18/6/20: Cheap Institutional Money: It's Supply Thingy

In a recent post, I covered the difference between M1 and MZM money supply, which effectively links money available to households and institutional investors for investment purposes, including households deposits that are available for investment by the banks (https://trueeconomics.blogspot.com/2020/06/what-do-money-supply-changes-tell-us.html). Here, consider money instruments issuance to institutional investors alone:

Effectively, over the last 12 years, U.S. Federal reserve has pumped in some USD 2.6 trillion of cash into the financial asset markets in the U.S. These are institutional investors' money over and above direct asset price supports via Fed assets purchasing programs, indirect asset price supports via Fed's interest rates policies and QE measures aimed at suppression of government bond yields (https://trueeconomics.blogspot.com/2020/05/21520-how-pitchforks-see-greatest.html). 

Any wonder we are in a market that is no longer making any sense, set against the economic fundamentals, where free money is available for speculative trading risk-free (https://trueeconomics.blogspot.com/2020/06/8620-30-years-of-financial-markets.html)?

8/6/20: 30 years of Financial Markets Manipulation

Students in my course Applied Investment and Trading in TCD would be familiar with the market impact of the differential bid-ask spreads in intraday trading. For those who might have forgotten, and those who did not take my course, here is the reminder: early in the day (at and around market opening times), spreads are wide and depths of the market are thin (liquidity is low); late in the trading day (closer to market close), spreads are narrow and depths are thick (liquidity is higher). Hence, a trading order placed near market open times tends to have stronger impact by moving the securities prices more; in contrast, an equally-sized order placed near market close will have lower impact.

Now, you will also remember that, in general, investment returns arise from two sources: 

1. Round-trip trading gains that arise from buying a security at P(1) and selling it one period later at P(2), net of costs of buy and sell orders execution; and 
2. Mark-to-market capital gains that arise from changes in the market-quoted price for security between times P(1) and P(2+).

The long-running 'Strategy' used by some institutional investors is, therefore as follows: 

Here is the illustration of the 'Strategy' via Bruce Knuteson paper "Celebrating Three Decades of Worldwide Stock Market Manipulation", available here: https://arxiv.org/pdf/1912.01708.pdf.

• Step 1: Accumulate a large long portfolio of assets;
• Step 2: At the start of the day, buy some more assets dominating your portfolio at P(1) - generating larger impact of your buy orders, even if you are carrying a larger cost adverse to your trade;
• Step 3: At the end of the day, sell at P(2) - generating lower impact from your sell orders, again carrying the cost.

On a daily basis, you generate losses in trading account, as you are paying higher costs of buy and sell orders (due to buy-sell asymmetry and intraday bid-ask spreads differences), but you are also generating positive impact of buy trades, net of sell trades, so you are triggering positive mark-to-market gains on your original portfolio at the start of the day.

Knuteson shows that, over the last 30 years, overnight returns in the markets vastly outstrip intraday returns. 

Per author, "The obvious, mechanical explanation of the highly suspicious return patterns shown in Figures 2 and 3 is someone trading in a way that pushes prices up before or at market open, thus causing the blue curve, and then trading in a way that pushes prices down between market open (not including market open) and market close (including market close), thus causing the green curve. The consistency with which this is done points to the actions of a few quantitative trading firms rather than

the uncoordinated, manual trading of millions of people."

Sounds bad? It is. Again, per Knuteson: "The tens of trillions of dollars your use of the Strategy has created out of thin air have mostly gone to the already-wealthy: 

• Company executives and existing shareholders benefi tting directly from rising stock prices; 
• Owners of private companies and other assets, including real estate, whose values tend to rise and fall with the stock market; and 
• Those in the financial industry and elsewhere with opportunities to privatize the gains and socialize the losses."

These gains to capital over the last three decades have contributed directly and signi ficantly to the current level of wealth inequality in the United States and elsewhere. As a general matter, widespread mispricing leads to misallocation of capital and human effort, and widespread inequality negatively a effects our social structure and the perceived social contract."

25/2/2020: No, 2019-nCov did not push forward PE ratios to 2002 levels

Markets are having a conniption these days and coronavirus is all the rage in the news flow.  Here is the 5 days chart for the major indices:

And it sure does look like a massive selloff.

Still, hysteria aside, no one is considering the simple fact: the markets have been so irrationally priced for months now, that even with the earnings being superficially inflated on per share basis by the years of rampant buybacks and non-GAAP artistry, the PE ratios are screaming 'bubble' from any angle you look at them.

Here is the Factset latest 20 years comparative chart for forward PEs:

You really don't need a PhD in Balck Swannery Studies to get the idea: we are trending at the levels last seen in 1H 2002. Every sector, save for energy and healthcare, is now in above 20 year average territory.  Factset folks say it as it is: "One year prior (February 20, 2019), the forward 12-month P/E ratio was 16.2. Over the following 12 months (February 20, 2019 to February 19, 2020), the price of the S&P 500 increased by 21.6%, while the forward 12-month EPS estimate increased by 4.1%. Thus, the increase in the “P” has been the main driver of the increase in the P/E ratio over the past 12 months."

So, about that 'Dow is 5.8% down in just five days' panic: the real Black Swan is that it takes a coronavirus to point to the absurdity of our markets expectations.

1/9/19: Priming the Bubble Pump: Extreme Credit Accommodation in the U.S.

Using Chicago Fed National Financial Conditions Credit Subindex (weekly, not seasonally adjusted data), I have plotted credit conditions measurements for expansionary cycles from 1971 through late August 2019. Positive values of the index indicate tightening of credit conditions in the economy, while negative values denote loosening of credit conditions.

Since the start of the 1982 expansionary cycle, every consecutive cycle was associated with sustained, long term loosening of credit conditions, which means the Fed and the regulatory authorities have effectively pumped up credit in the economy during economic expansions - a mark of a pro-cyclical approach to financial policies. This trend became extreme in the last three expansionary cycles, including the current one. In simple terms, credit conditions from the end of the 1990s recession, through today, have been exceptionally accommodating. Not surprisingly, all three expansionary cycles in question have been associated with massive increases in leverage and financialization of the economy, as well as resulting asset bubbles (dot.com bubble in the 1990s, property bubble in the 2000s, and financial assets bubbles in the 2010s).

The current cycle, however, takes this broader trend toward pro-cyclical financial policies to a new level in terms of the duration of accommodation and the fact that it lacks any significant indication of moderation.

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.

6/3/19: Expectations Sand Castles and Investors

As raging buybacks of shares and M&As have dropped the free float available in the markets over the recent years, Earnings per Share (EPS) continued to tank. Yet, S&P 500 valuations kept climbing:

Source: Factset 

As noted by the Factset: 1Q 2019 "marked the largest percentage decline in the bottom-up EPS estimate over the first two months of a quarter since Q1 2016 (-8.4%). At the sector level, all 11 sectors recorded a decline in their bottom-up EPS estimate during the first two months of the quarter... Overall, nine sectors recorded a larger decrease in their bottom-up EPS estimate relative to their five-year average, eight sectors recorded a larger decrease in their bottom-up EPS estimate relative to their 10-year average, and seven sectors recorded a larger decrease in their bottom-up EPS estimate relative to their 15-year average."

Bad stuff. Yet, "as the bottom-up EPS estimate for the index declined during the first two months of the quarter, the value of the S&P 500 increased during this same period. From December 31 through February 28, the value of the index increased by 11.1% (to 2784.49 from 2506.85). The first quarter marked the 15th time in the past 20 quarters in which the bottom-up EPS estimate decreased while the value of the index increased during the first two months of the quarter."

The disconnect between investors' valuations and risk pricing, and the reality of tangible estimations for current conditions is getting progressively worse. The markets remain a spring, loaded with the deadweight of expectations sand castles.

20/11/18: Bitcoin's Steady Loss of Fundamentals

Base rate fallacy is one of the key behavioral heuristics or biases in economics and finance, defined as a cognitive error whereby too little (or too much) weight is placed on the base (original) rate of possibility (e.g., the probability of A given B). In behavioral finance,

• Base rate neglect is the case of giving not enough weight to the prior/original fundamentals in analyzing a complex phenomena, focusing analyst's attention instead on more proximate/more recent trends. Put differently, analysts tend to assign greater weight to a rare category / outrun when tested with a single symptom whose objective diagnosticity was equal for all possible outruns; and 
• The inverse base rate fallacy is the case when too much weight is given to the complex priors / original fundamentals, downgrading newer information. In other words, people tended to give higher probability to a rare outrun when tested with a combination of conflicting priors or cues.

Some research has shown that the key effect of the base rates on judgement error is that base rate presence distorts our analysis by making more frequent outruns of uncertain events more important in our analysis. Thus, more common realizations of the uncertain gambles are magnified in perceived frequency, overriding either the original priors (neglect) or the changing nature of the priors (inverse neglect).

You really can't avoid stumbling on both of these manifestations of the fallacy in today's Bitcoin markets analysis.

Take for example this:

A 'guru' of Bitcoin investment world has been issuing absurd forecasts like a blind drunk armed with an AK47: fast, furious and vastly inaccurate.

The dude, armed with 'fundamentals' (unknown to anyone in the finance research universe, where predominant consensus is that Bitcoin has no defined price fundamentals), has predicted BTCUSD at $22,000-$25,000 for the end of 2018 some months ago (back in January). He upped the ante around March by 'forecasting' BTCUSD at $91,000 some time before the end of 2019, and scaled this back to $36,000 in May. He then re-iterated his $25,000 target in July, just around the same time another 'Hopium sniffing' 'analyst' - Julian Hosp - put a target of $60,000 for BTC in 2018. Four days ago, Lee scaled back his 'forecast' for the end of 2018 to $15,000. This comes on foot of the guru adding lots of mumbo-jumbo to qualify his optimism, saying in early November 2018 that he was "pleasantly surprised" by Bitcoin's stability around the newly found price floor close within the $6,400-$6,500 range.

Taking decreasing doses of the sell-side drug-of-choice, Mike Novogratz was a bit more 'reserved'. In November 2017, struck by the recency bias (the fallacy of not even bothering considering any information other than hyperbolic BTC price dynamics around the end of 2017), he 'forecast' Bitcoin to reach $45,000 by November 2018. This 'forecast' was trimmed back to $9,000 for the end of 2018, issued by Novogratz on October 2, 2018.

There were madder ravings still on offer this year. Mid-April 2018, Tim Draper and CNBC's Brian Kelly pushed out (separately) 'research' arguing that BTC will be hitting $250,000 by 2022. Lee's prediction for 2022 target was $125,000 per BTC mid-January 2018, and advised investors to follow his alleged strategy: "We expect bitcoin's major low to be $9,000, and we would be aggressive buyers around that level... We view this $9,000 as the biggest buying opportunity in 2018."

Note: this drivel has been reported by the likes of Bloomberg, CNBC, et al - the serious analysis folks, employing a bunch of CFAs. I mean, you wouldn't be conflicted if you employed institutional investors trading in Bitcoin as your analysts, would you? Of course, not! Next up: CNBC to hire Wells Fargo sitting executive to analyse Wells Fargo.

But returning to the behavioral anomalies, both base rate neglect and inverse base rate effect can (and do), of course, take place in the same analysts' decisions and calls. Framing - conditioning on surrounding attributes of the decision making - determines which type of the base rate fallacy holds for which 'analyst'. Hence, this:

Ever since the collapse of the parabolic trend, Bitcoin price dynamics can be seen as a series of down-trending sub-cycles, with only one slight deviation in the pattern since mid-September 2018 (the start of the 6th cycle). I wrote about this back in August, suggesting that we will see new lows for BTCUSD - the lows we are running through this week.

When you look at liquidity (trading volumes), you can see that the 'price floor' period from mid-September through the start of November has been associated with extremely low trading. This runs contrary to the 'fundamentals' stories told by the aforementioned 'analysts': the increasing efficiency of the cryptos networks and mining, the growing rates of cryptos adoption in the real economy, and the rising interest in cryptos from institutional investors.

Put more simply, the period of 'calm' (and it wasn't really a period of low volatility, just a period of lower volatility compared to the internecine levels of volatility that BTCUSD investors have been conditioned to accept in the past) was the period when the Bitcoin Whales (large miners) stuck to their mine-and-hold strategies, so that pump-and-dump scams were running wreckage across smaller investors portfolios. The events of the last two weeks seem to have broken that pattern, removing the supports from one of the only two fundamentals Bitcoin has: the fundamental factor of cross-collaterlization a myriad of junky ICOs with Bitcoin capital.  (see volume dynamics below)

As the ICOs crash, their collateral Bitcoins are being dumped into the markets to recover some sort of liquidity necessary for a shutdown or a run from the creditors and regulators, the only floor that BTCUSD has is the floor of the Whales still sitting on large BTC holdings accumulated from mining. Which is not the good news the BTC 'analysts' can hang onto with their 'forecasts'. Cost of mining is rising (as local energy utilities are jacking up electricity rates on large scale mining operations). Just as profit margins on mining are turning negative (at current prices). This means that in the short run, Whales are going to start dipping into their BTC reserves to sustain operations. In the longer run, two things can happen:

1. If the miners shut down their operations to cut on variable costs of mining, BTC might find a new temporary 'floor' until another regulatory assault on Bitcoin takes place and the downward momentum returns; or
2. If the miners decide to double-down in hope of price stabilization and continue to beef up their fiat cash reserves to pay for loss making mining, there will be a new sell-off coming soon.

Behaviorally, both mean that at some point in the future (no, I am not talking about end-of-2022 outlook, but something much sooner), the Whales will decide to cut losses and sell their holdings. As usual in such circumstances, first off, retail investors will step in to soak up some of the supply avalanche. The first sellers in this game will be the winners. The followers will be the relatively uninjured party. The hold-outs will end up with the proverbial bag in the end of the game. It is how all bubbles end up playing out in the end.

Now, go on, listen to the idiot squad of BTC 'analysts'. Everything will be fine. $15,000 --> $25,000 --> $36,000 --> $91,000 --> $125,000 --> $250,000 --> Takeover of the Universe. The Death Star is powering its lasers...

17/6/18: ECB's Shift of Gears Presents Another Set of Risks

My article for Business Post from Friday covering ECB's latest announcements on QE and interest rates: https://www.businesspost.ie/opinion/ecbs-shift-gears-presents-another-set-risks-418797.

7/4/18: Markets Message Indicator: Ouuuuch... it hurts

An interesting chart from the VUCA family, courtesy of @Business:

'Markets Message Indicator', created by Jim Paulsen, chief investment strategist at Leuthold Weeden Capital Management, takes 5 different data ratios: stock market relative performance compared to the bond market, cyclical stocks performance relative to defensive stocks, corporate bond spreads, the copper-to-gold price ratio, and a U.S. dollar index. The idea is to capture broad stress build up across a range of markets and asset classes, or, in VUCA terms - tallying up stress on all financial roads that investors my use to escape pressure in one of the asset markets.

Bloomberg runs some analysis of these five components here: https://www.bloomberg.com/news/articles/2018-04-03/paulsen-says-proceed-with-caution-across-many-asset-classes. And it is a scary read through the charts. But...

... the real kicker comes from looking back at the chart above. The red oval puts emphasis on the most recent market correction, the downturn and increased volatility that shattered the myth of the Goldilocks Markets. And it barely makes a splash in drawing down the excess stress built across the 'Markets Message Indicator'.

Now, that is a scary thought.

19/11/17: The Next Global Financial Crisis

My column for Cayman Financial Review on how the stage has been now set for the next Global Financial Crisis is available at http://www.caymanfinancialreview.com/2017/10/20/the-stage-has-been-set-for-the-next-global-financial-crisis/.

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.

9/9/15: MSCI World EV/EBITDA ratio: Happy Bubbly

In the lightness of being inhabited by the world's investors, no valuation is a bubble, until it is officially declared to not be a bubble. And so it has been since the start of the year, just as EV/EBITDA (Enterprise Value ratio to Earnings before interest, tax, depreciation and amortisation) ratio of MSCI World Index for 23 Developed Markets economies peaked at levels ahead of all previously recorded ones:

Source: @zerohedge

But never mind, for that promised growth rebound is just around the corner... where it has been for the last seven and a half years... just one period ahead forecast from today...

Note: h/t and thanks to Rouben Indjikian for spotting EBITDA definition missing reference to interest.

1/1/2015: Tech Bubble 2.0 & the Irrelevant VCs

Very interesting take on the growing irrelevance of the VC sector in terms of tech funding and tech valuations bubble: http://www.institutionalinvestor.com/Article.aspx?ArticleId=3412986#.VJzH58AjJA

Some quotes:

"…standard VC line on a standard question in technology today…" is that "it's been a very good year for VC, but 2014 fundraising is still nowhere near levels of 1999 and 2000". Hence, no tech bubble, despite the fact that "Soaring valuations for private companies, some of them in sectors previously thought bubble-prone - even media start-ups are being valued at over USD1 billion these days - have made the bubble question one of this year's most asked". In fact, "2014 has been the year of the monster funding round, led by taxi service Uber, which raised USD1.2 billion in June; Cloudera, a big data start-up, and Flipkart, an e-commerce site, also closed rounds greater than USD1 billion." Note: Uber is now being forced, literally, out of major markets by legislators, regulators and bad PR.

The reason why VC industry is below 1999-2000 bubble funding allocations is, however, not the absence of the bubble, but the decline of the VCs relevance to the sector, where increasingly funding comes from hedge funds, large mutual funds and other non-VC investors.

The above makes it also harder for us to put actual data behind the argument as to whether or not we are witnessing a bubble formation in tech funding, because many non-VC funding sources are not transparent. Two players who tried to put the number on 2014 funding inflow into tech sector find "overall equity funding levels for this year, including investments from traditional VC, dedicated seed funds, angel investors, corporate venture arms and private equity, in the region of USD100 billion. Once mutual and hedge fund stakes are added, it seems fair to conclude that investments in private companies will end the year at or above the levels seen during the dot-com boom."

Ouch! There is a good indication of a bubble maturing, not just forming.

And double-ouch! The old VCs are simply not as relevant anymore.

And triple-ouch! When the dot-com bubble burst in 2001-2002, much of the impact was absorbed by the VCs, which have weaker exposure to the markets at large. This time around, the impact is going to be more broadly based, with adverse spillovers to the markets, pensions funds and bigger investment funds.