlation to Japan has more to do with their inability to write off bad debt at the banks in the 90's--and that is exactly the parallel that is happening now with our system. Additionally, the demographic in 1990 in Japan was not that dissimilar to ours now. Many Japanese companies--the automakers in particular--were (and are) very nimble.
Leo... point well taken on the adjustment process in the U.S. economy. Most companies have been very aggressive this time around in cutting cost. What the U.S. is NOT doing well is rationalizing debt... and that's a problem.
As for demographics, Japan is indeed in terrible shape... but they've had a society of savers to target as source of borrowing. The U.S. is heading the in the direction of Japan demographically BUT individuals' balance sheets are much worse on average than in Japan.
I think the real difference in opinion here is what the Fed CAN do to combat deflationary forces. In think there are some serious constratins that the Fed recognizes as being mindful to monitor. Otherwise, they might as well line up QE 2.0 and buy any mortgare that's delinquent 90 days or more. The Fed is (slowly) easing out of QE 1.0, and hoping the economy gets its own legs.
That all being said, the "here and now" is that the Fed/U.S. Govt is at "full liquidity bore", and is correctly written, we should expect asset bubbles to appear in many places. I do think, though, we are at a "liquidity peak" that is likely to cycle several times before we get to a self sustaining expansion.
Life is what happens to you while you are making other plans. Same with the Market. Buy low. Sell high. When unsure of where you are at, stay in cash.
Polly wanna cracker?
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To the MOON Alice!
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Yep trap in progress. Then then moonshot