"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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Bruin4's picture

PLEEEEEEEEASE its all under control....you guys are so kidding

Whoa Dammit's picture

We would be much better off without a stock market.

Dewey Cheatum Howe's picture

Do these accidents require a change of pants?

AllWorkedUp's picture

The market isn't going down again ever. Gold will stay below $1700, silver below $35 and the 10 year will stay below 2% - for fucking ever.

 It's the new normal.

Dr. Engali's picture

That's what they want you to think. But as more and more gold and silver is pulled off the market they will eventually break the paper price. Take advantage of the manipulation while you can.

Whiteshadowmovement's picture

Doc I know this isnt going to win me any friends here, but honestly I think Bernanke will end up breaking gold bugs' backs. They will use strategic "corrections" so it will look like the decade long bull pattern is collapsing, and retail will panic, first at $1500, then at $1200. They wont let paper gold rise up again after that. What happens to bullion is another thing maybe, but I doubt very much anyone will be buying bullion from you for very much above spot. I think its just like stocks- they will succeed in getting retail in, just like they will succeed in getting them to capitulate and sell gold (as many have gotten excited and bought at very high prices- I personally know several who got in north of $1800). Once retail goes you guys will fight a losing battle, they will manage to quash interest in gold as an alternative investment through the media and make sure to keep other commodities flat to control inflation

willwork4food's picture

+1 Shadow makes a good point, but so does Doc. I see the achilles heel of the consumer explained in two words: Food & gas. Both they can manipulate. You can't get to work without gas, and you cant work without food. If they cost too much there won't be anything left for PMs, stocks or superbowl tickets. You'll have massive selling of individual investor's stash because the wives will tell their husband they better do something-or else. But when the dust clears, and the shit hits the fan it will be evident as the sky is blue and that Congress is as worthless as tits on a bull that PMs will be very, very valuable indeed.

Dr. Engali's picture

You had me until you said " once retail goes you guys will fight a losing battle", because I totally agree with the first part of your statement. I believe that the weak hands have to be shaken out of gold and has to plow into stocks. But we all know what happens then.. retail will be holding the bag in stocks and the" smart money " will be in gold. Then retail will chase gold higher, while the smart money is selling to them. That's generational wealth creation game. Any market needs a good shake out to move higher, and they need a bag holder once they top out.

Whiteshadowmovement's picture

I really see where you're coming from Doc but I think we're due for a repeat of the 90's. A soaring market and flatlining commodities.

The problem with your current contention in my opinion is that its tough to make the case that the "smart" money will be in gold as:

A. The smart money got into gold WAY before it was on everybodys lips and if anything needs to get out here at the peak.

B. When idiots like John Paulsen are basing their investing philosophy on "buy gold" its tough to say the smart money is going to do the same.

C. The main investment idea behind gold is extremely simple- the hyperinflationary outcome. Due to the fact that this is so widely discussed and debated, it doesnt take a very smart individual to figure this out. If the Fed, is indeed in control of markets and does manage to keep all commodity prices stable as I suspect, the hyperinflationary argument will lose traction until there is nothing left except a core group of staunch die-hard gold bugs, and they will be too small to propo up e price against the Fed.

D. The enthusiasm for gold is way out of hand among gold bugs (they are the biggest permabulls out there, it makes Tom Lee look rational when he talks equities). Whenever anyone is 100% certain *every* opportunity is a good chance to buy the dip, and conversely there is no point in selling until something "explodes", as they do with gold, they are just asking to get crushed.

E. I think its the personal objective of the Bernank to crush gold (as the enemy of fiat) and see to it that it is dead money for an entire generation just as a huge fuck you to you guys. My moneys on the Bernank...

Dr. Engali's picture

You bring up some solid points, but I will argue that

1) Paulson invests in GLD and doesn't take delivery of real gold. He's a one hit wonder that doesn't grasp the real reason why you hold physical gold over paper

2) there are very few "investors" (renters) who hold assets in gold. If they allocate a mere 5% of their allocation to gold that means we go higher.

3) interest rates are at their lowest and they will eventually go higher. Sure they may tac down to sub 1% on the 10 year and I expect them to, but the long term trajectory is up, and gold will follow.

4) overlay the national debt with the gold price and you get an interesting picture. Without massive growth there is no hope for the deficit, so the debt goes higher.

5) Okay....... I forgot what five is because I've been drinking wine, but I'm sure it was a good point. Bottom line is I expect paper gold to get hammered (much like me) the weak hands to get shaken out , the strong hands to pick it up, and finally gold to go higher.

Whiteshadowmovement's picture

Doc I hope you dont mind if I stay brief and let us pick this up again tomorrow, but let me just note:

1. I sort of dont buy the argument that there is real inherent difference in phyz vs. paper gold. Clearly if bullion prices surged, paper would track it to some degree. Likewise, if paper prices plummeted, I cant help but think the same would occur. Really gold is no different from scrap iron that way.

2. Larger investors have to play in the paper market. Paulsen and others (smart and dumb money alike are bullish gold) cant feasibly take delivery of gold. It doesnt really work except in a few small cases. Its just like when oil prices sometimes go up and the media starts going into a huff about 'forcing speculators to take delivery' and we all know how absurd that is. I think gold is no different from the rest of paper commodities in that the vast majority of price action is paper based and if suddenly paper prices plunged as big investors (ahem, Paulsen) all had to start dumping because gold is dead money, the bullion prices would follow suit. All thats left to pick them up afterwards (which you say is the smart money) is in my mind nothing but the most die hard gold bugs.

3. In my thesis doc, the Bernank comtrol interest rates and artificially keeps them under 4%. Interest rates will never go up as TPTB simply wont allow it. It doesnt give a shit what the market thinks, as long as the US has the worlds dominant military, it will set its own interest rates, thank you very much.

4. You would of course have to come back to the national debt argument to support the underlying hyperinflation thesis in the first place. However, its not really fears of inflation that gold is reflecting imho, rather fears of bond/currency collapse, as people feel hard assets in the form of PMs are truly a last resort. However, imagine a scenario such as i propose: a few years of Bernanke keeping commodities totally flat, ramping stocks at 10%+ per year and *allowing* interest rates to calmly hover between 2-4%. After years of this, nobody will really believe in the possibility ofimminent collapse anymore and the only enthusiasm left in the gold market will be the die hard bugs who still expect hyperinflation just around the corner.

5. Dont you think Bernanke will personally see to it to crush gold as an asset class for a generation? Wouldn't you, if you were him? It will be the crowning achievement of his behavioral financing experiment. A giant cherry on the "fuck you bernanke" cake.

You know, as I one mentioned, my grandfather left me a stack of 1967 Krugerrands which are now worth a modest fortune and Ill always be grateful to him. Interestingly, he actually bought them solely for numismatic purposes and not strictly as a gold investment. They do carry a huge premium to spot even today. I keep them hidden for an emergency (bribe the border guards, that sort of thing) but I never think of them as an investment that has upside from here. Ive often toyed with cashing out at what I consider very elevated prices, but I dont really need the money at the moment and I figure theyre always good to have around for emergencies or a big ticket purchase I just can't refuse down the line. Ideally Id love to give them to my grandson one day.

Just to tell you, even as owner of phyz, I can feel very little enthusiasm for the idea that tptb will "allow" gold to rise as it would be illogical to think they get *everything* else they want, but not this...

Dr. Engali's picture

I look forward to this discussion later. Just an FWI.. I didn't downtick you. I think you make a good solid argument , and I enjoy a good debate. I think you're wrong, but I still enjoy the debate. If nothing else it helps me to challenge myself.

Whiteshadowmovement's picture

Thanks doc, I feel exactly the same. I know you wouldnt downtick me by the way, from the context of what i was writing, I was expecting our fellow ZHers to put a burning cross on my virtual lawn, so I figure I got away easy with 1 downtick. All the best doc.

If you want to check out Withnail and I, I promise you wont regret it:



tenpanhandle's picture

I see you are tired and want to leave the floor, so I won't ask for a dance but please forgive me as I critique your last dance.  You profess that you don't see a meaningful difference between physical and paper gold.  Well, most gold bugs are buggy about gold because they see the ongoing destruction and eventual (near term) failure of our financial system which consists of a mountain of paper products derived out of a molehill of tangible products.  In a world that was going to plod on indefinately as is, I'd say you may be right.  But, again, us bugs are buggy because we believe the system is going to tilt. Paper derivitives will become worthless in a crashed system.  People who are holding their gold in hand will be able to use the historically validated and human nature inspired value holding properties of precious metals in any new replacement system.  In all likelyhood, the paper derivitives and promises to deliver will be firestarter only.  Similarly, the holders of a loaf of bread will be better off than someone with a fistfull of wheat futures that rely on a coherent system in place to provide the value.

Also, you mentioned a generational bearish attitude being  fostered in the market and that being needed before gold can truely go bullish again.  We have had a generational bear market from approx. 1983 to 2001 and I put forward that while we may have had a bullish market since 2001, it was in price only, as the mainstream market makers always maintained a predominately bearish view and commentary all during that time.  This served to keep a true bull market from developing where the proletariat jumped in.  In essance, the current so called bull market in PMs was and is generated by the bugs.  There is no bubble and no irrational exuberance by the masses; quite the contrary, actually.  In my view, the true bull awaits and needs no correction to begin it.

Peace be with you.

fonzannoon's picture

Whiteshadow you could absolutely be right. But I am curious, can you envision Doc being right? Do you concede the possibility that it could go the other way?

zkay's picture

I would be inclined to believe you if only for the reason that no sane person would be fighting the fed at the moment. Look back to that chart listing prices from last year vs. the beginning of the decade with potatoes up some 500%.

Start a garden, buy some chickens, buy long term storable food, sure. It is harder/impossible for them to attack the value of these things. But as you point out, and as everyone here is surely aware, silver and gold are quite easily manipulated.


BTC: 12imfrCcAJvc2GRBoBaaHpYwvYFU2H21NC

lakecity55's picture

+1, Doc. Look at the sales numbers coming from the Mint (USA).

Dewey Cheatum Howe's picture

Deleverage takes place if all the major hedge funds and retail investors (basically anyone not attached to the money spigot) pull their money out and into tangible assets or business startups (that produce real tangible assets and services) to preserve the existing wealth instead of letting it be inflated away. Fuck the rigged market.

geewhiz190's picture

over 1000 13f filings for 12/31 public so far,,,,,,AAPL remains main holding of many of the larger hedge funds and many of the big corporate pension funds.  most added to their holdings in 4th quarter. practically no shorts in the stock as of last report about a week ago. if this stock falls further from here it will pressure a lot of major players to do something

Falconsixone's picture

Made me think of how well your 401k is going to do once the government takes it over..lol

....and your broke...

must be nice to run the wave machine

Ned Zeppelin's picture

Not that I don't firmly believe this will all end badly, I do think that, but without a doubt the right move was to ignore all of this naysaying, and go way long equities in March 2009 and keep loading up.  The only lesson I've learned is to that it is foolish to fight the Fed.  Of course, gold hasn't done too badly since then either, and it's real.

Of course, the day of reckoning will come, and I point out the foregoing without any conviction that it will last much longer, 'cause you can't simply print real wealth, but Lawd it really does take a long, long time for reality to catch up with these boys. So, I'll keep the cash and hang out on the sidelines, looking at real assets, staying out of the HFT casino, and puzzling till my puzzler is sore.   

willwork4food's picture

I'll take that bet. Look at Zimbabwe post crash & Argentina's current stock market. If you can afford to be in, you are making a killing. Notwithstanding the occassional 'fat finger' elite rake off. Why roll the die when you can own silver or gold?

vamoose1's picture

  so   good    well  put   i  think  this  site  is  the  best  site  on  the  worldwide  internet

    so  i  thank  the  tylers  ?   and  the  brilliant    and   weepingly    tm  FUNNY   people  that   hang  here .  Truly  i  do  not  understand  why   its  allowed ....  this   site...  its  flat  subversive   but  i  remem  old  herbert  marcuse  in  his  strangulated   translated  syntax    who   taught  a  kid  something   decades  ago.

    One   Dimensional  man   was the book   and  repressive   tolerance  the   concept    as  in   toss  em  a   bone  like  bart  chilton  another  excellent  example    get  all  their  ips   then  we  round  em  up  more  easily at  a  time  of  our  choosing .....  fine   fuckyas   i  will  at  least  be  among  kindred   friends   kindly  pick  up  those   concrete  mattresses  couldja   and  are  there  any  drugs  in  here   for  a  70  year  old ass?

   rumor  has  it  tyler  wants  this  edifice  to  collapse   because  he  got  rejected   or  possibly  fired  in  the  business   some  years  ago  hence  the  unremitting  gleeful  bearishness    that  colours   zero  hedge.


  FINE  WITH   MOI. An  ELECTRONIC PAUL  REVERE     with  kinda  serious  guts.

    As  Ned  Zep  so  eloquently   says   this  thing  is  on  fumes   but  the  opposition  is   viciously  devious   its  not  a  question  of  respecting  them    any  more  than  one  would  respect  a fucking   scorpion    butt  probably  wise  to  wait  and  watch  the   cracks  widen

    People  these  cracks  are  rather obviously  on  the  move   even  in  the  last  6  months  even  the  last  six  weeks    it  screams LOOKOUT      and  cracks  accelerate  and  then   they  split, Patience  Petunia,    its  not  long  now  and of  course  a  new   set  of  problems  presents itself  ,  50  million  Americans  on  food  stamps    you  shut  that  card  down  and   72  hours  later   you  can  shoot  a  howitzer  through  every  empty   supermarket  in  america .  You  are invited  to  Vamooses  barbie  though,  bring  intoxicants.


edwardo1's picture

Deleveraging will not be achieved by any other means then asset monetization, where currency values fall against the heavy yellow hued subtance which is on the balance sheets of every CB from Seoul to Santiago.  Don't expect the stock market to be cut by two thirds. It will continue to deliver nominal performance. So you can forget revisiting the S&P 500 levels of March 2009. Physical gold will be revalued and the public debt, which is presently a massive drag on the global economy, will be rendered harmless.

vamoose1's picture

  pucker  up  greaseball    you   supperating   cunt    dribbling   indeterminate  liquids

americanspirit's picture

An "accident" is an unanticipated, unintended event - a consequence of unforeseen factors. This is the very heart of people and institutions being able to successfully escape blame - it was an accident. When this implosion occurs it will not be an accident - it will be a result of culpable actions by culpable people and institutions. The question is whether or not they will escape the consequences by being able to claim"it was an accident". Yes I pointed the loaded gun at her. Yes I shouted "I'm going to kill you", but I didn't really mean it. I was upset. But then the gun just went off. I didn't mean to kill her. I don't know why it happened. I loved her. It was an accident.

Falconsixone's picture

I blame her for standing between you and your congressmen like the dumb bitch she was.....she commited the accident in the eyes of law.....you get another shot

CheapBastard's picture
Sucker Alert? Insider Selling Surges After Dow 14,000

February 5th




I know, I know, it's CNBC but still kind of interesing they would be warning investors....they're usually spinning the other way to Buy! Buy! Buy!

Spigot's picture

There is no market. There is an illusion of a market. Stop talking about the numbers. They are meaningless. Up, down, sideways, VIX, etc. Its all a sham. Best thing to do is simply laugh out loud at the fools who keep dithering around with the numbers. 90% of these numbers are meaningless because 90% of the "market" is a computerized fraud.

reader2010's picture


JR's picture

When you see it’s going toward the wall, you don’t say how are we going to ride in the car?

That’s the stock market. Bernanke is running it up far beyond what he can hold. He is stealing the nation's seed money; the sound money, funneling it into Wall Street. Biggest of all, he is leaving the people without a place to go. He’s taken away their incentive to find a better job, to get a better education, start a business, move on to a better house, to try to improve their lives by building a nest egg. People just say, What’s the use?

And the bankers say, Maybe you had a future but we need that now; we need you to sacrifice for Wall Street; we need six homes instead of five. You see, we’re smarter.

What this all means is that Bernanke’s time is getting short and his run on the fast track is approaching the end.

Recovery is a fraud, of course, unless you just want to talk about the corporate culture. There’s incredible unemployment; small businesses are in trouble and closing; there’s no GDP growth except government spending. Yet corporate profits are at an all-time high even though there are no new major companies and lots of companies are closing branches. In short, it’s the bankers that are on an all-time high.

It reminds me of the story of the little kid whose mother gave him a medical thermometer to put under his tongue to see if he should go to school or not. So he held it up to the light bulb and the mercury rose to 111. So he was packed off to school.

That’s the stock market rise; Bernanke’s held it up to the light bulb. It doesn’t take a genius to know it's not real.

helping_friendly_book's picture

Blah, blah blah, blah.......withdrawl cash from bank, after ever payday, and bury in yard. Keep paper checks on hand so you can produce notes, your own, when FRN dry up.

Cash out 401k, while you still can, take the wife someplace with coconut trees.

Don't forget your tool box.....not the bubbles bernanke type.....the box with real wrenches and pipe fitting tools.

Thank god I know how to change washers in a faucet and replace a toilet seal, build a manifold to service industrial fluid delivery.

Change oil in truck every 3000 miles. Keep plenty of pouch, high grade tuna and fixings on hand.

Coleman stove with 20 gallons of fuel, 20 lbs. of Colombian bean and good water. French press $20/cup. Latte 35$/cup. 

Contact friends with same attitude. Free coffee for armed protection.

If you let shysters lord over and whittle away at your savings you have no one else, except for you, to blame.

Ask all those people, mostly law enforcement, living on Staten Island who still have no power...... how is the gov't working for them? They seem to be going it alone....and managing from what I have heard.



MeelionDollerBogus's picture

Hm. I'll give a 7/10 rating. In the event of actual currency collapse, or in the event of grid-failure including banking grid, your plan is hindered but you'd surive. You're clever so you'll adapt of course. Toss back in gold, silver & multiple locales to live in & I bump that up to 9/10. 10/10 needs another legal jurisdiction to safely live in AND store some of the goods.

Stuck on Zero's picture

A 100 percentage point decrease would make things manageable?  I don't think so.  It is in the nature of markets to see a debt/GDP slide from 400% to 0% without pause.  Markets always over react.


Common_Cents22's picture

Don't fight the fed works, until it doesn't.  It's truly a game of musical chairs everyone hunky dory running in circles, when no chairs exist except for only a couple elite.   Then the music stops.....

Black Markets's picture

What a load of shit.

Free market prices aren't determined by 'value' or any other formula, they are determined by the balance of selling and buying.

Value is something that exists merely in the eye of the beholder. But there are millions of beholders, so ascribing a correct valuation is an impossible task.


All that really matters is how the balance of buyers and sellers will compare in the future. Everything else is a distraction, designed to sway your thinking. There are a million reasons why people buy and sell, working out one of those reasons to the Nth degree is futile any such insight is negligible.


All Wall St does is tends to the herd and occasionally drives everyone into a corner so they can bet on them coming out again. You can see when this is happening as correlation across markets will tend towards 1.


The worst trader's picture

Never wil happen.BTFD


Grand Supercycle's picture

Get Ready Bears.

Wile E. Coyote overdue sell off awaits as SPX daily & weekly charts continue their protracted topping process from current extreme levels.