Every year, friend-of-the-site David Collum writes a detailed “Year in Review” synopsis full of keen perspective and plenty of wit. This year’s is no exception. As with past years, he has graciously selected PeakProsperity.com as the site where it will be published in full. It’s quite longer than our usual posts, but worth the time to read in full. A downloadable pdf of the full article is available here, for those who prefer to do their power-reading offline. — cheers, Adam
If you’ve not yet read Part 1, click here to do so. The whole enchilada can be downloaded as a single PDF here or viewed in parts via the hot-linked contents as follows:
Canyon Distressed Opportunity Fund likes the backdrop for credit
The Canyon Distressed Opportunity Fund III held its final closing on Jan. 1 with total commitments of $1.46 billion, calling half of its capital commitments so far. Canyon has about $26 billion in assets under management now. Q4 2020 hedge fund letters, conferences and more Positive backdrop for credit funds In their fourth-quarter letter to Read More
- Natural Disasters
- Price Gouging
- The Biosphere and Price Gouging
- Civil Liberties
- Harvey Weinstein and Hollywood
- Political Correctness–Adult Division
- Political Correctness–Youth Division
- Campus Politics
- Unionization: Collum versus the American Federation of Teachers
- Political Scandals
- Las Vegas
- Links in Part 2
“He is funnier than you are.”
~David Einhorn, Greenlight Capital, on Dave Barry’s Year in Review
Every December, I write a survey trying to capture the year’s prevailing themes. I appear to have stiff competition—the likes of Dave Barry on one extreme1 and on the other, Pornhub’s marvelous annual climax that probes deeply personal preferences in the world’s favorite pastime.2 (I know when I’m licked.) My efforts began as a few paragraphs discussing the markets on Doug Noland’s bear chat board and monotonically expanded to a tome covering the orb we call Earth. It posts at Peak Prosperity, reposts at ZeroHedge, and then fans out from there. Bearishness and right-leaning libertarianism shine through as I spelunk the Internet for human folly to couch in snarky prose while trying to avoid the “expensive laugh” (too much setup).3 I rely on quotes to let others do the intellectual heavy lifting.
“Consider adding more of your own thinking and judgment to the mix . . . most folks are familiar with general facts but are unable to process them into a coherent and actionable framework.”
~Tony Deden, founder of Edelweiss Holdings, on his second read through my 2016 Year in Review
“Just the facts, ma’am.”
By October, I have usually accrued 500 single-spaced pages of notes, quotes, and anecdotes. Fresh ideas occasionally emerge, but most of my distillation is an intellectual recycling program relying heavily on fair use laws.4 I often suffer from pareidolia—random images or sounds perceived as significant. Regarding the extent that self-serving men and women of wealth do sneaky crap, I am an out-of-the-closet conspiracy theorist. If you think conspiracies do not exist, then you are a card-carrying idiot. Currently, locating the increasingly fuzzy fact–fiction interfaces is nearly impossible thanks to the post-election bewitching of 50 percent of the populace.
“The best ideas come as jokes. Make your thinking as funny as possible.”
~David Ogilvy, marketing expert
You might be asking, “What’s with the title, Dave? My 401K is doing great, and I own a few Bitcoin!” Yes, indeed: your 401K fiddled its way to new highs day after day, but this too shall pass—it always does—and not without some turbulence. This year was indeed a tough one to survey. As many peer through beer goggles at intoxicatingly rising markets, I kept seeing dead people (Figure 1).
“We seem to be living in the riskiest moment of our lives, and yet the stock market seems to be napping: I admit to not understanding it.”
~Richard Thaler, winner of the 2017 Nobel Prize in Economics
Figure 1. An original by CNBC’s Jeff Macke, chartist and artist extraordinaire.
A poem for Dave’s Year In Review
The bubble in everything grew
This nut from Cornell
Say’s we’re heading for hell
As I look at the data…#MeToo
Some will notice that in decidedly political sections, the term “progressives” is used pejoratively. Their behavior has become nearly incomprehensible to me. My almost complete neglect of the right wing loonies may reflect some bias, but politically, they have taken a knee. They have become irrelevant. Free speech is a recurring theme, introducing interesting paradoxes for employee–employer relationships.
Some say I have no filter. They obviously have no clue what I want to say. In case my hints are too subtle, I offer the following:
I sit in front of a computer 16 hours a day, at least three of which are dedicated to non-chemistry pursuits. I’m a huge fan of Adam Taggart and Chris Martenson (Peak Prosperity), Tony Greer (TG Macro), Doug Noland (Credit Bubble Bulletin), Grant Williams (Real Vision and TTMYGH), Raoul Pal (Real Vision), Bill Fleckenstein (Fleckenstein Capital), James Grant (Grant’s Interest Rate Observer), and Campus Reform—but there are so many more. ZeroHedge is by far my preferred consolidator of news. Twitter is a window to the world if managed correctly. Good luck with that. And don’t forget it’s public! Everything needs an open mind, discerning eye, and a coarse-frit filter.
“You are given a ticket to the freak show. When you’re born in America, you are given a front row seat, and some of us get to sit there with notebooks.”
~George Carlin, comedian
Footnotes appear as superscripts with hyperlinks in the “Links” section. The whole beast can be downloaded as a single PDF xxhere or viewed in parts—the sections are reasonably self-contained—via the linked contents as follows:
- My Personal Year in Review
- Broken Markets
- Market Valuations
- Market Sentiment
- Stock Buybacks
- Indexing and Exchange-Traded Funds
- Miscellaneous Market Absurdities
- Long-Term Real Returns and Risk Premia
- Housing and Real Estate
- Inflation versus Deflation
- Corporate Scandals
- The Fed
- North Korea
- Middle East
- Links in Part 1
- Natural Disasters
- Price Gouging
- The Biosphere and Price Gouging
- Civil Liberties
- Harvey Weinstein and Hollywood
- Political Correctness–Adult Division
- Political Correctness–Youth Division
- Campus Politics
- Unionization: Collum versus the American Federation of Teachers
- Political Scandals
- Las Vegas
- Links in Part 2
Who cares what an academic organic chemist thinks? I’m still groping for that narrative. In the meantime, let me offer a few personal milestones that serve as a résumé while feeding my inner narcissist. I remain linked into the podcast circuit, having had chats with Max Keiser and Stacy Herbert (Russia Today aka RT),5 Chris Martenson,6 Jim Kunstler (The KunstlerCast),7 Lior Gantz (Wealth Research Group),8 Anthony Crudele (Futures Radio Show),9 Susan Lustick (News-Talk 870 WHCU),10 Jason Burack (Wall St. for Main St.),11 Dale Pinkert (FXStreet),12 Lance Roberts (Lance Roberts Show),13 and Jason Hartman (Hartman Media Company).14 I also spoke at Lance Roberts’s Economic and Investment Summit discussing campus politics15 and the Stansberry Conference (Figure 2) arguing the merits of price gouging.16 I got into a big spat with the American Federation of Teachers and some local social justice warriors that made it to the national press (see “Unions”) and dropped 30 pounds unaided by disease.
“And, before anyone should doubt what a chemistry professor would know about unions and what effect they would have, it should be noted that Collum has amassed a following for his annual 100-page papers on the state of business and politics. Turns out, he knows a thing or two about economics and politics as well.”
~Joe Cunningham, RedState
Figure 2. The lovely Grant Williams, brainy Danielle DiMartino Booth, and one of the Paddock brothers in Las Vegas.
On the professional side, I had a great year: I finished my stint as department chair; started a sabbatical leave; broke my single-year total publication record; and broke my single-year record for papers in the elite Journal of the American Chemical Society. I attempted to extend a contiguous string of 20 federal grants without a rejection by submitting two NIH grants and subsequently got totally blown out of the water. (OK. I’m still walking that one off. I think the panel finally noticed that I am deranged.) I was accepted into an organization called the Heterodoxy Academy, whose membership includes hundreds of tenured professors standing up for free speech on college campuses.17
“My job is to write the exact same thing between 50 and 100 times a year in such a way that neither my editors nor my readers will ever think I am repeating myself.”
~Jason Zweig, Wall Street Journal columnist
“I dig your indefatigable bearishness, my friend.”
~Paul Kedrosky, one of the earliest bloggers
I’m sensing a tinge of Paul’s sarcasm. My net worth from January 1, 2000, has compounded at a ballpark annualized rate of 7 percent. That’s not so bad, but the path has been rather screwy. From mid ’99 through early ’03, I carried cash, gold, silver, and a small short position. I kept buying gold through about 2005 (up to $700 an ounce), resumed in 2015, and bought several multiples of my annual salary’s worth in 2016. I’m done now. Gold is up 8 percent, and silver is down –2 percent in 2017 thanks to a minor end-of-year sell off. The spanking from ’11 to ’15 seems to have subsided.
Precious metals, etc.: 29%
Cash equivalent (short term): 62%
Standard equities: 9%
“Most people invest and then sit around worrying what the next blowup will be. I do the opposite. I wait for the blowup, then invest.”
I was totally blindsided by the downturn in gold starting in ’11 and energy in ’13. (Energy peaked in ’08 but was on the mend until ’13.) I bought energy steadily starting in ’01 with broadly based energy funds and a special emphasis on natural gas. The timing of entry was impeccable and all was going swimmingly—I was a genius!—until the Saudi oil minister attempted to talk oil down from $110 to $80 per barrel18 in ’13. He thought he could blow the frackers out of the game fast, but it was a hold-my-beer moment for our credit system. The frackers kept fracking, the oil price overshot the Sheik’s target by $50 per barrel, and I got whacked for 30–45% losses over four years starting in ’14.19
It is impossible to know when you’re being a highly disciplined buy-and-hold investor—a Microsoft and Apple gazillionaire refusing to sell—or just an idiot. I sensed that the rotten debt had been purged and we were through the worst of the energy downturn. I worried that a recession could do a number on me, but it took years to get to my position through incremental buying. I’m holding on, goddammit! We seem to be running out of downside. Unbeknownst to me until October, however, my employer had liquidated my energy funds—every last one of them—and put me in a life-cycle fund in April. Sell ’em after they plummet? Thanks guys. A rational investor, if committed to hold them, would undo the general equity fund restrictions—I did—and buy the energy funds right back—I didn’t. Friends in high places all said to wait. About a week later, the Middle East erupted in what looked like a sand-to-glass phase transition (see “Middle East”), and energy started to move in sympathy. Peachy.
Fidelity actually saved me a little money, but I am still white-knuckling the cash, growing a long wishlist, waiting for a generalized sell-off/recession to offer some serious sub-historical-mean bargains (see “Broken Markets”). The correction in ’09 at the very bottom brought us to the historical mean, but not through it. For this reason, I have largely skipped this equity cycle. The current expansion is long in the tooth and founded on poor fundamentals. I hope that the wait won’t be too long. Until then . . .
“Remember, when Mr. Market shows up at your door, you don’t have to answer.”
~Meb Faber, co-founder and CIO of Cambria Investment Management
“A decade after the biggest crisis since the Depression, a broad synchronized recovery is under way.”
~The Economist, March 2016
Whoa! Fantastic! Goldilocks survived another bear. There is just one hitch: that was a total load of crap in 2016, and it’s a colossal load now. Let’s take a peek at a few gray rhinos—“large and visible problems in the economy that are ignored until they start moving fast.” GDP growth rates from 1930–39 and 2007–16 were as follows:20
GDP growth in the 1930’s
1930: –8.5% 1935: 8.9%
1931: –6.4% 1936: 12.9%
1932: –12.9% 1937: 5.1%
1933: –1.3% 1938: –3.3%
1934: 10.8% 1939: 8.0%
GDP growth in the new millennium
2007: 1.8% 2012: 2.2%
2008: –0.3% 2013: 1.7%
2009: –2.8% 2014: 2.4%
2010: 2.5% 2015: 2.6%
2011: 1.6% 2016: 1.6%
Whether you use the arithmetic or geometric mean, both gave us 1.3 percent annualized growth. Let’s spell this out: during the recent era in which markets soared, the economy tracked the Great Depression. It is instructive to look at the economy with a little more granularity than the writers at The Economist-Lite.
According to John Mauldin, total domestic corporate profits have grown at an annualized rate of just 0.1 percent over the last five years.21,22 Goldman’s Abby Joseph Cohen says R&D spending is down to 2.5 percent of GDP from 4.5 percent and is a drag on the economy.23 Economic bellwether General Electric saw revenue drop 12 percent and earnings fall 50 percent year-over-year,24 and these numbers are aided by the company’s legendary creative accounting schemes.25 Meanwhile, corporate America witnessed a 71 percent rise in business debt since 2008. According to economist Lacy Hunt, “It’s the investment, the real investment, which grows the economy,” prompting the legendary market maven @RudyHavenstein to state dryly, “I like Hunt.” Where are they spending all that borrowed money? Hold that thought. Long-term demographic problems—“quantitative aging” (Figure 3)—exacerbated by dropping sperm counts26 suggests the economy will continue to shoot blanks.
Figure 3. Demographics looking sketchy.
Putative job gains affiliated with this low growth are fragile if not dubious as hell and are being boosted by the “Dusenberry effect”—consumers’ reluctance to stop spending even after their income drops—which will cause the next recession to be a real Dusey. (Sorry.) Eventually, common sense prevails as companies run out of credit and savings-deficient consumers reassume the fetal position. According to extensive work by Ned Davis Research, cash levels among households are near their lowest levels of all time; consumer resiliency is always temporary.
“When it is all said and done, there are approximately 94 million full-time workers in private industry paying taxes to support 102 million non-workers and 21 million government workers. In what world does this represent a strong job market?”
~Jim Quinn, The Burning Platform blog
The Bureau of Labor Statistics has turned to Common Core math. How can we have 100 million working-age adults—40 percent of the working-age population—not working, 4 percent unemployment, and employers claiming the labor market is tight? Are 90 percent of those without jobs professional couch potatoes? Let’s first look at employment in some detail and then address that whole “tight” part. Googles of pixels have been dedicated to the obligatory labor force participation rate (Figure 4), a critical component of any economic debunking. Of those employed, 26 million people are in low-wage, part-time jobs (Figure 5), 8 million hold multiple jobs, and 10 million are “self-employed.”27 Another 21 million work for the government, which means they are a tax on the free market. In 2016, 40 percent of new jobs were fabricated through the specious “birth and death model.”28 2017 will presumably post similar numbers. Occasional reports of large job growth are deceptive. July, for example, witnessed 393,000 benefit-free, part-time, low-skill jobs offset by a drop of 54,000 full-time workers. Payroll numbers keep coming in lower than expected, which economists invariably blame on some big, yet unseen effect they are paid to notice. Nine out of 10 millennials living on their parents’ couches a year ago are still clutching TV remotes.29 There are now 45–50 million Americans on food stamps, up from 14 million in December 2007,30 when the last recession was already underway.
Figure 4. Labor force participation.
I am going to let Jeff Snyder take a crack at explaining the tight labor market:31
“The economy is tight, not favourably tight as in no slack in the labour market, but more so tight in that there is little margin for addition. . . . The reality in the markets is this: executives are reluctant to pay wages at a market-clearing rate.”
~Jeff Snyder, Alhambra Investments
Figure 5. Low-paying service jobs versus manufacturing jobs.
Poor economic numbers are pervasive. Auto sales are canaries in the coal mine and getting crushed despite aggressive incentives.32 Ford is already suffering and predicting a multi-year slowdown.33 A car industry crunch analogous to that in ’09 may appear in ’18 as expiring leases leave consumers underwater owing to dropping used car prices, and decreasing profits in the auto industry may “then turn from secular to structural problems.”34 Morgan Stanley predicts a 50 percent drop in used car prices over the next 4–5 years,35 which will gut the new car business. The auto downturn has already begun. Wells Fargo is reporting large drops in auto loans after a long stretch during which subprime car loans flourished yet again.36 That should put a fork in the new car market.
Yield-starved investors are chasing cash- and income-starved car buyers. Subprime auto-asset-backed securities will take yet another beating. Chrysler is teaming up with Santander Consumer USA to push out “unverified income” subprime auto loans using “automated decision making.” Santander seems to have nine lives, and they’ll need all of them. The hyperdeveloped loan market for used cars, however, is already faltering (Figure 6); delinquency rates are rising. Goldman expects “challenging consumer affordability” and has downgraded General Motors to “sell.”37 Those cars y’all bought on cheap credit yesterday will not be bought tomorrow. Claims that the hurricanes cleared out auto inventory38 are grotesquely underestimating the magnitude of the overhang and will be paid for by reduced consumption in other sectors. Any consumption pulled forward with debt has a deferred cost.
Figure 6. Some key auto industry stats (a) loans and leases, (b) loan delinquencies.
We’ll take a crack at the housing market in its own section and simply note here that the cost of renting or buying normalized to income has never been higher. Approximately half of tenants spend more than 30 percent of their income on rent, doubling from a decade ago.39 A survey of 20 cities showed that housing costs are growing at a 6 percent annualized pace. Our paychecks are not. Housing is a bubblette and likely to offer fire-sale bargains again. What many fail to grasp is that the reduced cost of borrowing owing to low rates is offset by higher prices. When interest rates were 15 percent, houses were cheap.
Austrian business cycle theory says easy money policies generate overdevelopment and other malinvestment. The day of reckoning appears to be here. (I say that every year…channeling Gail Dudek.) Familiar brands like Toys “R” Us (my keyboard has no backwards R), JCPenny, Abercrombie & Fitch, Sears, Bon-Ton, and Nordstrom are gasping their last gasps before drowning in debt with no customers to save them. Total retail revenues and sales (including online) are up only 28 percent from the 2007 high.40 The management of Ascena Retail referred to an “unprecedented secular change.”41 More than 100,000 retail jobs have vaporized since October 2016.42 Credit Suisse estimates that more than 8,000 retail outlets closed this year.43 Consumer goods companies have held up better because consumers generally put off starving or freezing to death until all options are exhausted. Restaurants are extending the longest stretch of year-over-year declines for 16 consecutive months (last I looked).44 Business Insider blames millennials because they are “more attracted than their elders to cooking at home” (particularly when it’s their parents’ home.) Manhattan retail bankruptcies are called “horrifying.”45
Chapter 11s and company reorganizations in foreign courts increased sevenfold.46 Mall owners are using jingle mail—a term from the ’08–’09 crisis referring to leaving keys to creditors. Commercial retail will be coming into its own refinancing wave in 2018. Bears are sniffing around commercial-mortgage-backed securities as malls around the country begin to die.47 The next downturn will finish many of them off. Exchange-traded funds (ETFs) are positioning to short the brick-and-mortar retail. (Quick: somebody grab the ticker symbol “MAUL.”) Some suggest the Rout in Retail is merely a secular shift to online. Sounds logical except online sales represent only 8.5 percent of total retail sales.48 This argument might be masking a huge downturn in retail corresponding to the bursting of yet another Fed-sponsored bubble.
As Amazon encroaches on every nook and cranny of retail sales, what began as a murmur has turned into a chorus: “This isn’t fair; somebody must do something!” Walmart knows this plotline. Market dominance does not connote “monopoly,” but Amazon has an image problem. Amazon gets a $1.46 subsidy (discount) per box from the USPS, well below its cost.49 Seems cheesy. Congress is showing concern out of self-interest. A monopoly is when a company uses its power to blow its competitors out of the water garishly. Who decides what is garish and when enough is enough? A judge under political pressure. A detailed summary of the breadth of Amazon’s market share and its anti-competitive pricing suggests that we are getting close.50 There’s nothing like a protracted anti-trust suit to mute the growth of a large conglomerate. Just ask the Microsoft high command.
If our problems are not Amazon, what are they? Austrian business cycle theory says that our debt-driven, consumer-based economy endorsed by sell-side economists and analysts worldwide is unsustainable. Wealth is made, mined, grown, or coded, only then do you get to consume it. Wealth is extinguished by consumption, depreciation, and destruction. Central bankers seem to believe you can will wealth into existence by generating animal spirits.
The next recession will start unnoticeably. Economists seem to miss every single one, often declaring telltale indicators irrelevant. Then you will hear phrases like “technical recession,” “growth recession,” or “earnings recession,” all eventually giving way to somebody opening the Lost Arc. If the next recession flushes the waste products (malinvestment) left behind by the central-bank-truncated ’08-’09 recession, it will reveal the central bankers to be charlatans. Even a typical recession witnesses near 40 percent losses in equity portfolios, which will leave already immunocompromised consumers vegetative. Banks will constrict lending to preserve capital, further slowing the economy. Weak businesses living off easy credit will become pink mist. An accelerating vicious cycle downward will take with it formerly viable businesses that could have survived a less arrogant monetary policy. This collateral damage was avoidable at least in its magnitude, but it can’t be avoided now. Are we on the cusp of the next recession? Citigroup “clients” say not even close (Figure 7). I think we are staring into the abyss.
Figure 7. June 2017 Citigroup client survey of recession odds.
Will this expansion continue because it has been pathetic or die because it is old? I cast my vote for the latter. The Fed and its central bank brethren, whether to retrieve residual credibility—they have precious little—or out of the deep-seated, albeit misguided belief that they are in charge of the economy, have decided it is time to “normalize rates” and undo quantitative easing. (We are now forced to accept the equally silly term “quantitative tightening.”) You can blame the ensuing problems on the tightening if you wish, but the huge mistakes were made long before this tightening cycle commenced. Every postwar recession until now was been preceded by a tightening cycle (although not all tightening cycles lead to recessions). Why not simply refuse to tighten? It won’t work, but the Fed governors are probably entertaining this possibility.
“The central banks did their job. Unfortunately, almost nobody else has done theirs.”
~Martin Wolf, Financial Times
“As has come to be commonplace, almost everything Mr. Wolf suggests is incorrect.”
~Tim F. Price, Cerberus Capital and author of Investing Through the Looking Glass (see “Books”)
I’ll close this discussion with a brief mention of “creative destruction,” the process by which the new (and improved) ushers out the decrepit and out-of-date. It is a central tenet of capitalism—survival of the fittest—but has a disruptive dark side. McDonald’s (and every other service industry) is turning to kiosks to replace more costly human labor. Driverless cars will be awesome but also force car-based workers—potentially millions of them—to find new work. The financialization of the economy by central bankers has tipped the capital–labor balance profoundly toward capital. We will produce goods better and more efficiently, but the Darwinian adjustments will rock the system. Accelerated product cycles facilitated by excess capital can also be highly inefficient. The Erie Canal was completed in 1825 and faced its own black swan—railroads—that same year. Blockbuster was offed by Netflix as fast as it appeared. Can creative destruction happen too fast? Have product cycles become too short? Bulldoze your house every five years to build a better one and tell me how that works. Loose credit accelerates creative destruction, but not without a price.
“A high initial saving rate has been associated with subsequently stronger economic growth, while a low saving rate produces a lower growth pattern.”
~Lacy Hunt, economist, noting soaring consumer debt
“I think we have fake markets. . . . Everything is so tight, it is hard to pick a winner from a group that is fake.”
~Bill Gross, Janus
“One word characterizes why the bull market can go on for years…’Goldilocks'”
~Sam Ro, Yahoo Finance
“I’m not worried about the economy so much; what I’m concerned about is valuation.”
~David Swensen, Yale University’s longtime CIO
“I think the bull market could continue forever.”
~Jim Paulsen, Wells Fargo
Regression to the mean is a force of nature. It is also a mathematical truism that markets reside below the mean for half of their price-weighted existence. The failure to go through the mean in ’09 is an anomaly caused by global central bankers that remains as an IOU on investors’ balance sheets and foreshadows trouble to come.
Our system is constantly being overtly displaced from equilibrium by central bankers who view displacement as their mandate. Physical scientists know that any system displaced from equilibrium tends to return to equilibrium. The French physicist Carnot, often called the father of modern thermodynamics, showed that the round trip necessarily comes at a cost no matter how efficient the process: it’s a law of physics. Any chemist will tell you that a system massively displaced often returns with a considerable cost: you blow up your laboratory. Geologists? Volcanoes and earthquakes. Ski bums? Avalanches. How far are asset markets from equilibrium? The pros have some opinions:
“Asset valuations historically aren’t way out of line, but elevated I would say, relative to historical averages.”
~Lael Brainard, Federal Reserve governor
“Measured against interest rates, stocks actually are on the cheap side compared to historic valuations.”
~Warren Buffett, Berkshire Hathaway, channeling the Fed model
“Compared to the Dutch Tulip Mania of 1637, stocks still look undervalued.”
~Rudy Havenstein (@RudyHavenstein), Funniest Tweeter of the Millennium
Case closed. Let’s get a six-pack and watch football. The problem is that Brainard is a Fed governor, Havenstein is nuts, and Buffett is known for spewing some serious bullshit. Buffett’s favorite indicator—market cap to GDP—is double the historical mean (vide infra)—what market analyst John Hussman calls “historically offensive valuations.” Buffett also wrote an article in 1999 stating without qualification that returns are not about the economy at all.51 Secular bull markets are powered by falling interest rates and secular bear markets by rising rates. With interest rates at multi-century lows, it seems likely the old codger knows that his implicit reliance on the Fed’s valuation model is lunacy. As an aside, Berkshire has the largest cash hoard in its history—$100 billion—and it’s not being used to buy stocks that are “on the cheap side.”
Others, only partially impeded by cognitive dissonance and the task of selling assets at any cost, seem to have neurons firing spasmotically (sense something):
“We think the market still has the potential to move higher as investors capitulate into equities.”
“Folks, I have been in this business for over 46 years, and observing markets with my father for 54 years, and I have never experienced anything like what is currently happening. . . . There are years left to run in this one.”
~Jeff Saut, Raymond James
“It seems like uncertainty is the new norm, so you just learn to live with it.”
~Ethan Harris, global economist at Bank of America Merrill Lynch
The fear of missing out (FOMO) is driving the markets way out over their skis. Markets could get much crazier, of course, but as any serious blackjack card counter will tell you, when the deck is stacked against you, size your bets accordingly.
“If you pay well above the historical mean for assets, you will get returns well below the historical mean.”
~Paraphrased John Hussman
This Hussman quote is a recycle from last year but well worth repeating to make sure you understand it. He goes on to channel Ben Graham by noting that the devastating losses come from purchasing low-quality securities when times are good. The Hussman quote also pairs well with ideas about valuation I cobbled together from a well-known maxim about savings:
“Overvaluation is appreciation pulled forward.”
“Undervaluation is deferred appreciation.”
This one passed the Google test for originality. I don’t know about you, but I want my appreciation in the future, or as James Grant (channeling Joe Robillard) likes to say, “I want everybody to agree with me . . . only later.” Valuations are meaningless as long as market participants are determined to buy stocks, but that mood will change at some point. Once markets are overvalued, however, you will give back those and any further gains during the next irrepressible regression to the mean, more so as you linger below the mean. I hasten to add that slight overvaluation is not a problem: the regression will be embedded within the noise. If, however, markets are way overvalued, an unknowable but inevitable combination of price drop and time—a retrenchment that could last decades—will usher invested boomers to the Gates of Hell. What do current valuations tell us about future returns assuming the laws of thermodynamics have not been repealed?
“The median stock in the S&P has never been valued higher than it is today.”
~Jesse Felder, The Felder Report
“There’s just no other way to say it: the market is insanely overvalued right now. It’s the longest recovery in history. It’s also the weakest. But you’d never know it from the stock market.”
~ David Stockman, former Reagan economic advisor and former Blackstone group partner
“We are observing an episode that will make future investors wince. Just like the two closest analogs, the 1929 high and the tech bubble, I expect that future investors will shake their heads in wonder at the stark raving madness of it all, and ask what Wall Street could possibly have been thinking.”
~John Hussman, Hussman Funds
“The gap between the S&P 500 and economic fundamentals can now be measured in light years.”
~Eric Pomboy, president of Meridian Macro Research
“I believe fragilities today are much more systemic on a global basis than back in 2007. Where’s the Bubble? Virtually everywhere… The scope of today’s global Bubble goes so far beyond 2007.”
~Doug Noland, McAlvaney Wealth Management
It took a few years to blow up yet another equity bubble—referred to fondly by Jesse Felder and others as the “everything bubble”—but determined central bankers are not in short supply. A host of metrics point to a very mean regression cited below. As I rattle off a few stats, bear in mind the serious yet unknowable losses possible if regression rips through the mean.
“Russell 2000 with a 75 p/e is just astronomical.”
Starting simple: McDonald’s saw zero revenue growth between 2008 and 2016 but had a 154 percent growth in debt. Its share price is up more than 200 percent. This is not an outlier. Additional examples assembled by Mike Lebowitz of 720Global are shown in Figure 8. I know it’s a table, but look at the contrasting revenue growth versus share price gains!
Figure 8. Revenue growth versus price change.
“And please don’t claim corporate profits are soaring, so the valuations are justified. . . . Corporate profits are unchanged since 2014—no growth at all.”
~Charles Hugh Smith, Of Two Minds blog
The S&P 500 resides 70 percent above its ’07 high even though nominal GDP and total sales rose 10 percent during the same period. Price-to-revenue ratios are sharing the nosebleed seats with 1929 and 2000 (Figure 9).52 Buffett’s market cap–to-GDP indicator is no better, prompting Felder to guesstimate prospective 10-year returns—returns going to somebody else, apparently—at -2.6% annualized.53 In case you suck at math, you will be 10 years older, 33 percent poorer, and in need of a 50 percent gain to stumble your way back to even. Ever the optimist, John Hussman and his relatively complex valuation model, which shows high correlations when back-tested, predicts 60–70 percent losses over the next 10 years.54 To help the value-driven bottom-feeders, Hussman broke down the markets by valuation “deciles” and found that even the deep-value guys are looking at a >50 percent haircut—“haircut” sounds better than “castration” or “blood eagle”—at the end of the current market cycle.55
“Given the performance of certain stocks, we wonder if the market has adopted an alternative paradigm for calculating equity value. . . . What if equity value has nothing to do with current or future profits and instead is derived from a company’s ability to be disruptive, to provide social change, or to advance new beneficial technologies, even when doing so results in current and future economic loss? . . . After years of running into the wind, we are left with no sense stronger than, ‘it will turn when it turns.’ . . . Just because AMZN can disrupt somebody else’s profit stream, it doesn’t mean that AMZN earns that profit stream. For the moment, the market doesn’t agree. Perhaps, simply being disruptive is enough.”
~David Einhorn with tongue in cheek
The legendary Howard Marks, using non-GAAP earnings (with a 25 percent fictional fudge factor)56 to calculate trailing P/E ratios, sees a 40 percent regression to the mean. The Case-Shiller weighted P/E ratio—far superior to the non-GAAP alternatives—is in the top 3 percent of historical readings,57 prompting Bob Shiller to dryly note that the markets are “at unusual highs.” (By the way, it was Shiller who slipped Greenspan the phrase “irrational exuberance.”) Dividend yields have flopped around over the centuries. A 56 percent equity decline is required to attain the 150-year historical average of 4.4 percent—assuming reduced cash flows owing to the price collapse don’t lead to dividend cuts.58 Tobin’s Q—essentially price-to-book value ratio and the favorite of Mark Spitznagle—is at all-time highs. The Economist sounds dismissive by suggesting that “a high Tobin’s Q signals that an industry is earning a lot from its assets,”59 which suggests that The Economist is underutilizing its intellectual assets.
Figure 9. Valuation metrics from Grant Williams’s World of Pure Imagination.60
Consistency aside, how can these predictions possibly be correct? The reported P/Es are not that bad. The high-growth QQQ index, for instance, is sporting a P/E of only 22, and the Russell 2000—the small-cap engine of economic growth—is in the same neighborhood. Alas, Steve Bregman of Horizon Kinetics notes that the P/E of the QQQ is calculated by rounding all P/Es above 40 down to 40 and assigning a P/E of 40 to all negative P/Es—companies losing money, aka Money Pits.61 For some of the largest companies in the QQQ—think Amazon—with almost no GAAP earnings, these little fudge factors are not just rounding errors. In the scientific community, we call such adjustments “fraud.” Bregman pools the market caps and earnings to give a more honest analysis, which gently nudges the QQQ P/E to 87. In short, Wall Street is “making shit up.” Mark Hulbert, noting that more than 30 percent of the Russell 2000 companies are losing money, concurs with Bregman and suggests that the rascals at the parent company would get a P/E of 80 if they weren’t fibbing like teenagers.62