"Brace For A Stock Market Accident", GLG Chief Investment Officer Warns

Tyler Durden's picture

Authored by Jamil Baz (CIO, GLG), Originally posted at The FT,

Brace For A Stock Market Accident

Profits and leverage are locked in a deadly embrace

There is a time-honoured tradition in statistics: whipping the data until they confess. Bullish and bearish equity analysts are equally guilty of this practice.

It would seem that statistical conclusions are merely an ex-post justification of a long-held prior belief about equity markets being cheap or overpriced. Clearly, consensus, notably among sellside analysts, is bullish. I present the bullish view before discussing a bearish counterpoint.

Who can blame the equity bullish consensus? Earnings yields – a proxy for real equity yields – stand at comfortably high levels. For example, the forward earnings yield on the S&P 500 is 8.3 per cent.

Contrast real equity yields with real bond yields: with the US Consumer Price Index at 1.7 per cent and the nominal Federal Reserve funds rate at 15 basis points, real bond yields are at -1.55 per cent.

The difference between equity and bond yields – also known as the equity risk premium – is therefore close to 10 per cent. This is way above the 4-5 per cent premium required by investors to own equity, and therefore indicative of an ultra-cheap equity market.

There are two reasons why this consensus is misguided. First, because it uses dubious metrics. It is wiser to use a long-dated real bond yield because equity is a long-dated asset.

And forward earnings yields are misleading for well-documented reasons: analysts’ earnings consensus forecasts are known to be wildly optimistic; in a bid for juicier equity and call option compensations, managers encourage their accountants to inflate earnings numbers; and earnings are partially squandered by managements as they seek to prioritise growth over profitability.

So it is probably a good idea to use dividend-based – as opposed to earnings-based – equity valuation models. Unlike earnings, dividends do not lie.

Second, because consensus disregards leverage. Profits and leverage are linked (in a deadly embrace, it turns out). If deleveraging is yet to happen, then earnings growth can only be headed south.

So what if you trust dividends more than forward earnings? In a simple dividend discount model, the real equity yield is the sum of dividend yield and real dividend growth. The S&P dividend yield is 2.15 per cent. The real dividend growth has been historically 1.25 per cent.

The real 30-year yield is 0.4 per cent. Using these numbers, the equity risk premium is now 3 per cent, less than the premium level deemed acceptable. But we are not done yet, as we have not factored leverage into our equation.

Enter Michal Kalecki, a neo-Marxist economist who specialised in the study of business cycles and effective demand. Mr Kalecki showed that profits were the sum of investments and the change in leverage.

In the current environment, the implications of this equation are clear: in G7 economies, total debt is at a record 410 per cent of GDP. And this is excluding the net present value of social entitlements and healthcare expenditures, which is larger than the total debt.

Because leverage stands at unsustainably high levels in advanced economies, it should fall substantially over the long term, affecting profits negatively.

It can be assumed conservatively that the total-debt-to-GDP ratio needs to fall by 100 per cent before the debt position becomes sustainable in advanced economies. This would bring the US back to 1995, when the profit-to-GDP ratio was 45 per cent lower.

We can value the S&P under the following scenario: dividends fall by 45 per cent over a zero-growth period of 10 years. Then they resume their real growth of 1.25 per cent per year. Again, assuming a real yield of 0.4 per cent and a required risk premium of 4.5 per cent, fair market value is only one-third of current market levels.

Leverage is hence the fly in the ointment, begging the obvious question: when does the deleveraging take place? Answering this question is tantamount to timing the next major bear market. It is, of course, futile to predict a date, but as economist Herbert Stein used to say, if something cannot go on for ever, it will stop.

It is increasingly obvious that governments will take no active step towards deleveraging unless they are under the gun. But there are institutions and mechanisms that will trigger deleveraging, namely: Basel III, the bond market, default and, rarely, courageous politicians.

Inflation can also help delever, except in economies where social entitlements are inflation-indexed.

In the short term, it is clear that central banks need to entertain the illusion of viable stock market valuations by pulling rabbits from a hat. But as high-powered money reaches ever higher levels, the probability of accidents looms large.

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zero deception's picture

What am I supposed to get points from your panttheon of minor deities the Tylers for hitting that milestone?

Hahahahahahahkahahahahahahahahahahahahhahahahahahahahahahah! (No I didnt' spell it correctly.)

Dr. Engali's picture

Oh are you still here? I would have thought it was way past your bed time. You better not let your mommy catch you under the covers with your iPhone. Speaking of "pantheon" aren't you missing your dungeon and dragon game ?

BTW... Welcome to fight Club

zero deception's picture

Bow down to your gods Engals. Im not hear to fight, Im here to lay waste.

Dr. Engali's picture

Who is this "waste"person? And is she expensive?

zero deception's picture

Do not mess with me I've bloodied several allready in the short time a been here. Some have not reappeareed after a round or too with me.

zero deception's picture

Who. Fucking. Cares.

I can spell perfectly well but I'm not going to be a slave to the rules of orthography or proper punctuation. Like you.

Whiteshadowmovement's picture

Slave to orthography? Dude you're hardly James Joyce here...

Sore and soar are totally different words

PS- just noticed you were apparently "riffing" according to your post, in which case sorry i didnt get it but from your tone, syntax, and your content, the spelling seemed like a fit...so either your comic timing or your spelling could really use lots of improvement.

PPS- if the doc's right and you are coming down off a bad acid trip (a really bad one from the sound of it)- just try to maintain and put on some chilled out tunes and get yourself some sugar cubes

zero deception's picture

So war? Put a period at the end of that sentence.

And an occasional flashback  can add depth.

rob g's picture

If you're gonna be a dick be a total dick. You missed you're, happen, certainty, of, and caught. Still on the fence on the use of capita though.

Dr. Engali's picture

He did throw in an "etc." to cover his bases.

Whiteshadowmovement's picture

Ill keep that in mind, but a study of everything thats wrong with the above diction and syntax would take a good week by experts. I was merely pointing out the most blatant offences, as I imagined it wouldnt take much to get the point across...

CoolBeans's picture

With all due respect, please be gentle to the homeschoolers....I have some of those and they're brilliant.  

Oh and "thats" is actually a contraction and requires a " ' " as in:  That's

It isn't "in tact" but rather "intact".  But, I also make mistakes everyday and try to be forgiving.  It was just the homeschool remark I didn't care for much.


Whiteshadowmovement's picture

+1, I was wondering if someone was going to call me out on that intact! Kudos to you, it was just a typo on my part and I couldnt edit as it was already commented on. No disrespect to homeschooling- but had to cover my bases, you know?

Regarding the "thats" though, Im pretty sure we can differentiate between leaving out a contraction here on an online forum in the interest of saving time (90% of my shit is typed off the ipad) and just really poor and bizarre spelling, right?

Freddie's picture

To his credit, he used the word "perdition" and I think it was in the correct context.  Bullish! 

Dr. Engali's picture

I disagree. There will be a crash, but it won't happen until they are ready for it.

bobert's picture

2008 redux. (All asset classes crash.)

Then hyperinflation.

Then higher interest rates.

The most interesting part to watch will be the ratio of public debt to GDP.

When this goes beyond 100% (say 2015) the interest rate burden for the US Treasury will be the issue.

Get long interest rates and add as time goes by.

Stacking is probably a good idea too.

ZeroAvatar's picture

Some shitbag politician in Spain gets caught taking bribe money.  The Spanish Stock market takes a 5% hit.  Next day, world markets down 2-5%.

NEXT day, back up. Then, BAM!........everything crashes downward, down 1000 points in one day, no one ever saw it coming........Clean up on aisle 500.   Brokers being taken off the floor feet first in stretchers.....some, having lost every penny, JUMP.....carnage...horror.....news at 10:00!

steve from virginia's picture



"Kalecki showed that profits were the sum of investments and the change in leverage."


Also Minsky ... Leverage is still high, look for that Minsky Moment.


Look to the banks, which are wilting, look @ Brent crude which is above $115/barrel.


$120 crude is the new $147.

SheepleLOVEcheddarbaybiscuits's picture

crude is headed much higher than 120....try 175


Demand is gaining traction, so is money printing. Oil is going to explode soon.

steve from virginia's picture



What planet are you on?


Nobody is printing anything, everyone is broke/underwater.


Oil will 'explode' when the customers magically get richer. Instead, more part-time, low paying jobs and more debts.


The background noise in Europe, Japan and elsewhere is the effect of fuel that is right now too costly, forget about $175.

Unprepared's picture

Yes, and the 70's never happened.

zero deception's picture

Oil is going down and your cerrtain ot be punked if yo enjoy that delusion.

Yardfarmer's picture

that is a very reasonable assessment. unfortunately, in a hopelessly corrupted and bankrupt shytstem sense makes no sense. everyone seems to waiting breathlessly for the "moment of truth" when the lies, the open malfeasance, and econnomic chicanery will be revealed and the world will enter the "golden" age and we will suddenly discover, to our satisfaction, honest valuation in equities and especially precious metals. dream on. the wages of sin is death. and we will merely have hell to pay for our chronic moral bankruptcy and mental enslavement. the precise reason that equities continue and still continue to obscene overvaluations is that these indices feed off social stagnation, societal depravity and political impotence not to speak of the demoralization of honest working people. there are other and more profound metrics than well meaning economic analysis.

Lewshine's picture

Son of a BITCH!! Yardfarmer!!! ...That was like seeing Jesus walk on water!! Well done my brother!!! Damn!!

world_debt_slave's picture

PPT hard at work to keep the illusion/delusion going.

zero deception's picture

They can kep it going a long-time Slave. ONe billinaire equals ten milloion debt slaves. Rememeber that. Your rulers are plotting right now-they adn there minions to keep the chains tight on you. You dont' stand a chance.

tenpanhandle's picture

No, you don't stand a chance as it appears that you have admitted defeat.  In my mind, one 75 cent bullet equals "ONe billinaire".     ("ONe billinaire" is that Mumbai-eze?)

jerry_theking_lawler's picture

absolutely.....because when you have trillions at your finger tips, moving the markets in billions is fairly easy to do......how do i know, i once moved a penny stock with a few grand on low volume....they are doing the same thing on a massive scale.

Tsar Pointless's picture

One acronym trumps all rational "market" analysis:



thismarketisrigged's picture

stock market accident in this market-


examples- yesterday dow was down 129 s&p down 18 and nasdaq down 47


clearly a mistake, bc god forbid there would be a marginal down day, so what happens? the criminals make sure we get back nearly all of those losses today.


accident- down dropped 5 pts, never supposed to happen. 


it sad that these are accidents in the market.


fuck u bernanke and obama

Freddie's picture

Somoeone posted recently that POMO or Fed money dumped in the mkt is the lowest on Monday.  I looked back over the past month or so and Mondays are flat to slightly down.   Corrections and crashes are verboten.

Drones killing American citizens is a very bullish sign.  It makes SkyNet and the algos very happy.

Silver Garbage Man's picture

My tin foil hat inspired precious metal portfolio is accident proof!

Silver Garbage Man's picture

FYI the 6th coin in the Canadian wildlife series is out......... It's a bison.

tenpanhandle's picture

Nothing is accident proof.  Got a canoe?

secret_sam's picture

       It can be assumed conservatively that the total-debt-to-GDP ratio needs to fall by 100 per cent before the debt position becomes sustainable in advanced economies.

Never learned how to work percentages, eh?  Is this guy actually EMPLOYED in finance?


slightlyskeptical's picture

It is now approaching 400%. A 100 percentage point decrease would leave it at 300%.

secret_sam's picture

Any figure that drops BY 100% goes to zero.

Derp derp.

CaptainSpaulding's picture

"Brace for a stock market accident"

   Uhhhhh.... No

q99x2's picture

Banksters have already lost. Their actions have condemned them. The lives they lead are their snares. Nagging thoughts arise to eat them. They are disintegrating. It is the way of the poisoned mind.

zero deception's picture

Poetry. But poetyr wont' pay the bills.

Savyindallas's picture

If they already lost, when do we get to hang them?

ebworthen's picture

Time for a horrific train wreck with the CEO's and Boards of the TBTF banks and Ben Bernanke on board.

Falconsixone's picture

Get the right accidents all in a row maybe all the new governers will start shooting down all the red chinese/usaf chemtrail jets.

Falconsixone's picture

Oh! We got a red gun grabbing commie!

buzzsaw99's picture

Rigged markets don't have accidents.