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A-Rod And Janet Yellen: What Valuation, Debt And The Fed Can Say About The Next Bear Market

Tyler Durden's picture


Submitted by F.F. Wiley of Cyniconomics

What Can Valuation, Debt and the Fed Tell Us about the Next Bear Market?

We last wrote about stock valuation in August, when we looked at three types of P/E multiples and argued that stocks were more stretched than you would think if you only relied on the simplest measure.

Since then, we’ve had the non-taper, non-Larry Summers Fed, non-Syria ultimatum, non-keeping your plan if you like it, and non-market bubble (according to Janet Yellen’s soon-to-be authoritative judgment).  You might say we’ve had an unusual amount of non-sense.

After all that’s happened – and with the S&P 500 (SPY) about 7% higher – it seems time to update our research. We’ll look at the three P/Es again as part of a new analysis that ties in credit markets and the Fed and ends with a prediction about the next bear market.

We start with a chart that marks and categorizes 11 historical bears that will play a part in our conclusions:

These bears are slightly different to other lists you may have seen because we’re using Robert Shiller’s long data history, which shows average figures for each month without the daily detail. We’re also identifying all corrections of over 20% as bears, even if the market failed to make a new all-time high at the prior peak.  “Mega-bears” are corrections of more than 40%, while “über-bears” are corrections of over 60%.

Now for the valuation history, starting with traditional P/Es based on trailing 4 quarter earnings:

Here are Shiller’s P/Es, which are based on 10 year trailing averages for earnings:

And here are P/Es derived from 40 years of trailing earnings but using trend lines instead of Shiller’s averages (click here for further detail):

Trailing P/Es are inferior to the other two measures because they don’t account for earnings cycles. As we wrote in August:

[I]t’s clear that changing perceptions about earnings explain a substantial portion of the market’s volatility. Just as investors can easily forget that P/E doesn’t rise forever, they sometimes forget that earnings don’t climb forever. And when earnings are unusually high, traditional P/E multiples fail to capture the full risk of a correction.

Moreover, earnings cycles are more pronounced in recent decades, due to the Fed’s increasing interventions.  (See here for more on this topic.)  Interventionist policies suggest an even stronger case for following the Shiller P/Es or trend earnings P/Es – not the more traditional measure – and we’ll come back to these results in a moment.

Turning to the credit markets, the next chart combines the Fed’s “Flow of Funds” data on nonfinancial private debt with an earlier series that isn’t exactly the same but captures credit trends, nonetheless:

Three time periods stand out as distinct debt or policy regimes:

1929 to 1946 (the Great Deleveraging). Private debt fell from a pre-Great Depression high of 163% of GNP in 1928 to 83% in 1947. Moreover, there was an even greater fall from the economic trough in 1932-33, when nominal GNP dropped to about half the 1929 amount and pushed private debt above 250% on a GNP ratio basis.

1946 to 1998 (the Long Re-Leveraging). Using the Flow of Funds data this time, nonfinancial private debt climbed from only 37% of GDP in 1945 to about 130% by 1998.

1998 to today (the Big Experiment). While re-leveraging continued through the housing boom, it was further supported during the Alan Greenspan and Ben Bernanke Feds by a new policy approach, which combines limited intervention in good times (leaving bubbles alone, for example) with ample stimulus at any whiff of volatility, deleveraging or deflation. The Greenspan/Bernanke “puts” have emboldened risk takers and pushed valuation measures upward, as shown in the P/E charts. For credit and asset markets, the puts mark a new regime that stands far apart from the old-fashioned approach of “taking the punch bowl away when the party gets going.” We’ll call the new regime a “Big Experiment.”

The Big Experiment began, arguably, with the Fed’s actions after the 1987 market crash and then strengthened progressively. But we chose a 1998 start date because it coincides with Greenspan’s aggressive response to the LTCM crisis and implicit support for the Internet bubble, while also marking the early stages of the housing and mortgage booms.  By the end of the 1990s, the Fed had clearly crossed the Rubicon into a new era that David Stockman aptly calls “bubble finance.”

The three regimes’ relevance may not be immediately clear, but consider what happens when we sort all bear markets since 1929 by size:

It turns out that sorting by size is the same as sorting by our three regimes. Together with the P/E histories, the table gives us a few reasons to expect the next bear to be a big one. (Note that we’re separating the size of the bear from its timing, which we’ll discuss in a later post and doesn’t depend much on valuation.)

First, one thing we’ve learned about the Big Experiment is that stocks tend to fall a long way after the Fed loses its grip.  The bear markets of 2000-03 and 2007-09 were more severe than all but the Great Deleveraging bears of the 1930s and 1940s.

Second, stocks are more expensive than at any of the Long Re-Leveraging peaks, which is the only period in which bear market losses fell short of 40%.  In fact, the Shiller P/E is now higher than it was in any bull market before the Internet bubble except for the 1929 peak, while the trend earnings P/E has breached even the 1929 levels.

What’s more, it’s reasonable to expect big cycles to persist in today’s policy environment, because it relies so heavily on the Fed. When so much depends on a single, binary factor (in this case, faith in the FOMC’s support), corrections tend to be particularly severe after the factor reverses (when judgment swings from full faith to loss of faith). By comparison, a less manipulated market responds to a wider variety of inputs, most of which develop gradually.

Why so doom and gloomy?

If you disagree with these conclusions, you probably believe we’re headed for another long re-leveraging, thanks to the fall in private debt since the housing boom. The Fed’s policies, you may say, are merely cushioning the path to a lower debt burden and more balanced economy. It’s only a matter of time before the post-WW2 credit boom reignites. In Ray Dalio’s parlance, this scenario would be a “beautiful deleveraging.”

While the beautiful deleveraging is worth contemplating, it seems highly unlikely. Here are three reasons for skepticism:

  1. Private debt hasn’t fallen all that much. Nonfinancial private debt was 156% of GDP as of the latest data point, which is exactly where we were in the second quarter of 2006 as the housing boom was running out of steam.
  2. The Fed’s actions have barely registered with the all-important middle class. Not only is median household income 8% below its 2007 peak after adjusting for inflation, but it was still falling as of 2012 (the latest data point). The median household is now earning the same real income as it was in 1989 – 24 years ago! In addition, the jobs picture is abysmal by any honest assessment (which should include the composition of job gains, unemployed folks who’ve dropped out of the labor force and involuntary part-time workers).
  3. Just about everywhere you turn these days, you’re looking at another classic sign that credit and asset markets are getting out of hand. From record margin debt to a deluge of covenant-lite loans to 1990s-like enthusiasm for Internet companies, it’s hard not to see froth (regardless of your views on bubbles). When we compare these warning signs to the slow progress on debt reduction and no progress for the middle class, the financial economy is too far ahead of the real economy for the eventual outcome to be beautiful.

Put differently, the giant gap between the financial and real economies tells us that any normalization of the real economy will prove fleeting.

Think of it this way:

You’re a baseball player trying to break into the majors despite mediocre fielding skills, no foot speed, and a batting average that hovers around 250. Egged on by your friend, A-Rod, you think you can make it by using steroids and turning yourself into a power hitter. But it doesn’t work out as planned. After a year, you’re losing hair, your skull’s gotten bigger, there’s fatty tissue on your chest that wasn’t there before, and you’ve still only managed 18 home runs in a season. You finally accept that it’s not going to happen for you.

In the baseball scenario, steroids didn’t show enough payoff before the side effects told you enough was enough. And you can say pretty much the same thing about our economic scenario and monetary steroids.  We’re seeing dubious benefits and fast developing side effects from the Fed’s actions, causing many observers to recommend a rethink of the Big Experiment. Yet, the experiment continues.

Getting back to our question about the next bear market, the Fed’s unshakable commitment to its approach – despite growing evidence that it may do more harm than good – is our last reason to expect the next bust to be another killer. When the bull finally runs out of steam, it’s likely to be March 2000 or October 2007 all over again.

Bonus result for Austrians

Although we started our analysis with the Great Depression (because of limited debt data and less familiarity with earlier markets), we sized up all of the bear markets in the Shiller database, which goes back to 1871.

These include a fourth regime: the classical gold standard from 1880 to 1914. There’s also an extra period from 1914 to 1921 that was marked by both World War 1 and the fact that the newly hatched Federal Reserve hadn’t yet established its so-called stabilization policies.  I’ll call this period “transitional.”

Here’s the full list of bear markets, sorted by size:

Note that every one of the pre-Fed stabilization bears is less severe than:

  • All of the Great Deleveraging bears
  • The most extreme Long Re-Leveraging bear (the 43% drop in 1973-74, which would look much worse if you were to factor in inflation)
  • All of the Big Experiment bears

In other words, our stock market history doesn’t reflect very well on the Fed.

(Click here for technical notes about this article and a few more charts.)


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Sat, 11/30/2013 - 10:53 | Link to Comment y3maxx
y3maxx's picture

...Obama has everything under control across the Homeland friends.

Of course the Diktator in Chief would love to have a third term to prove his platforms will follow thru successfully.

Sat, 11/30/2013 - 11:07 | Link to Comment VD
VD's picture

the takeaway: Janet Yellen has significantly bigger cock than A-Rod, and infinitely way more juice to pump.


f_s&co kilt off; TD 666 : feed me

Sat, 11/30/2013 - 11:20 | Link to Comment mofreedom
mofreedom's picture

I'm still of the belief that Yellen was chosen becasue she is a woman who will pull all this funny money back, likely very quickly, too quickly, thus causing widespread panic and suffering leading to the next leg of fundamental transformation and possibly a third term of some fashion for our current president.  Do doubt he hates this country more than he hates his white grandma, so this seems a very likely next path to take control of everything for the statists.  See, he shall say, capitalism has failed again folks, time we take over whether you like your freedom or not.  Too many folks will be glad to surreneder more of their sovereignty to the state.

No men.

Sat, 11/30/2013 - 11:39 | Link to Comment SafelyGraze
SafelyGraze's picture

what a healthy economy looks like:

... still looking for an example that's more than 200 years old ..

Sat, 11/30/2013 - 22:52 | Link to Comment philipat
philipat's picture

If you like your QE.................

Sat, 11/30/2013 - 20:17 | Link to Comment Renfield
Renfield's picture

<<I'm still of the belief that Yellen was chosen becasue she is a woman who will pull all this funny money back, likely very quickly, too quickly, thus causing widespread panic and suffering leading to the next leg of fundamental transformation and possibly a third term of some fashion for our current president.>>

I hate to agree with you but green-arrow.

If they jawboned tapering all the way thru reflation attempt #QE4, then what's to stop them from jawboning QE5 thru QE8 while attempting to "taper" in ways that (they hope) won't be noticed or cause damage?

I'm not saying they WILL taper. But I agree with you that Yellen will try, or at least try for the appearance. We'll get our market dip. I've heard something about her background: she used to be a 'hawk'. (If any central planner can be called that.) Right up thru the '90s.

Has she really forgotten those roots and is she ready to open the QE floodgates like Bermonkey's mini-me, especially as Bermonkey rides out of his office on a wave of public contempt? Which is exactly what EVERYONE is expecting? The Fed is going to go ahead and play to popular expectations like that?

Only way for a 'tapering' attempt (and the resulting market 'crash') to have any effect of looking like 'taking responsibility' at all, is if it's a SURPRISE. (To the general public at least. Not to the 0.0001% but.)

Surprise! Yellen jawbones MOAR while commencing some attempt at 'taper' as priority one. This will show everyone how responsible she is, how very very different she is from Bermonkey, and how completely unrigged the market is. MSM will trot her out everywhere as example of American Austerity and the Fiscally Responsible Fed II. And if it gives the USD a bit of a lift, then all the better.

I also agree that Barky will not let this crisis go to waste, either. Third term is already on the table. (Guess even Billary don't want it.) "To The Rescue!" will be the media cry. And thank you, mr president, for not bailing on your country in her hour of need.

Sat, 11/30/2013 - 23:11 | Link to Comment the grateful un...
the grateful unemployed's picture

you have two points out of three, (pt 2 the rest of the FED isn't necessarily her whipping boy) the public believes point one is bigger, what obama wants, obama gets. 

Sat, 11/30/2013 - 11:17 | Link to Comment max2205
max2205's picture

1.  The bullshit upward vector of 150 years of up will break in the next 10 years


2  recession began q3 will be announced by q2 droos at least 30%...which ain't shit compared to the manufactored 150% market appreciation we've this point is where another 20 to 30% drop begins if Congress doesn't act responsibly. 

3. Ben will get the blame just like the last 4 Fed heads before them.

4. Looking forward to 5% plus on the 5 year to retire on

5. Fuck the Fed

Sat, 11/30/2013 - 11:23 | Link to Comment Beam Me Up Scotty
Beam Me Up Scotty's picture

"4. Looking forward to 5% plus on the 5 year to retire on"

When inflation is 10% a year, or a day, or a minute, 5% on the 5 year isn't going to mean much more than Alpo for you for dinner.

Sat, 11/30/2013 - 12:16 | Link to Comment TheReplacement
TheReplacement's picture

Alpo Shmalpo.  We'll have baby boxes and permanent retirement facilities.  Peeps be eatin' Soylent Green (but it will have another color to throw off the sleuths).

Sat, 11/30/2013 - 11:32 | Link to Comment stocktivity
stocktivity's picture

Black Friday IDIOTS compilation of what this country has become ... Fat and Greedy -


Sat, 11/30/2013 - 12:48 | Link to Comment Groundhog Day
Groundhog Day's picture


I juncked you for being so naive to think the puppet in chief pulls any real strings in the economy

Sat, 11/30/2013 - 10:55 | Link to Comment billybobtx
billybobtx's picture

Spelled A-Roid


Fixed it for ya.

Sat, 11/30/2013 - 10:59 | Link to Comment Derf Scratch
Derf Scratch's picture

luckily Yellen's nads are showing no ill effects from the monetary steroid abuse  ... so far 

Sat, 11/30/2013 - 11:00 | Link to Comment SilverIsKing
SilverIsKing's picture

It all boils down to interest rates on TSYs and the credit markets. P/Es can continue to grow as long as the risk adjusted returns on stocks appears greater than that which can be obtained in the credit markets on a risk adjusted basis.

Sat, 11/30/2013 - 11:01 | Link to Comment Marco
Marco's picture

I don't understand why anyone pretends that if the government/FED had just acted differently somewhere in the last decade the steady state of the economy and standard of living could have been preserved.

The global and US economy as it stands are inherently unstable because of trade imbalances ... accelerating intervention is necessary merely to stay in this unstable state.

Sat, 11/30/2013 - 13:38 | Link to Comment Papasmurf
Papasmurf's picture

You could conclude from that, they didn't want a standard of living preserved.

Sat, 11/30/2013 - 11:05 | Link to Comment Peter Pan
Peter Pan's picture

Debt and savings have to be destroyed in equal measure rather than the one sided haircuts to savings we have seen. Only this can allow interest rates to return to a market rate of real interest.

It cannot be dirt cheap finance that primarily determines the value of investments but rather their real cash flows.

The haircut to savings and debts and the return of interest rates to normal levels will wreak havoc on asset values but things must revert to a mean soon if they are to avoid reverting to zero.

Sat, 11/30/2013 - 11:28 | Link to Comment Peter Pan
Peter Pan's picture

I really don't mind the down vote but can someone explain to me how almost zero rate nominal return on savings and negative real rates of interest do not eventually destroy savings through inflation and the need to consume savings in order to survive.

We either bite the bullet and destroy debt whilst restoring real rates of interest to savings or we continue until there is nothing left except meaningless price tags on FED induced asset values and a dysfunctional market where wholesale destruction takes place.

Sat, 11/30/2013 - 12:02 | Link to Comment centerline
centerline's picture

I didnt downvote you.

Just adding to the discussion that long ago on smaller scale, a jubilee could affect a reset.  Now, the economy is global.  A debt jubilee of any fashion just isn't going to happen.  Debt and savings are disproportionately held - as are resources, industrial capacity, etc.  A global jubilee would result in chaos.  And, it can't happen in any major economy as if it was a closed system.

Prepare for zero.

Sat, 11/30/2013 - 11:13 | Link to Comment OneTinSoldier66
OneTinSoldier66's picture

Bearish! Hold on to your short and curlies. Crash helmet, ON!

Sat, 11/30/2013 - 11:15 | Link to Comment Elliptico
Elliptico's picture

"After a year, you’re losing hair, your skull’s gotten bigger, there’s fatty tissue on your chest that wasn’t there before." - A bit cruel portrayal of Yellen, no?

Sat, 11/30/2013 - 11:15 | Link to Comment dcohen
dcohen's picture

Man she is ugly

Sat, 11/30/2013 - 11:21 | Link to Comment q99x2
q99x2's picture

WTF I hate NWO propaganda. There is no experiment. The FED is transferring the wealth of the nation to the bank owners. They are paying politicians to pass draconian legislation, building the DHS, NSA, FEMA and TSA to kill the citizens of the United States of America and preparing to confiscate everyone's bank accounts.

No good stinking M'Fers that write these treasonous FED articles.

Die Die Die mother fucker.

Sat, 11/30/2013 - 11:35 | Link to Comment macbone
macbone's picture

Yellen is being setup so that
The liberals can keep saying
The same thing they've been
Saying for the last five years...
"I blame bush for all our problems."

Sat, 11/30/2013 - 11:39 | Link to Comment Seasmoke
Seasmoke's picture

18 HRs and .250 ....... shit, that dude just signed a 5 year $85 million contract. 

Sat, 11/30/2013 - 11:39 | Link to Comment Trimmed Hedge
Trimmed Hedge's picture

Today is Small Business Saturday..

Shouldn't every day be Small Business Day??

Sat, 11/30/2013 - 15:49 | Link to Comment Tulpa
Tulpa's picture

Small business is usually small for a reason.  High prices, lousy selection, inconvenient hours, and rude to nonexistent customer service.  If mom and pop have been making and selling toys for 50 years and are still operating out of a tiny shop on a lightly-trafficked street, that says a lot about mom and pop.

If I want to keep my money local, I'll shop at Walmart and keep more of it in my wallet, which is as local as it gets.

Sat, 11/30/2013 - 11:52 | Link to Comment falak pema
falak pema's picture

If we compare the current crisis to lasted from 1929 to 1942 in uber mode and it came out of it due to a WW.

So...from 2008 to...2021...then WW3 if we cut n paste it.

Damn, 2021 is when the world hits peak HC bigtime (not counting the frack to really whack the hole of conventional ongoing  attrition). By then the world demand will be beyond 105 Million BPD of liquid fuel to service DC demand. 

Sat, 11/30/2013 - 12:16 | Link to Comment centerline
centerline's picture

I agree that this is where the potential is.  And the timing sounds about right.  I suspect 2014 is more of the same and things start to get real interesting in 2015.  By 2016 things start coming unglued in a hurry.  EU tees off first and hits bottom around 2020 or so with the US in tow.


Sat, 11/30/2013 - 12:19 | Link to Comment the grateful un...
the grateful unemployed's picture

they're committed to growing an economy linearly, while the real rate of growth is something less than linear

Sat, 11/30/2013 - 12:31 | Link to Comment Seasmoke
Seasmoke's picture

I am sure 2020 will have some fucked up meaning for TPTB. So I say collapse in 2020. 

Sat, 11/30/2013 - 16:54 | Link to Comment Pareto
Pareto's picture

how about 2112!  ahh.  just kidding.

Sat, 11/30/2013 - 12:15 | Link to Comment the grateful un...
the grateful unemployed's picture

Obama hates white males, he appoints mostly women and black men to cabinet posts. he has appointed white males to Treasury, in deference to his contributors on Wall Street. he has also purged the military leadership using NSA to pull up dirt on them (mostly white males). Obamas problem is that white males have a lot of power. Obamas minor dustup with Bernanke is just more black man hates white guy drama (then appointing someone more dovish to the job begs the question, what is his policy agenda?) W Bush used a political litmus test for all his appointments, and likewise Obama. (if Boehner was replaced a woman or a black Obama could deal with that) the issue remains, can Yellen keep the rest of the Fed board together, and can she stand up to Congress. (in an election cycle) the answer to that is probably no unless Obama has the two term limit rescinded (just like Bush wanted) and gets reelected with something substantially less than a majority of the people supporting him, as Bush did in 2004) ending the Fed wont matter if the POTUS then empowers Treasury to perform the same functions, and that would involve taking debt off balance sheet, (just like Bush did) did Bush do it, sure he did, and Obama does it too.

Sat, 11/30/2013 - 15:52 | Link to Comment Tulpa
Tulpa's picture

Obama is as much a white male as he is a black male, so I don't get where you're going with this.

Sat, 11/30/2013 - 23:07 | Link to Comment the grateful un...
the grateful unemployed's picture

no he's not, get your head out of your ass (cambridge professor? susan rice, benghazi?)

Sat, 11/30/2013 - 12:16 | Link to Comment ToNYC
ToNYC's picture

Hypnotized by safe sex narratives of unnatural acts they go. They want to believe so they can never see it coming. That would ruin the theme that leaves the treasure chests open for mostly the right people.

Sat, 11/30/2013 - 13:07 | Link to Comment Bangin7GramRocks
Bangin7GramRocks's picture

QE = Bitch Tits?

Sat, 11/30/2013 - 15:57 | Link to Comment Tulpa
Tulpa's picture

His name is Henry Paulson.

Sat, 11/30/2013 - 13:56 | Link to Comment sbenard
sbenard's picture

Dr. John Hussman, in his weekly commentary last week, made the point that the E part of the P/E ratio is currently 70% above its historical average. Thus, the P/E ratio is also closer to historically unsustainable highs as well. That only spells disaster going forward.

Sat, 11/30/2013 - 14:22 | Link to Comment Professorlocknload
Professorlocknload's picture

 After a 50% devaluation these last 5 years, that just hasn't trickled through the system yet, do these stock prices really look all that extreme?

 Priced in money, they don't...



Sat, 11/30/2013 - 14:30 | Link to Comment AngelEyes00
AngelEyes00's picture

I'll take 18 homers a year as a sign of unimaginable success, because knowing baseball salaries, it will be far greater than any single year of my working career.  Load me up with steroids I'm playing ball!

Sat, 11/30/2013 - 16:36 | Link to Comment Goldilocks
Goldilocks's picture


Sat, 11/30/2013 - 22:23 | Link to Comment mkhs
mkhs's picture

Uploaded October 11, 2009.

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