29/11/20: Bubblishiousness

 

Illustrating FOMO and Bubblishiousness vs Reality: Tesla

Source: https://twitter.com/michaeljburry/status/1333110859329990661?s=20

Ya kidding me, not... It's like 10:0 score right now...

20/3/20: Central Banks are Failing to Reinflate the Deflating Bubble

In the last 5 days, central banks around the world have announced 2020 monetary stimuli to the tune of USD 4 trillion (inclusive of measures continuing from those announced back in late 2019). This is what this bought them in the markets:

The problem with 'doing more of the same and expecting different results' is that the measures being deployed by the monetary authorities are predominantly skewed on simply increasing the total quantum of debt in the global economy already croaking under a mountain of debt. The markets see this. The markets know this. And, at long last, the markets are not buying any more of this.

On what timeline will the central bankers and their masters in the governments recognize the same?..

8/2/20: Price-to-Sales Ratio Hits an All-Time High for S&P500

Stock are not overvalued, folks. Because, you know, stocks valuations are no longer making any sense...

Via @HondoTomasz, comes this nice chart, plotting the 18-year high in S&P500 PE ratios (gamable) and the all-time highs in Price-to-Sales ratio (less gamable). Do remember, folks, sales are a positive function of inflation and inflation has been pretty weak, of late. Which means that sales are facing two headwinds at the same time: low inflation pressures and low demand growth pressures. Yet, share prices are just keep climbing up in this new economic paradigm that looks like the old Dot.Com paradigm.

2/7/19: Factset: Negative EPS guidance hits the highest 2Q level since 2Q 2006

Bad news for the 'fundamentals are sound' crowd when it comes to justifying stock markets exuberance: based on data from Factset, to-date, the number of companies reporting negative earnings per share (EPS) guidance in 2Q 2019 has reached 87 - the highest number after 1Q 2016, and the highest number for any 2Q period since 2006. Total number of reporting companies to-date is 113, which means that so far in the reporting season, a whooping 77% of reporting companies are guiding negative EPS.

Technology sector leads negative EPS guidance issuance. Per Factset: "Information Technology sector, 26 companies have issued negative EPS guidance for the second quarter, which is above the five-year average for the sector of 20.4. If 26 is the final number for the quarter, it will tie the mark (with multiple quarters) for the second highest number of companies issuing negative EPS guidance in this sector since FactSet began tracking this data in 2006, trailing only Q4 2012 (27). At the industry level, the Semiconductor & Semiconductor Equipment (9) and Software (6) industries have the highest number of companies issuing negative EPS guidance in the sector." Which means the tech sector is singing the blues. Consumer discretionaries and Healthcare are the other two sectors showing underperformance relative to 5 year average.

Which is ugly. Uglier, yet, as we are not seeing any correction in the markets to reflect the deteriorating fundamentals. And uglier still when one considers the fact that the 'S' part of EPS has been gamed dramatically in recent years through rampant shares buybacks, while the 'E' bit has been gamed via opportunistic M&As.

23/4/19: Property, Property and More Property: U.S. Household Wealth Bubble

According to the St. Luis Fed, U.S. household wealth has reached a historical high of 535% of the U.S. GDP (see: https://www.zerohedge.com/news/2019-04-16/where-inflation-hiding-asset-prices).

There is a problem, however, with the above data: it reflects some dodgy ways of counting 'household wealth'. For two primary reasons: firstly, it ignores concentration risk arising from wealth inequality, and secondly, it ignores concentration risk arising from households' exposure to property markets. A good measure of liquidity risk controlled allocation of wealth is ownership of liquid equities (note: equities, of course, and are subject to Fed-funded bubble dynamics). The chart below - via https://www.topdowncharts.com/single-post/2019/04/22/Weekly-SP-500-ChartStorm---21-April-2019 shows a pretty dire state of equity markets (the source of returns on asset demand side being swamped over the last decade by shares buybacks and M&As), but it also shows that households did not benefit materially from the equities bubble.

In other words, controlling for liquidity risk, the Fed's meme of historically high household wealth is seriously challenged. And controlling for wealth inequality (distributional features of wealth), it is probably dubious overall.

So here's the chart showing just how absurdly property-dependent (households' home equity valuations in red line, index starting at 100 at the end of the Global Financial Crisis) the Fed 'wealth' figures (blue line, same starting index) are:

In fact, dynamically, rates of growth in household home equity have been far in excess of the rates of growth in other assets since 2012.  In that, the dynamics of the current 'sound economy' are identical (and actually more dramatic) to the 2000-2006 bubble: property, property and more property.

10/4/19: Rewarding Reckless Risk Pricing, Again

Markets are supposed to be efficient. At least, on the timeline that allows to price in probabilistically plausible valuations of the firms. Markets failed to be efficient at the time of the dot.com bubble. And, it appears, they are back at the same game:

As the chart above shows, share of IPOs issued at negative earnings (companies losing money) is now at the levels last seen during the height of the dot.com bubble. What can possibly go wrong?

9/1/2019: Assets with Negative Returns: 1901-present [Updated]

Updating the chart for major assets performance 1901-present, based on data from http://trueeconomics.blogspot.com/2018/12/191218-assets-with-negative-returns.html:

This is epic.

22/12/18: Millennials and Buffetts: It’s a VUCA Investment World

My August 2018 Economic Outlook for Manning Financial:


What unites Warren Buffett, Apple and the financially distressed generation of the Millennials? In one word: cash and preferences for safe haven assets. Consider three facts.

Financial Markets

One: at the start of August, Berkshire Hathaway Inc. gave Buffett more room to engage in stock buybacks, just as company cash holdings rose to USD111 billion at the end of 2Q 2018, marking the second highest quarterly cash reserves in history of the firm. This comes on foot of Buffett's recent statements that current stock markets valuations price Berkshire out of "virtually all deals", just as the company took its holdings of Apple stock from USD40.7 billion in 1Q 2018 filings to USD47.2 billion in 2Q filings. Historically, Berkshire and Buffett are known for their high risk, nearly contrarian, but fundamentals-anchored investments: a strategy for selecting companies that offer long term value and growth potential and going long big. Today, Buffett simply can’t find enough such companies in the markets. His call is to return earnings to shareholders instead of investing them in buying more shares.

Two: on August 2nd, Apple became the first private company in history to top USD1 trillion market valuation mark when company stock closed at above USD207.05 per share. Company's path to this achievement was based on far more than just a portfolio of great products. In fact, two key financial engineering factors in recent years have contributed to its phenomenal success: aggressive tax optimisation, and extremely active shares buybacks programme. In May 2018, the company pledged USD100 billion of its USD285 billion cash stash (accumulated primarily off-shore, in low tax jurisdictions such as Ireland, Jersey and in the Caribbean) for shares buybacks. As of end of July, it was already half way to that target. Apple is an industry leader in buybacks, accounting for close to 15 percent of all shares buybacks planned for 2018. But Apple is not alone. A study by the Roosevelt Institute released in August shows that U.S.-listed companies spent 60 percent of their net profits on stock buybacks between 2015-2017. And on foot of the USD1.5 trillion tax cuts bill passed by Congress in December 2017, buybacks are expected to top USD 800 billion this year alone, beating the previous historical record of USD 587 billion set in 2007. Whichever way you take the arguments, accumulation of tax optimisation-linked cash reserves, and aggressive use of shares buybacks have contributed significantly to the FAANGS (Facebook (FB), Amazon (AMZN), Apple (AAPL), Netflix (NFLX), and Alphabet (GOOG)) dominance over the global financial markets.


The Squeezed Generation

And this brings us to the third fact: the lure of cash in today's world of retail investment. If cash is where Warren Buffetts and Apples of the financial and corporate worlds are, it is quite rational that cash is where the new generation of retail investors will be. Per Bankrate.com July 2018 survey data, 1 in 3 American Millennials are favouring cash instruments (e.g. savings accounts and certificates of deposit) for investing their longer-term savings. In comparison, only 21 percent of Generation X investors who prefer cash instruments, and 16 percent for the Baby Boomers. American retail investors are predominantly focused on low-yielding, higher safety investment allocations. For example, recent surveys indicate that only 18 percent of all American investment portfolios earn non-negative real returns on their savings, and that these households are dominated by the Baby Boomers generation and the top 10 percent of earners. Amongst the Millennials, the percentage is even lower at 7.4 percent.

The conventional wisdom suggests that the reasons why Millennials are so keen on holding their investments in highly secure assets is the fear of market crashes inherited by their generation from witnessing the Global Financial Crisis. But the conventional wisdom is false, and this falsehood is too dangerous to ignore for all investors - small and large alike.

In reality, the Millennials scepticism about the risk-adjusted returns promised by the traditional asset classes - equities and bonds - is not misplaced, and dovetails neatly with what both the largest American corporates and the biggest global investors are doing. Namely, they are pivoting away from yield-focused investments, and toward safe havens. The reason we are not seeing this pivot reflected in depressed asset prices, yet is because there is a growing gap between strategic positioning of the Wall Street trading houses (all-in risky assets) and those investors who are, like Buffett, focusing on longer-term investment returns.


Overvalued Investment

In simple terms, the U.S. asset markets are grossly overvalued in terms of both current pricing (including short term forward projections), and longer term valuations (over 5 years duration).

The former is not difficult to illustrate. As recent markets research shows, all of the eight major market valuations ratios are signalling some extent of excessive optimism: the current S&P500 ratio to historical average, household equity allocation ratio, price/sales ratio, price/book value ratio, Tobin's Q ratio, the so-called Buffett Indicator or the total market cap of all U.S. stocks relative to the U.S. GDP, the dividend yield, the CAPE ratio and the unadjusted P/E ratio. Take Buffett's Indicator: normally, the markets are rationally bullish when the indicator is in the 70-80 percent range, and investors pivot away from equities, when the indicator hits 100 percent. Today, the indicator is close to 140 percent - a historical record.

But the longer run valuations are harder to pin down using markets-linked indices, because no one has a crystal ball as to where the markets and the listed companies might be in years to come. Which means that any analyst worth their salt should look at the macro-drivers for signals as to the future markets pressure points and upside opportunities.

Here, there are worrying signs.

In the last three decades, bankruptcy rates for older households have increased almost three-fold, according to the recent study, from the Consumer Bankruptcy Project (https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3226574). This suggests that not all is well amongst the wealthiest retired generation, the Baby Boomers, who are currently holding the vastly disproportionate share of all risky assets in the economy. For example, 80 percent of Baby Boomers own property, accounting for roughly 65 percent of the overall housing markets available assets. All in, Baby Boomers have over 50.2 percent share of net household wealth. As they age, and as their healthcare costs rise, they will be divesting out of these assets at an increasing rate. This effect is expected to lead to a 3-3.5 percent reduction in the expected nominal returns to the pensions funds for the Generation X and the Millennials, per 2016 study by the U.S. Federal Reserve (https://www.federalreserve.gov/econresdata/feds/2016/files/2016080pap.pdf). The latter is, in part, the legacy of the 2007 Global Financial Crisis, which has resulted in an unprecedented collapse in wealth held by the American middle classes. Based on the report from the Minneapolis Federal Reserve (https://www.minneapolisfed.org/publications/the-region/race-and-the-race-between-stocks-and-homes), current household wealth for the bottom 50 percent of U.S. households is at the lowest levels since the mid-1950s, while household wealth of the middle 40 percent of the U.S. households is comparable to where it was in 2001. In other words, nine out of ten U.S. households have not seen any growth in their wealth for at least 18 years now.

Over the same period of time, wages and incomes of those currently in middle and early stages of their careers, aka the Generation X and the Millennials, have stagnated, while their career prospects for the near future remain severely depressed by the longer in-the-job tenures of the previous generations.

June 2018 paper from the Opportunity and Inclusive Growth Institute, titled “Income and Wealth Inequality in America, 1949-2016” (https://www.minneapolisfed.org/institute/working-papers-institute/iwp9.pdf) documented the dramatic reallocation of purchasing power in the U.S. income across generations, from 1970 to 2015, with the share of total income earned by the bottom 50 percent dropping from 21.6 percent to 14.5 percent, while the top 10 percent share climbed from 30.7 percent to 47.6 percent. Share of wealth held in housing assets for the top 1 percent of earners currently stands at around 8.7 percent, with the remained held in financial assets and cash. For top 20 percent of income distribution, the numbers are more even at 28 percent of wealth in housing. Middle class distribution of wealth is completely reversed, with 62.5 percent held in the form of housing.

The problem is made worse by the fact that following the financial crash of 2007-2008, the U.S. Government failed to provide any meaningful support to struggling homeowners, focusing, just as European authorities did, on repairing the banks instead of households.


Markets Forward

What all of this means for the asset values going forward is that demographically, the economy is divided into the older and wealthier generation that is starting to aggressively consume their wealth, looking to sell their financial assets and leverage their housing stocks, and those who cannot afford to purchase these assets, facing lower incomes and no tradable equity. This is hardly a prescription for the bull markets in the long run.

In this environment, on a 5-10 years time horizon, holding cash and money markets instruments makes a lot more sense not because these instruments offer significant current returns, but because the expected upcoming asset price deflation will make cash and safe haven assets the new market king.

The same is apparent in the corporate decisions to use tax and regulatory changes to beef up their cash holdings and equity prices, as opposed to investing in new growth activities. Even inclusive of buybacks, and Mergers & Acquisitions in the corporate sector, aggregate investment as a share of GDP continues to slide decade after decade, as highlighted in the chart below.

CHART

What makes matters even worse is that until mid-2000s, the data for investment did not include R&D activities, normally classed as expenditure in years prior. Adjusting for M&As, buybacks and R&D allocations, aggregate investment in G7 economies has declined from 24.9 percent of GDP in the 1980s to around 16-17 percent in 2010-2018. In simple terms, neither the public nor the private sector in the largest advanced economies in the world are planning for investment-driven growth in the near future, out into 2025.

None of which should come as a surprise to those following my writings in recent years, including in these pages. Over the years, I have written extensively about the Twin Secular Stagnations Hypothesis - a proposition that the global economy has entered a structurally slower period of economic growth, driven by adverse demographics and shallower returns to technological innovation. What is new is that we are now witnessing the beginning of the demographics-driven investors' rotation out of risky assets and toward higher safety instruments. With time, this process is only likely to accelerate, leading to the structural reversal of the bull markets in risky assets and real estate.

19/12/18: Assets with Negative Returns: 1901-present

Highlighting the evidence presented in the earlier-linked article, here is the chart based on data from the Deutsche Bank Research team, showing historical evidence on the total percentage of all key asset classes with negative annual returns:

CHART

Source: Data from Deutsche Bank Research and author own calculations.

I have highlighted 7 occasions on which the percentage of negative returns assets exceeded 50%. Only three times since 1901 did this percentage exceed 60%, including in YTD returns for 3Q 2018.

19/12/18: From Goldilocks to Humpty-Dumpty Markets

As noted in the post above, I am covering the recent volatility and uncertainty in the financial markets for the Sunday Business Post : https://www.businesspost.ie/business/goldilocks-humpty-dumpty-markets-2018-433053.

Below is the un-edited version of the article:

2018 has been a tough year for investors. Based on the data compiled by the Deutsche Bank AG research team, as of November 2018, 65.7 percent of all globally-traded assets were posting annual losses in gross (non-risk adjusted) terms. This marks 2018 as the third worst year on record since 1901, after 1920 (67.6 percent) and 1994 (67.2 percent), as Chart 1 below illustrates. Adjusting Deutsche Bank’s data for the last thirty days, by mid-December 2018, 66.3 percent of all assets traded in the markets are now in the red on the annual returns basis.

CHART 1: Percentage of Assets with Negative Total Returns in Local Currency

Source: Deutsche Bank AG

Note: The estimates are based on a varying number of assets, with 30 assets included in 1901, rising to 70 assets in 2018

Of the 24 major asset classes across the Advanced Economies and Emerging Markets, only three, the U.S. Treasury Bills (+19.5% YTD through November 15), the U.S. Leveraged Loans (+7.45%), and the U.S. Dollar (+0.78%) offer positive risk-adjusted returns, based on the data from Bloomberg. S&P 500 equities are effectively unchanged on 2017. Twenty other asset classes are in the red, as shown in the second chart below, victims of either negative gross returns, high degree of volatility in prices (high risk), or both.


CHART 2: Risk-Adjusted Returns, YTD through mid-December 2018, percent

Source: Data from Bloomberg, TradingView, and author own calculations

Note: Risk-adjusted returns take into account volatility in prices. IG = Investment Grade, HY = High Yield, EM = Emerging Markets

The causes of this abysmal performance are both structural and cyclical.


Cyclical Worries

The cyclical side of the markets is easier to deal with. Here, concerns are that the U.S., European and global economies have entered the last leg of the current expansion cycle that the world economy has enjoyed since 2009 (the U.S. since 2010, and the Eurozone since 2014). Although the latest forecasts from the likes of the IMF and the World Bank indicate only a gradual slowdown in the economic activity across the world in 2019-2023, majority of the private sector analysts are expecting a U.S. recession in the first half of 2020, following a slowdown in growth in 2019. For the Euro area, many analysts are forecasting a recession as early as late-2019.

The key cyclical driver for these expectations is tightening of monetary policies that sustained the recovery post-Global Financial Crisis and the Great Recession. And the main forward-looking indicators for cyclical pressures to be watched by investors is the U.S. Treasury yield curve and the 10-year yield and the money velocity.

The yield curve is currently at a risk of inverting (a situation when the long-term interest rates fall below short-term interest rates). The 10-year yields are trading at below 3 percent marker – a sign of the financial markets losing optimism over the sustainability of the U.S. growth rates. Money velocity is falling across the Advanced Economies – a dynamic only partially accounted for by the more recent monetary policies.

CHART 3: 10-Year Treasury Constant Maturity Rate, January 2011-present, percent

Source: FRED database, Federal reserve bank of St. Louis. 

Structural Pains

While cyclical pressures can be treated as priceable risks, investors’ concerns over structural problems in the global economy are harder to assess and hedge.

The key concerns so far have been the extreme uncertainty and ambiguity surrounding the impact of the U.S. Presidential Administration policies on trade, geopolitical risks, and fiscal expansionism. Compounding factor has been a broader rise in political opportunism and the accompanying decline in the liberal post-Cold War world order.

The U.S. Federal deficit have ballooned to USD780 billion in the fiscal 2018, the highest since 2012. It is now on schedule to exceed USD1 trillion this year. Across the Atlantic, since mid-2018, a new factor has been adding to growing global uncertainty: the structural weaknesses in the Euro area financial services sector (primarily in the German, Italian and French banking sectors), and the deterioration in fiscal positions in Italy (since Summer 2018) and France (following November-December events). The European Central Bank’s pivot toward unwinding excessively accommodating monetary policies of the recent past, signaled in Summer 2018, and re-confirmed in December, is adding volatility to structural worries amongst the investors.

Other long-term worries that are playing out in the investment markets relate to the ongoing investors’ unease about the nature of economic expansion during 2010-2018 period. As evident in longer term financial markets dynamics, the current growth cycle has been dominated by one driver: loose monetary policies of quantitative easing. This driver fuelled unprecedented bubbles across a range of financial assets, from real estate to equities, from corporate debt to Government bonds, as noted earlier.

However, the same driver also weakened corporate balance sheets in Europe and the U.S. As the result, key corporate risk metrics, such as the degree of total leverage, the cyclically-adjusted price to earnings ratios, and the ratio of credit growth to value added growth in the private economy have been flashing red for a good part of two decades. Not surprisingly, U.S. velocity of money has been on a continuous downward trend from 1998, with Eurozone velocity falling since 2007. Year on year monetary base in China, Euro Area, Japan and United States grew at 2.8 percent in October 2018, second lowest reading since January 2016, according to the data from Yardeni Research.

Meanwhile, monetary, fiscal and economic policies of the first two decades of this century have failed to support to the upside both the labour and technological capital productivity growth. In other words, the much-feared spectre of the broad secular stagnation (the hypothesis that long-term changes in both demand and supply factors are leading to a structural long-term slowdown in global economic growth) remains a serious concern for investors. The key leading indicator that investors should be watching with respect to this risk is the aggregate rate of investment growth in non-financial private sector, net of M&As and shares repurchases – the rate that virtually collapsed in post-2008 period and have not recovered to its 1990s levels since.

The second half of 2018 has been the antithesis to the so-called ‘Goldolocks markets’ of 2014-2017, when all investment asset classes across the Advanced Economies were rising in valuations. At the end of 3Q 2018, U.S. stock markets valuations relative to GDP have topped the levels previously seen only in 1929 and 2000. Since the start of October, however, we have entered a harmonised ‘Humpty-Dumpty market’, characterised by spiking volatility, rising uncertainty surrounding the key drivers of markets dynamics. Adding to this high degree of coupling across various asset classes, the recent developments in global markets suggest a more structural rebalancing in investors’ attitudes to risk that is likely to persist into 2019.

17/11/18: Nine in Ten in the Red: Asset Markets YTD Returns Signal Risk Repricing

According to a recent research note from the Deutsche Bank, 89% of global macro assets are posting losses on year-to-date basis. This is the highest level of losses in more than a century.

Given the scale of financial risk mis-pricing in equities and bonds markets in the post-QE period, we are likely to witness more downward movement in the assets valuations in months to come. A gradual deleveraging that the market trends have been supporting so far remains highly incomplete and requires more pronounced re-pricing of assets to the downside.

Read more on this here: http://trueeconomics.blogspot.com/2018/11/161118-horsemen-of-financial-markets.html. 

16/11/18: The Horsemen of the Financial Markets Apocalypse

My column for the Manning Financial  is now available here: http://issuu.com/publicationire/docs/manning_financial_november_2018?e=16572344/65613030.

3/10/18: Dumping Ice bags into Overheating Reactor: Bonds & Stocks Bubbles

Wading through the ever-excellent Yardeni Research notes of recent, I have stumbled on a handful of charts worth highlighting and a related blog post from my friends at the Global Macro Monitor that I want to share with you all.

Let's start with the stark warning regarding the U.S. Treasuries market from the Global Macro Monitor, accessible here: https://macromon.wordpress.com/2018/10/03/alea-iacta-est/.  To give you my sense from reading this, two quotes with my quick takes:

"Supply shortages, induced mainly by central bank quantitative easing have been a major factor driving asset markets, in our opinion.  Not all, but a big part." So forget the 'not all' and think about risks pairings in a complex financial system of today: equities and bonds are linked through demand for yield (gains) and demand for safety. If both are underpricing true risks (and bond markets are underpricing risks, as the quote implies), it takes one to scratch for the other to blow. Systems couplings get more fragile the tighter they become.

"The float of total U.S. equities has shrunk dramatically, in part, due to cheap financing to fund share buybacks.   The technical shortage of stocks have helped boost U.S. equity markets and killed off most bears and short sellers." In other words, as I have warned repeatedly for years now, U.S. equity markets are now dangerously concentrated (see this blog for posts involving concentration risks). This concentration is driven by three factors: M&As and shares buy-backs, plus declined IPOs activity. The former two are additional links to monetary policies and, thus to the bond markets (coupling is getting even tighter), the latter is structural decline in enterprise formation and acceleration rates (secular stagnation). This adds complexity to tight coupling of risk systems. Bad, very bad combination if you are running a nuclear power plant or a major dam, or any other system prone to catastrophic risk exposures.

How bad the things are?

Since 1Q 2009, total cumulative shares buy-backs for S&P500 amounted (through 2Q 2018) to USD 4.2769 trillion.

Now, those charts.

Chart 1, via Yardeni Research's "Stock Market Indicators: S&P 500 Buybacks & Dividends" book from October 3rd (https://www.yardeni.com/pub/buybackdiv.pdf)

What am I looking at here? The signals revealing flow of corporate earnings toward investment, or, the signs of the build up in the future economic capacity of the private sector. The red line in the lower panel puts this into proportional terms, the gap between the yellow line and the green line in the top panel puts it into absolute terms. And both are frightening. Corporate earnings are on a healthy trend and at healthy levels. But corporate investment is not and has not been since 1Q 2014. This chart under-reports the extent of corporate under-investment through two things not included in the red line: (1) M&As - high risk 'investment' strategies by corporates that, if adjusted for that risk, would have pushed the actual investment growth even lower than it is implied by the red line; and (2) Risk-adjustments to the organic investments by companies. In simple terms, there is no meaningful translation from higher earnings into new investment in the U.S. economy so far in 2018 and there has not been one since 2014. Put differently, U.S. economy has been starved of organic investment for a good part of the 'boom' years.

Chart 2, via the same note:

Spot something new in the charts? That's right: buybacks are accelerating in 1H 2018, with 2Q 2018 marking an absolute historical high at USD 1.0803 trillion (annualized rate) of buybacks. Guess what does this mean for the markets? Well, this:

And what causes the latest spike in buybacks? No, not growing earnings (which are appreciating, but moderately). The fiscal policy under the Tax Cuts and Jobs Act 2017, or Trump Tax Cuts.

Let's circle back: monetary policy madness of the past has been holding court in bond markets and stock markets, pushing mispricing of risks to absolutely astronomical highs. We have just added to that already risky equation fiscal policy push for more mispricing of risks in equity markets.

This is like dumping picnic-sized bags of ice into the cooling system to run the reactor hotter. And no one seems to care that the bags of ice are running low in the delivery truck... You can light a smoke and watch ice melt. Or you can run for the parking lot to drive away. As an investor, you always have a right choice to make. Until you no longer have any choices left.

12/5/18: Bubbles or Gartner Cycles? Tech is in it, again...

Nice visual on Gartner-maturity curve structure of sentiment driven fads in sectoral valuations:

9/2/18: Markets Mess: Sunday Business Post

My Sunday Business Post article from last week on the beginnings of the stock markets troubles: https://www.businesspost.ie/business/markets-mess-unable-take-decisive-much-needed-downward-correction-yet-equally-unable-push-valuations-much-higher-408224.

As predicted: we had a messy week, with no catalyst to inflict a real, much needed and deeper correction onto grossly overvalued markets.

My next instalment on the continued mess is due this Sunday. Stay tuned.

4/12/17: The Other Hockey Stick (not Bitcoin)

Financialization of the global economy is now complete, thanks to the world's hyperactive Central Banks and the age of riskless recklessness they engendered.

Source: https://www.bloomberg.com/gadfly/articles/2017-12-04/98-750-067-000-000-reasons-to-be-scared-about-2018

The notable 'hockey stick' that is, dynamically reminiscent of the Bitcoin craze is now evident in the stock markets too, and it has zero parallels in the post-dot.com period. In fact, this is the highest global market capitalization level on record, as data from the World Bank augmented with current data through November 2017 shows:

You can think of the stratospheric rise in world equities valuations as a reflection of liquidity supply generated by the Central Banks since 2007. You can also think of it as a wealth buffer built up by the world's wealthy elites to protect themselves against potential future stagnation and political populism. You can equally think of it as a bubble.

Whichever way you spin these numbers, the rate of increase since 2015 has been simply unprecedented by historical standards, faster than the dot.com bubble and faster than the pre-GFC bubble.

29/11/17: Four Omens of an Incoming Markets Blowout

Forget Bitcoin (for a second) and look at the real markets.

Per Goldman Sachs research, current markets valuation for bonds and stocks are out of touch with historical bubbles reality: https://www.bloomberg.com/news/articles/2017-11-29/goldman-warns-highest-valuations-since-1900-mean-pain-is-coming. As it says on the tin,

“A portfolio of 60 percent S&P 500 Index stocks and 40 percent 10-year U.S. Treasuries generated a 7.1 percent inflation-adjusted return since 1985, Goldman calculated -- compared with 4.8 percent over the last century. The tech-bubble implosion and global financial crisis were the two taints to the record.”

Check point 1.

Now, Check point 2: The markets are already in a complacency stage: “The exceptionally low volatility found in the stock market -- with the VIX index near the record low it reached in September -- could continue. History has featured periods when low volatility lasted more than three years. The current one began in mid-2016.”

Next, Check point 3: Valuations are not everything. In other words, levels are not the sole driver of blowouts. In fact, per Goldman, valuations explain “less than half the [markets] variation since 1900.” But, when blowouts do happen, involving 60/40 portfolios “over the past century [these] amounted to 26 percent in real terms on average, lasting 19 months. It took two years to get back to previous peaks, on average.” And the problem with this is that there might be no firepower to fight the next blowout. “Central banks “might not be able or willing to buffer growth or inflation shocks.” They also face fewer options to ease monetary policy given low rates and big balance sheets.”

So to sum the above up: levels of market valuations are screaming bubbles in both bonds and stocks; investors are fully bought into the hype of rising valuations; and there might be a shortage of dry powder in store at the Central Banks.

Goldman’s team, predictably, thinks the likeliest unwinding scenario from the above will involve, you’ve guessed it… a soft landing.

Now to Check point 4:

Source: ZeroHedge

Observe the following simple fact: the rate of the ‘balanced’ portfolio appreciation in the current cycle is sharper than in the 2002-2007 cycle. And it is sharper, in cumulative terms (both nominal and real), than any other cycle in modern (post 1970s - end of Bretton Woods and stagflationary environments) period.

So the Check point 5 adds strong bubble dynamics to bubble signals of levels of out-of-touch valuations, investors complacency and risks to the Central Banks’ commitment.

This is, put frankly, ugly. Because all four components of a major market blowout are now in place. So while the froth might still run for some weeks, months, quarters, … and may be even a year or two, the longer it runs, the worse the fallout will be. And the fallout is coming.

20/11/17: Bitcoin: an Unknowable Bubble?

There is a much-discussed in the crypto-sphere chart making rounds these days, plotting Bitcoin price dynamics against the historical bubbles of the past:

The chart is striking. Albeit simplistic. See Note 1 below for a technical argument on the chart timing.

On price dynamics alone, Bitcoin looks like a sure bubble - a disaster waiting to happen. But Bitcoin dynamics are basically not suited for any empirical analysis of any significant accuracy.

As noted by some commentators, Bitcoin had numerous 80-90% and larger drawdowns in the past (given its immense volatility). It keeps coming back from these. Some claim this to be the evidence that Bitcoin it not a bubble. Which is neither here nor there: bubbles are generated by exuberant expectations of investors, not by actual parameters of price processes. Causality does not flow from dynamics to bubbles, but the other way around. So to identify a bubble, one needs to identify exuberance. See Note 2 below for more on 80% drawdowns.

In the case of Bitcoin fans, there is clearly such.

No investor or serious analyst has been able to provide a fundamentals-based valuation model for Bitcoin.

A disclosure in order here: myself and a graduate student of mine have looked at the fundamental modelling for Bitcoin over the summer. We found no tangible relationship between any economic or financial parameters tested and Bitcoin price dynamics. In another piece of research, myself and two co-authors are currently looking at empirical dynamic and fractal properties of Bitcoin. Again, we finding nothing consistent with a behaviour of an asset with fundamentals-derived valuations.

Absence of evidence is not the same as evidence of absence. But, taken together with the general lack of credible fundamentals-linked modelling of the crypto-currency, this means that, at this point in time, Bitcoin price can be potentially driven solely by… err… expectations held by its enthusiasts, plus the incentives by the predominantly China-based investors to avoid extreme risks of capital controls and expropriations. If so, both drivers would make it a speculative bubble.

The only quasi-fundamentals-linked argument for Bitcoin has been the blockchain one - the promise of Bitcoin serving as a key tool for data aggregation, recording and transmission. This argument, however, no longer holds. Blockchain technology has migrated from public blockchains, like Bitcoin, to either open blockchains, like Ethereum or, increasingly more frequently, private blockchains. It is the latter that currently hold the promise to serve as viable platforms for data economy.

As a libertarian, I should like a private currency system that supports anonymity of transactions. As an economist, I should like the innovative nature of Bitcoin. And, put simply, I do. Both.

But as an investor, I do not have the stomach for Bitcoin’s valuations and volatility, as well as for its higher moments behaviour (in particular worrying are kurtosis, co-skews and co-kurtosis, which severely complicate empirical dynamics analysis, see Note 3 below). And I have even less enthusiasm for the crypto market that is sustained increasingly by undertakings, like BitMEX - a purely speculative platform trading some $35 billion in Bitcoin derivatives with leverage up to x100 to the amateur speculators who, put frankly, have zero idea what they are buying and at what price. The vast majority of Bitcoin investors have no clue what a butterfly option looks like and how it can be valued. And the vast majority of financial markets analysts and professionals won’t be able to price a butterfly strategy for Bitcoin, given its painfully twisted moments. Yet, within a month of starting trading, BitMEX reached 1/3 of the market capitalisation of Bitcoin. This is not just a shoe-shine-boy moment, folks. It is white-powder-under-the-nose-and--empty-bottles-of-vodka-on-the-floor hour for high school dropouts with cash to burn.

Another worrying issue with Bitcoin is the argumentation of its main supporters.

This ranges from the cognitively biased “you don’t know anything about the Bitcoin” to “Bitcoin is scarce & limited in supply” to “Bitcoin is a promise of liberating the masses from the oppression of the Central Bankers”.

The first sort of argument exhibits not just Jurassic ignorance of logic, but also a gargantuan dose of arrogance. Repeated sufficiently enough, it signifies the absurd degree of exuberance of investors’ expectations.

The second argument is patently false. Bitcoin has undergone splits, and engendered dozens of other cryptos, with unlimited supply of such into the future. Bitcoin itself is divisible ad infinitum and, with forks, its supply is potentially unlimited. Worse, Bitcoin rests on man-made mathematical foundations. Which means it has no physical bound or constraint. Anything man-made (and even more so, anything mathematically derived) is, by definition, fungible and axiomatic. Just because to-date no one cracked the code to alter Bitcoin mid-stream or drain blockchain-held information does not mean that in the future such a code cannot be written. So hold your horses: gold is physically limited in quantity (even though in the Universe, it is not as scarce as it is on Earth, which makes long term supply constraint on gold potentially non-binding). Bitcoin is limited by our capacity to alter the underlying code defining it. Anyone thinking of an algorithm as a 'law' needs to go back to Godel's mathematics.

Finally, there is an argument of ‘liberation’. Bitcoin value is only sustained as long as it remains convertible into goods, services and other currencies. This means that Bitcoin cannot remain a government- regulation-free asset, as long as its popularity as a medium of exchange and a vehicle for store of value grows. Which means that in the medium terms (3 years or so?), Bitcoin will either cease to be, or cease to be anonymous. All protection from the dictate of the Central Bankers will be gone.  Benign tolerance of Bitcoin by some regulators can quickly turn into outright prohibition on trading - as current and past examples of China, Vietnam, Nigeria, Colombia, Taiwan, Ecuador, Bangladesh, Kyrgyzstan and Bolivia, Russia, and Thailand suggest. Evolution of cybersecurity measures and regulatory and supervisory tools, including their spread into cryptocurrencies domain will only increase effectiveness of such measures into the future. So, unless you are planning to live in a libertarian paradise, where legal norms of other states do not apply, good luck committing much of your wealth to Bitcoin as a safe haven for oppressive or coercive actions of the nation states.

Worse, anyone claiming that Bitcoin is a hedge against inflation fails to understand how modern markets work. Again, to increase in value, Bitcoin requires higher rates of adoption. Higher rates of adoption bring about higher rates of asset instrumentation (see above for BitMIX). Higher rates of instrumentation and adoption, taken together, imply higher holdings of Bitcoin by institutional and diversified portfolio investors. So far so good? Right, now the kicker: these holdings imply greater, not lower, positive correlations between Bitcoin and other asset classes in shock-experiencing markets. That's right, dodos: Goldman holdings of Bitcoin are correlated to liquidity supply in general markets, because if such liquidity starts evaporating, Goldman will sell Bitcoin to plug holes in other instruments. Sell-off in the markets can trigger sell-off in Bitcoin. Now, another kicker: Bitcoin is currently less liquid than any major asset class (see extreme volatility of pricing across various Bitcoin exchanges). Which means that smart folks at Goldman will be dumping Bitcoin before they dump gold and other assets. Hipsters hugging their laptops will be the last to wake up to this momentum (behavioural evidence suggests, they might actually buy into falling Bitcoin in hope of speculatively gaining on a bounce, which, incidentally, can explain why large drawdowns in Bitcoin can turn so fast into upward trends).

The tricky bit about Bitcoin is that its enthusiasts need to learn to live in the real world first. Until they do, Bitcoin will continue its upward path, and this process can go one for quite a while, depending on the supply of cash in the markets for Bitcoin. Once they are taught a sufficient lesson, however, the rest of us will be learning the long term fundamentals valuations of Bitcoin. I, for now, have no idea what these valuations might be.

So Bitcoin, then. A bubble or not? If you ignore the arguments that attempt to justify its valuations, it looks like one, albeit with dynamics that are very hard to interpret. If you listen to them, it looks that way even more, with more confidence in the arguments bogus nature. Draw your own final conclusions.



Note 1: In defence of the chart above, without validating its implied conclusions: the chart plots Bitcoin evolution from 3 years ago through today. This starting point makes sense. Until mid-2014, Bitcoin was extremely obscure, hype-only investor vehicle, with volatility so off the charts, any analysis of its dynamics was futile (I know, I did such analysis and presented the results in my talk at Bloomberg two years ago). Those us who do research in finance generally and routinely disregard the first 3-4 years of existence of Bitcoin for exactly that reason.

Note 2:  A note due here: Bitcoin's returns from 80-90% drawdowns is not a solid evidence of the crypto-currency not being a bubble, because they are in line with Bitcoins' overall massive volatility. In other words, a valid comparative for these drawdowns relative to other asset classes is not "an 80% drawdown in  Bitcoin ~ an 80% drawdown in stocks", but "an 80% drawdown in Bitcoin ~ an 8% drawdown in stocks". Apples to apples. Dust to dust.

Note 3:  Interesting Elliott Wave analysis of Bitcoin dynamics here: https://atozforex.com/news/29-september-bitcoin-elliott-wave-analysis/ and here https://www.cnbc.com/2017/07/20/bitcoin-bubble-dwarfs-tulip-mania-from-400-years-ago-elliott-wave.html, although I am not convinced Bitcoin price trends are established enough for this technique to work.

17/10/17: Welcome to the Keynesian Monetarist Paradise

Via IMF, a chart plotting changes in sovereign debt holdings across Government, International & Central Bank agencies (so-called G-4 Official) and private debt holders:

Note:

1. These are changes in the stock of debt, not the actual stock of debt;
2. These are changes in the stock of debt of only four largest advanced economies;
3. These are changes in the stock of only sovereign debt, excluding quasi-sovereign, private and household debts; and
4. The years of forward forecast are, allegedly, the years of QE unwinding.

This debt bubble is a money-printing bubble which is a Keynesian Government 'stimulus' bubble. Look at the above. QED.

And, if you have not reaped its upside, you will pay its downside. Now, check your pockets.

14/10/17: Happy Times in the Rational Markets

Two charts, both courtesy of Holger Zschaepitz @Schuldensuehner:

In simple terms, combined value of bond and stock markets is currently at around USD137 trillion or 179% of global GDP. Put slightly differently, that is 263% of global private sector GDP. There is no rational model on Earth that can explain these valuations. 

Since the start of this year, the two markets gained roughly USD15 trillion in value, just as the global economy is now forecast to gain USD3.93 trillion in GDP over the full year 2017. Based on the latest IMF forecasts, the first 9.5 months of stock markets and bonds markets appreciation are equivalent to to total global GDP growth for 2017, 2018, 2019 and a quarter of 2020. That is: nine and a half months of 'no bubbles anywhere' financial growth add up to thirty nine months of real economic activity.

Happy times, all.