As the marginal investing bot continues to invest his marginal leveraged dollar-on-the-sideline on an equity market that, as Janet Yellen has explained to the poor, will create a "wealth effect" to sustain everyone through rainy days and retirement, we thought some context worthwhile. On December 5th 1996, Alan Greenspan - upon the recognition that equity market capitalization has bubbled to over 100% of nominal GDP - opined that investors had succumbed to "irrational exuberance." Since then, that 'exuberance' has become increasingly rational as the Fed pulls all its monetary-base expanding, deficit-funding, asset-purchases to keep the American Dream alive for a select (and shrinking) few...
Rising rates would hurt bonds and equities but would support gold. This was clearly seen in the 1970s when rising interest rates corresponded with rising gold prices. Gold becomes vulnerable towards the end of an interest rate tightening cycle when there are positive real interest rates and savers earn something on their deposits.
Given that this is 'officially' the worst-recovery-ever, one wonders why does the abysmally failed and dangerous monetary experimentation continue unabated — as Yellen will undoubtedly confirm at Jackson Hole? Self-evidently, it is irresistibly convenient to both Wall Street and Washington. Yet these screaming juxtapositions are lost in the recency bias of the mainstream narrative. Invariably, the “in-coming” data is tortured and rationalized to prove that just a few more doses of money and debt will do the trick. Consequently, the pattern and signal is obscured amidst the immediate noise. It is therefore perhaps useful to consider a more advanced case of this Keynesian debauch from elsewhere in the world. Consider Italy.
With regard this week’s market debacle, the question, of course, is whether this was simply a blip – yet another one-day BTFD opportunity – or the start of something bigger and worse. The answer, we think, depends on how the media Narrative surrounding the week takes shape over the next several days. Right now the media Narrative about the week is in complete disarray, because there was no obvious “reason” for the sell-off. Or rather, there were too many possible reasons, from bad earnings reports to the Argentina default to worries about a strong jobs number to Espirito Santo cracking up to new Russian sanctions to just a generic “we were overdue for this”. From a game theory perspective, this sort of seemingly out-of-the-blue sharp move had very little to do with anything that happened this week, but is a natural by-product of the Common Knowledge Game in action.
One of the biggest mistakes that investors make is falling prey to cognitive biases that obfuscate rising investment risks. Here are 5 counter-points to the main memes in the market currently...
As part of Bernanke's and now Yellen's experiment in market central-planning, in which newsflow no longer matters to a market that has lost all ability to discount anything except how big a central bank's balance sheet will be and where HFT momentum is far more important than fundamentals, one of the greatest investing perversions to emerge has been our finding from two years ago since confirmed on a monthly basis, that the best performing asset classes happens to also be the most hated one, as the most shorted stocks have outperformed the market better than twofold just since 2012.
"The head of the International Monetary Fund warned on Friday that financial markets were "perhaps too upbeat" because high unemployment and high debt in Europe could drag down investment and hurt future growth prospects." To summarize: first the BIS, then the Fed and now the IMF are not only warning there is either a broad market bubble or a localized one, impacting primarily the momentum stocks (which is ironic in a new normal in which momentum ignition has replaced fundamentals as the main price discovery mechanism), they are doing so ever more frequently.
"... signs of risk-taking have increased in some asset classes. Equity valuations of smaller firms as well as social media and biotechnology firms appear to be stretched, with ratios of prices to forward earnings remaining high relative to historical norms. Beyond equities, risk spreads for corporate bonds have narrowed and yields have reached all-time lows. Issuance of speculative-grade corporate bonds and leveraged loans has been very robust, and underwriting standards have loosened. For example, average debt-to-earnings multiples have risen, and the share rated B or below has moved up further for leveraged loans." - Janet Yellen
"Whatever one feels about financials and the wider financial system, credit markets did arguably get a small glimpse of what things will be like when this cycle does actually end as the structurally impaired liquidity that exists in credit caused a small amount of panic yesterday morning before markets recovered in the European afternoon session. Liquidity is really poor in credit these days which doesn't matter when markets are in buy only mode as they have been for many quarters now, but it does matter on the days when you get a negative story."
According to just released data by Murray Devine, the Median Ebitda multiple for buyouts has exploded to nosebleed levels, rising by over one full turn of EBITDA since 2013 alone, and at 11.5x in the first half of 2014 is nearly 2x higher than during the last LBO bubble peak in 2008, when the average company was taken private at a conservative 9.6x EV/EBITDA.
Forget irrational exuberance; ignore exorbitant privilege; dismiss the idea that The Fed's actions are for Main Street not Wall Street... the following image says everything you need to know about "the recovery"...
The distinction between the world's only two types of traders (good vs bad) has been a very vague one. Until now. According to a new study by researchers at Caltech and Virginia Tech that looked at the brain activity and behavior of people trading in experimental markets where price bubbles formed, an early warning signal tips off smart traders when to get out even as the "dumb" ones keep ploughing in and chasing the momentum wave. In such markets, where price far outpaces actual value, it appears that wise traders receive an early warning signal from their brains—a warning that makes them feel uncomfortable and urges them to sell, sell, sell.
Janet Yellen is a chatterbox of numbers, but most of them are “noise”. And that’s her term. Yet here is a profoundly important set of numbers that you haven’t heard boo about from Yellen and her mad money printers. To wit, during the “difficult” economic times since the financial crisis began gathering force in Q1 2008, the S&P 500 companies have distributed $3.8 trillion in stock buybacks and dividends out of just $4 trillion in cumulative net income. That’s right, 95 cents of every dollar they earned - including the huge gains from restructurings, downsizings and job terminations - was flushed right back into the Wall Street casino.
There can be no doubt that computer science knowledge is currently in great demand; however, we do believe that there are some signs that the boom is - so to speak - 'getting out of hand' and is beginning to reflect the effects of the technology echo bubble on Wall Street. The give-away is the size of the demand for computer science studies relative to other fields of study. The last time enrollment in computer science peaked was in the year 2000 – concurrently with the technology mania. This is obviously no coincidence. What is slightly disconcerting is that the current peak in enrollments towers vastly above that previous bubble peak.
It is not too early to ask how the present US business cycle expansion, already more than five years old, will end. The history of the last great US monetary experiment in “quantitative easing” (QE) from 1934-7 suggests that the end could be violent. Autumn 1937 featured one of the largest New York stock market crashes ever accompanied by the descent of the US economy into the notorious Roosevelt Recession. As we noted previously - it's never different this time...