In 1981 total US securities equaled 109% of GDP, today they sit at 417%. Overvalued equities alone account for 209% of GDP. Can this be sustained? I doubt it.
The numbers are provided by Doug Noland who has been “Chronicling History’s Greatest Financial Bubble“. Total securities include treasury, agency, corporate bonds, municipal debt, and US equities. He blames “activist” monetary management for the financial bubble and makes the following observations:
History is unambiguous: Credit is inherently unstable. And for years I have argued that market-based Credit is highly unstable. And especially after recent years, I will add more generally that a market-based financial system is dangerously unstable…Years of policy measures to intervene and manipulate markets essentially foster a massive financial scheme – a confidence game. The question then becomes the relative stability or fragility of this scheme. At this point, what are the prospects for an expansion of Credit sufficient to sustain a historic Bubble in market-based finance?
Dr. Hussman was on the same theme in Recognizing the Risks to Financial Stability. He shared these two quotes.
It was the greatest and boldest operation ever undertaken by the Federal Reserve System, and, in my judgment, resulted in one of the most costly errors committed by it or any banking system in the last 75 years. I am inclined to think that a different policy at that time would have left us with a different condition at this time… Business could not use and was not asking for increased money at that time.
Adolph Miller, former Federal Reserve Board Member, testifying to the U.S. Senate in 1931 about the Federal Reserve’s 1927 interest rate cuts and acceleration of open market purchases – which fueled speculation and low-quality credit expansion that culminated in the 1929 peak, collapse, and ultimately the Great Depression.
“Credit expansion cannot increase the supply of real goods. It merely brings about a rearrangement. It diverts capital investment away from the course prescribed by the state of economic wealth and market conditions. It causes production to pursue paths which it would not follow unless the economy were to acquire an increase in material goods. As a result, the upswing lacks a solid base. It is not a real prosperity. It is illusory prosperity. It did not develop from an increase in economic wealth [i.e. the accumulation of savings made available for productive investment]. Rather, it arose because the credit expansion created the illusion of such an increase. Sooner or later, it must become apparent that this economic situation is built on sand.”
Ludwig von Mises, The Causes of Economic Crisis (1931)
Dr. Hussman also provided another interesting data point on the stock market’s recent price action. If you do not recognize the years, all but one saw at least a 40% decline in the stock market starting within a year. The other one declined 20%.
In shorter-term market action, we see a general tendency toward distribution, for example, declines on expanding volume coupled with low-volume recoveries on mixed breadth and narrowing leadership (which was also the pattern last week). We note that prior to Friday, the Dow Jones Industrial Average had gone 40 trading sessions without setting a 20-day high or low. If we look across history for periods of extended range-bound activity in overvalued markets where: a) the DJIA had gone more than a month without setting a 20-day high or low; b) the DJIA was confined to a range of less than 6%; c) the DJIA was within 10% of a 2-year high; and d) the Shiller P/E was 18 or higher, there are only 7 clusters that fit the bill (1929, 1937, 1965, 1973, 1999-2000, 2007-2008, and today). While the full-cycle resolution was repeatedly brutal, I should note that the short-term resolution was not very informative at all, and didn’t depend on whether the initial break out of the range was higher or lower.
We are seeing a lot of foreboding from some very smart investment gurus. Not just the ones who are always bearish. Bill Gross’ monthly outlook at Janus Capital Group was not confidence building with a title like A Sense of an Ending. He is talking about more than the end of the 35 bull market in bonds. He also took shots at policymakers:
Policymakers and asset market bulls, on the other hand speak to the possibility of normalization – a return to 2% growth and 2% inflation in developed countries which may not initially be bond market friendly, but certainly fortuitous for jobs, profits, and stock markets worldwide. Their “New Normal” as I reaffirmed most recently at a Grant’s Interest Rate Observer quarterly conference in NYC, depends on the less than commonsensical notion that a global debt crisis can be cured with more and more debt.
His final paragraph is the bottom-line for investing going forward, period. The game is changing…active management was easy during the bull phase of the debt super-cycle. And on the future…
…This is all ending… As it is, in 2015, I merely have a sense of an ending, a secular bull market ending with a whimper, not a bang. But if so, like death, only the timing is in doubt. Because of this sense, however, I have unrest, increasingly a great unrest. You should as well.
And what is causing this foreboding. Is it that the economy is finally back to where it was prior to the great recession, but we have levered up another 40%. More debt with the same economy we had prior to the last financial crisis. Not good for the narrative that the trillions of Quantitative Easing dollars can be paid back through an accelerating economy. Especially when the global economy is decelerating and we are already at zero or negative interest rates.
Retail Sales and Industrial Production
And it is not that the S&P 500 failed to break the resistance of its 2 March peak for the fourth time. It might still manage to hit another high or extend another year thanks to record breaking stock buybacks from US companies who can not get enough of their own company’s stock at these clearly elevated prices. It is that we are approaching the end of both a super cycle of ever decreasing interest rates and another bull market top in the stock market. Approaching, but with “timing in doubt”.
The long view
The current chart reads it is not time to be “all in”.
Losing Momentum
I was talking to a 75 year old who recently retired and rolled her 401K into an IRA. She had to talk to an investment advisor to roll it over. He told her it might not be a good idea to remain 100% invested in the stock market as a retiree. Hmmm…good advice and only lucky it was not too late. She got to pick what percent of risk she wanted to dial in…25% or 50% or 75%. Her 75 year old friend who also retired chose 75% because she wanted a good return. But she decided to only dial in 50% risk. From this conversation, I learned a lot about the type of investors buying into this market and another reason why it has become so detached from economic reality. Dialing in returns with the risk knob. Oh my.
Smart birds fly south for the winter and smart investors sit out the unfavorable season in equities. See why dialing in 0% half the year has increased returns over the full market cycle. And at this point in the cycle, it makes even more sense.
Categories: The Smart Bird