Peak Hubris

Authored by Michael Lebowitz via,

In the past month, two well-known and highly respected money managers have made confident assertions about the markets. Their comments would lead one to believe that the future path of the market in the coming months is known.

Sadly, many investors put blind faith in the words of high-profile, accomplished professionals and do little homework of their own. While we certainly respect the background, knowledge, and success of these and many other professionals, we take exception with their latest bit of advice.

Before the election, in November 2016, were there investment professionals that claimed a Donald Trump victory would drive equity prices significantly higher? Although we are certain there were a (very) few, they certainly were not publicly discussing it, and the broad consensus was overwhelmingly negative.  

In March of 2009, which professional investors were pounding the table claiming that the next decade would produce some of the greatest market returns in history? Again, while some may have thought valuations were fair at the time, few if any were raging bulls.

The two instances are not unique. More often than not, investor expectations fail to accurately anticipate the future reality. This is not solely about amateur individual investors, as it equally applies to the best and brightest. Despite the urge to heed the sage advice of the “pros”, we must always remain objective, especially when everyone seems so certain about what will happen next.

The Known Future

The current message from Wall Street analysts, media gurus and most investors is that stock prices will undoubtedly go up for the foreseeable future.  Unbridled optimism about corporate earnings offer one point of fundamental justification for such views, but in large part these forecasts are predominantly based on the simple extrapolation of prior price trends. In late January 2018, a few esteemed Wall Street analysists actually raised their year-end S&P 500 price forecast from what it was only weeks prior. Although rationalized by stronger estimates of earnings expectations and an improving economic prognosis, the fact that January’s market rally has the S&P 500 already approaching their year-end forecast also played a meaningful role.

Basing future expectations on the most recent price activity is a great method of forecasting returns, until the trend changes. Wall Street analysts are not the only ones convinced the recent trend will continue in the months ahead. The graph below shows that expectations for stock price increases are now higher than at any time since at least 1987.

This second table from Ronnie Stoeferle at Incrementum provides a broad gauge of the excessive bullishness in the markets.

While there are a slew of technical reasons to suspect the recent market dip may be a speed bump on the way to higher prices, there are some serious fundamental warnings along with geopolitical concerns that argue downside risks are being grossly ignored. We would avoid using the word certainty to describe a market or economic forecast, and given the juxtaposition of risks and excessive valuations, relying on the certainty of others is not a prudent way to build wealth.

Ray Dalio

The following quotes came from a recent interview with Ray Dalio:

  • “We are in this Goldilocks period right now. Inflation isn’t a problem. Growth is good, everything is pretty good with a big jolt of stimulation coming from changes in tax ”
  • “There is a lot of cash on the sidelines. … We’re going to be inundated with cash,” … “If you’re holding cash, you’re going to feel pretty stupid.”
  • Finally, he said he expects to see “a market blow-off” despite the economy being in the last legs of the economic growth cycle.

What could go wrong? Ray Dalio, the billionaire founder of the world’s largest hedge fund, warns us that taking a conservative posture will make you “feel pretty stupid.”

There are four problems with these comments. First of all, does Ray Dalio really believes there is “cash on the sidelines”?  For every buyer there is a seller. The concept of “money on the sidelines” does not hold in a free market economy. This is one of Lance Robert’s 7 Myths of Investing.

Second, neither he nor anyone else knows what the future holds and for every buyer there is a seller. Third, even if we presume him to be correct concerning the market, will he let you know when it’s time to sell stocks and hold cash?  Keep in mind that wealth is compounded most effectively by not chasing markets higher but by avoiding large losses. Finally, Mr. Dalio almost certainly has hedges in place so that, even if he is wrong, his portfolio will have some cushion. Again, although we respect his insight and he may well be correct, it is concerning to hear a person of such influence potentially mislead investors into thinking the future is certain and worse mocking those taking precautionary measures.

Jeremy Grantham

Mr. Grantham, also a very successful investment manager, has made similar comments as to how this bull market ends.

  • “I recognize on one hand that this is one of the highest-priced markets in U.S. history. On the other hand, as a historian of the great equity bubbles, I also recognize that we are currently showing signs of entering the blow-off or melt-up phase of this very long bull ”
  • “A melt-up or end-phase of a bubble within the next six months to two years is likely, i.e., over 50%.”

Mr. Grantham has a perfect track record this millennium of calling out the equity bubbles of 2000 and 2008 well in advance. Further, he has stated unequivocally that equity valuations are excessive and investors should expect flat to negative returns over the longer term. Currently, his firm GMO is forecasting annualized inflation-adjusted returns of -4.4% for U.S. large-cap stocks over the next seven years. Despite the prospects of negative returns and wealth losses, he feels confident influencing others to chase a “melt-up” bubble that may last from six months to two years.

Dalio/Grantham Wisdom

Both highly successful investors and thought leaders are telling the story of tenable market risks but then tempting investors with the possibility of a grand finale worth chasing.

No one knows how this current bull market will end. Dalio and Grantham may be correct, and it may end with a melt-up, blow-off rally for the ages.  On the other hand, it may have ended last week with the blow-off rally having occurred over the last year.

To put a historical perspective on how this market may top, the following charts compare the death of the NASDAQ 100 bull market in 2000 and the end to the S&P 500 bull market in 2007.

As shown, the topping of the last two bull markets took vastly different paths. Whether a blow-off rally as seen in the late 1990s, the one advocated by Grantham and Dalio, is the right call or a more frustrating rounded top of 2008 is the answer, we do not know. Left for consideration is whether the 37% rally since Trump’s election was the blow-off top and, if so, has it reached its apex?


While market geniuses in their right, Dalio and Grantham’s ideas about how this ends have zero certitude. If their minds change, we will almost assuredly be the last to know. Although a cynical premise, could they be propping the market up with talk of a magnificent rally so they can reduce their own risk? There is abundant evidence this occurred in 2007 as the mortgage meltdown progressed, albeit with different protagonists.  So, we think it is a fair question to ask in this instance.

Given current valuations, the risks are significant, and if history is any indication, we can be assured that this bull-run will end sooner rather than later. This is not a message encouraging you to ignore the thoughts of Dalio, Grantham or other successful investors. Rather we remind you that you are solely responsible for the risks you take. Being a good fiduciary and worthy steward of wealth mandates that we understand the risks as highlighted by Dalio and Grantham and avoid being influenced by the consensus groupthink that often has an ulterior motive. We all know how that ends.

We leave you with the S&P 500 price projections from Wall Street’s best and brightest in 2008.


tunetopper Arrowflinger Wed, 02/07/2018 - 16:47 Permalink

Bear Stearns Mortgage SIVs doubted the reality of FAS 157 becoming "acctg law" in 2007.  The other law that was marching toward a rendezvous with reality was FIN 46R.  This was the bankers equivalent to the Enron Rule (which the financial industry was given an exception from),  FIN 46R said that the test for off-balance sheet companies of which Banks had a potential liability would no longer be a % of ownership / equity.  Instead it would become a test of economic exposure.  This is the true story of how the Financial Crisis got started.  All those off-balance sheet CDOs.MBS, ABS, and their "risk management tools" like the Credit Default Swaps on the synthetic indicies known as the ABX indicies.... were the real culprits.  Go see for your self --- even The Big Short among other "bogus chronologies" missed this altogether. 

In reply to by Arrowflinger

davatankool Wed, 02/07/2018 - 13:49 Permalink

I think today and tomorrow probably end in flat or a bit in red, Friday, there will be a big move. My reasoning is that the 10yr yield raising trend is happening, if it didnt stop for today and tomorrow, the selloff will resume. Remember why we have 1k drop on Monday. Yes, it will happen again and it will be much much worse.

Today's budget deal and bad auction just confirmed my theory, the yield will be higher.

khakuda Wed, 02/07/2018 - 13:59 Permalink

Exactly. There is no clear analogue to the period after 10 years of negative real interest rates globally. None.

As Buffett once said, you don’t know who is swimming naked until the tide goes out. We saw a little bit in the last week with the XIV

buzzsaw99 Wed, 02/07/2018 - 14:01 Permalink

god it would be funny if the 10Y actually did hit 4%-5% like most of them are saying.

some men just want to watch the world burn.  [/alfred]

edit:  oh hell i just noticed that those were 2008 predictions.  i knew they were full of shit back then.  i think abby baby stopped making predictions after that.

kellys_eye Wed, 02/07/2018 - 14:15 Permalink

We have repeated 15 YEAR predictions from .gov over the UK's economic performance post Brexit......

Tomorrow..., next week...., next month...??  Pfft.  Out .gov does it 'properly'.

Blankfuck Wed, 02/07/2018 - 14:54 Permalink

What? Just stay the course mother fuckers! The bankster ponzi fed preserve is always at your doorstep! Even the market that rose 20000 points more than it deserves, they will need to print another 20 trillion so it goes another 20,000! Those fat fucker bankers love this ponzi game! Just keep being a slave to the pigs, shut up and pay their debt. Let them shit big after the filet mignon they eat on those big yachts-its gods work so blankfuck said

venturen Wed, 02/07/2018 - 14:57 Permalink

time to rein in the money managers....Government prints $10 Trillion and give them unlimited 0% loans...and they KEEP ALL THE PROFITS.


They have their hands around the throat of the golden goose...who is dying

aqualech Wed, 02/07/2018 - 15:47 Permalink

The obvious conclusion is that the two are lying their asses off.  They are trying to take profits and scale back, but would never say so.  That might weaken prices before they could unwind.

tunetopper Wed, 02/07/2018 - 16:58 Permalink

If these VIX products were supposed to be for "institutional / sophisticated" investors- of which I doubt are nearly as common as widely believed, then why did those guys need an ETN /ETF structure when they could've bought PUTs on the SPY or SPX Futures.

The folks that think this will end well are kidding themselves.  This reminds me sooooo much of the days right after Bear Stearnes MBS Fund failed.


Risk Parity trades are the parlance used to explain the Long only portfolios which used Short VOL ETNs as a "perfect" hedge.  Well then, how much will it cost them to take the hit from a 92% loss on the hedge - then buy some other type of insurance for the portfolio?  And when the new products are created, as an offset - the Creators will have to buy protection - which will further distort the market.  

Captain Nemo d… Wed, 02/07/2018 - 18:12 Permalink

I love the "do not follow experts, do your own homework" advice. It's like the medical association telling you "of course you must go to the doctor and go through all these expensive tests, but after that you should not really believe the doctor and should self-medicate" or the safety board and engineers telling you "of course we will give you our opinion based on all our load-deflection and strength calculations but ultimately you have to come up with your own detailed design for your house"

If it so easy to home-calculate better than experts then they are not really experts are they? If everyone spent all their time trying to predict what the markets will do, who will have time for their three part-time jobs?

Basically you might as well have one guy write out the full range of possible predictions from their parents' basement: We think markets will crash soon; We think there is a slight downside risk; We think markets will essentially fluctuate around the current levels; We think markets will rise slightly; Buy! Buy!! Buy!!! This time it is different and you will get rich quick so do not miss this opportunity of a lifetime !!! Stamp different names on them. And add a disclaimer to each "please do your own homework".

Let it Go Wed, 02/07/2018 - 18:48 Permalink

A recent note from well-respected investor Jeremy Grantham, who is credited with calling the 2000 and 2008 downturns added to market enthusiasm by informing us we should be prepared for the possibility of a near-term “melt-up” but that is only part of the story. The negative part contained in Grantham's note that many seemed to discount were his feeling that this is one of the highest-priced markets in U.S. history and "this would likely set the stage for a burst bubble and a stock-market meltdown in the future." more below.

 http://Much Talk About Market Sweet Spot But Nothing Is Really different.html