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...

17/9/20: Stonks are Getting Balmier than in the Dot.Com Heat

Via Liz Ann Sonders @LizAnnSonders of Charles Schwab & Co., Inc. a neat chart summarizing the madness of the King Market these days:

Yeah, right: PE ratio is heading for dot.com madness levels, PEG ratio (price earnings to growth ratio or growth-adjusted PE ratio) is now vastly above the dot.com era peak, and EPS is closer to the Global Financial Crisis era lows. 

What can possibly go wrong, Robinhooders, when a mafia don gifts you some chips to wager at his casino?

24/7/20: Bonds v Stocks: Of Yields, Investors and Large Predators

Corporates are reeling from the COVID19 pandemic impacts, yet stocks are severely overpriced by all possible corporate finance metrics. Until, that is, one looks at bonds.

Over the 3 months through June 2020, average 10 year U.S. Treasury yield has been 0.69 percent. Over the same period, average S&P500 dividend yield was 2.02 percent. The gap between the two is 1.33 percentage points, which (with exception of March-May average gap of 1.42 points) is the highest in history of the series (from 1962 on).

Given that today's Treasuries are carrying higher liquidity risk (declining demand outside the official / Fed demand channel) and higher roll-over risks (opportunity cost of buying Ts today compared to the future), the real (relative) bubble in financial markets todays is in fixed income. Of course, in absolute returns terms, long-term investment in either bonds or equities today is equivalent to a choice of being maimed by a T-Rex or being mangled by a grizzly. Take your pick.

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."

6/5/20: S&P500 and Fundamentals: What should matter, doesn't

S&P500 and earnings per share: what should matter, doesn't

We are now in extreme territory of the markets ignoring basic corporate fundamentals.

6/5/20: S&P500 Earnings and Revenues Growth 1Q 2020

With early effects of COVID19 pandemic in:

Both charts via Factset.

15/1/20: S&P500 Historical Performance

Via BAML and @tracyalloway, a chart plotting the distribution of annual returns on S&P500, 1872-2019:

The stylised nature of this plot allows us to see the right-skew in the distribution, across all 

'bins', especially for the last decade.

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.

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.

8/12/18: Shares Buybacks Hit Diminishing Marginal Returns

The S&P 500 Buyback Index Total Return data tracks the performance of the top 100 stocks with the highest buyback ratios in the S&P 500 in terms of total return. As the chart below shows, the Buyback Index has generally and significantly outperformed S&P500 returns since 2008:

with three discernible periods of outperformance highlighted in the second chart:

In simple terms, since December 2015, the Buyback Index Total Return performance relative to S&P500 returns has stagnated, despite accelerating buybacks by the S&P500 corporates. In part, this is driven by the increased buybacks activity in the less active companies (not constituents of the Buyback Index), but in part the data suggests that the returns to buybacks are generally tapering out.

At the same time, correlation between S&P500 returns and Buyback Index returns has been weakening from around the same time:

All of the above indicates a breakdown in the traditional post-2008 pattern of returns, as buybacks role as the drivers for improved ROE performance for top S&P500 shares re-purchasers is starting to run into diminishing returns.

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.

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.

7/6/17: Equity Markets Continue to Mis-price Policy Risks

There has been some moderation in the overall levels of Economic Policy Uncertainty, globally, over the course of May. The decline was primarily driven by European Uncertainty index falling toward longer-term average (see later post) and brings overall Global EPU Index in line with longer term trend (upward sloping):

This meant that short-term correlation between VIX and Global EPUI remained in positive territory for the second month in a row, breaking negative correlations trend established from October 2015 on.

The trends in underlying volatility of both VIS and Global EPUI remained largely the same:

The key to the above data is that equity markets risk perceptions remain divorced from political risks and uncertainties reflected in the Global EPUI. This is even more apparent when we consider actual equity indices as done below:

Both, on longer-run trend comparative and on shorter term level analysis bases, both S&P 500 and NASDAQ Composite react in the exactly opposite direction to Global Economic Policy Uncertainty measure: rising uncertainty in the longer run is correlated with rising equities valuations.

7/6/17: Markets, Investors Exuberance and Fundamentals

Latest data from FactSet on S&P500 core metrics is an interesting read. Here are a couple of charts that caught my attention:

Look first at the last 6 months worth of EPS data through estimated 2Q 2017 (based on 99% of companies reporting). The trend continues: EPS is declining, while prices are rising. On a longer time scale, EPS have been virtually flat in 2014-2016, but are forecast to rise nicely in 2017 and 2018. Whatever the forecast might be for 2018, 2017 increase would do little to generate a meaningful reversion in EPS to price trend

However, the good news is, expectations on rising EPS are driven by rising sales for 2017, and to a lesser extent in 2018. This would be (if materialised) an improvement on the 2014-2016 core drivers, including shares repurchases (chart below).

Next, consider P/E ratios:

As the chart above indicates, P/E ratios are expected to continue rising in the next 12 months. In other words, the markets are going to get more expensive, relative to underlying earnings. Worse, on a 5-year average basis, all sectors, excluding Financials, are at above x14. Hardly a comfort zone for 'go long' investors. The overvalued nature of the market is clearly confirmed by both forward and trailing P/E ratios over the last 10 years:

Forward expectations are now literally a run-away train, relative to the past 10 years record (chart above), while trailing (lagged) P/Es are dangerously close to crisis-triggering levels of exuberance (chart below).

In summary, thus, latest data (through end-of-May) shows continued buildup of risks in the equity markets. At what point the dam will crack is not something I can attempt to answer, but the lake of investors' expectations is now breaching the top, and the spillways aren't doing the trick on abating them.

16/5/17: Navigating the Bubbling Up Investment Seas

Here are the slides from my presentation at the IPU Conference 2017 two weeks ago: