'..the problems that caused the global financial crisis a decade ago still haven’t been resolved..'<blockquote>'November 15 – Bloomberg (Nishant Kumar and Suzy Waite): “Hedge-fund manager David Einhorn said the problems that caused the global financial crisis a decade ago still haven’t been resolved. ‘Have we learned our lesson? It depends what the lesson was…’ Einhorn said he identified several issues at the time of the crisis, including the fact that institutions that could have gone under were deemed too big to fail. The scarcity of major credit-rating agencies was and remains a factor, Einhorn said, while problems in the derivatives market ‘could have been dealt with differently.’ And in the ‘so-called structured-credit market, risk was transferred, but not really being transferred, and not properly valued.’ ‘If you took all of the obvious problems from the financial crisis, we kind of solved none of them,’ Einhorn said… Instead, the world ‘went the bailout route.’ ‘We sweep as much under the rug as we can and move on as quickly as we can,’ he said.”
..
As Einhorn stated, “risk was transferred, but not really being transferred, and not properly valued.” It amounted to a historic market Bubble distortion. Underlying risks were being grossly distorted and mispriced in the marketplace. Distortions fostered a massive expansion of risky Credit and untenable financial intermediation – a powerful boom and bust dynamic that culminated in a crash. Amazingly, catastrophic market distortions evolved gradually enough over years so to barely garnered attention. Can’t worry about risk when there’s easy “money” to amass.'
- Doug Noland (
Source, November 18, 2017)</blockquote>
'..the Swiss National Bank has effectively become both the nation’s central bank and one of the largest, if not indeed the very largest, hedge funds in the world..'<blockquote>'But it wasn’t just the Federal Reserve. The European Central Bank and the Bank of Japan have both grown their balance sheets more than the US has. The Bank of Japan’s balance sheet is almost five times larger in proportion to GDP. And it is still growing. The Land of the Rising Sun has become the land of the rising central bank balance sheet.
Meanwhile, the more sober-minded (hah!) gnomes of the Swiss National Bank expanded their own balance sheet at a much steadier pace, though in percentage terms they blew it up far more than the Fed or the BOJ did theirs. The Swiss National Bank is now the world’s largest hedge fund.
<blockquote>"We have written many times about the fact... and it is a fact... that the Swiss National Bank has effectively become both the nation’s central bank and one of the largest, if not indeed the very largest, hedge funds in the world.."
- Dennis Gartman</blockquote>
- John Mauldin,
Bonfire of the Absurdities, November 17, 2017</blockquote>
'..In the meantime, my honest opinion is that Wall Street has gone completely mad.'<blockquote>'The most historically reliable valuation measures are obscene here. We expect the market to lose nearly two-thirds of its value by the completion of this cycle, while still posting negative total returns over the next 10-12 years. In my view, Wall Street is completely out of its gourd. Research, evidence, and historically-informed analysis can fight ignorance only when people value knowledge. The problem is that human beings are wired to chase what they associate with pleasure, and to shun what they associate with discomfort. Recall the dot-com bubble. Recall the housing bubble. Investors, given enough pleasure in the moment, will find rationalizations that allow them to maintain ignorant bliss, even if the long-term consequences are repeatedly devastating.
..
In 2009, after a market collapse that we had anticipated, I insisted on stress-testing our methods against Depression-era data because the economic fallout was unlike anything observed in the post-war period. The resulting methods performed even better than our pre-2009 methods in market cycles across history, but in the advancing half-cycle since the 2009 low, one single feature of the post-2009 methods turned out to be our Achilles Heel. Our methods gave those “overvalued, overbought, overbullish” syndromes priority, ahead of the uniformity or divergence of market internals, because of their reliability in other cycles across history. If those syndromes were extreme enough, they could encourage a hard-negative market outlook even if market internals had not yet deteriorated.
Unfortunately, this cycle was different than others across history. In the face of Fed-driven yield-seeking speculation and the novelty of zero interest rate policies, investors continued to speculate long after even extreme “overvalued, overbought, overbullish” syndromes emerged. In 2014, we introduced an adaptation: if zero interest rates are present, market internals have to be prioritized ahead of overextended syndromes, which means refraining from a hard-negative outlook in zero-interest rate environments as long as market internals remain uniformly favorable. That single adaptation would have been sufficient to dramatically change our experience in the advancing half-cycle since 2009.
Earlier this year, we raised the priority of market internals even further, so that they take precedence over “overvalued, overbought, overbullish” features of market action even when interest rates are above zero. This brought our treatment of “overvalued, overbought, overbullish” syndromes back to our pre-2009 practice: 1) if internals are still favorably uniform, these syndromes act as a signal to back off from a constructive outlook to a neutral outlook, but 2) the syndromes act as a warning signal justifying a hard-negative market outlook only if market internals are also unfavorable.
Put simply, we relied too heavily on “overvalued, overbought, overbullish” syndromes that had been reliable in prior market cycles, but were nearly useless in an environment where relentless speculation was encouraged by zero interest rates. I don’t hesitate to admit that stumble, but it’s equally important to emphasize what we’ve done to address it.
..
That’s exactly why our immediate outlook is neutral here, and why we would place safety nets and tail-risk hedges several percent below current levels, despite what regard as obscenely overvalued, overbought, and overbullish conditions (notably, advisory bullishness climbed last week to an extreme not seen since just before the 1987 crash).
..
..what’s “different” about “this time” is purely psychological, driven by:
1) the novelty of central bank interventions and the recent experience of zero-interest rates, which encouraged the belief that there was no alternative to buying riskier assets, no matter the price;
2) the fallacy that low interest rates “justify” arbitrarily high valuations even if economic growth rates are commensurately low, and;
3) the belief that elevated profit margins (largely a creature of depressed wage growth following extreme job losses in the global financial crisis) will be a permanent feature of the economic landscape, despite an unemployment rate that now stands at just 4.1%.
Given this belief system, encouraged by the novelty of zero-interest rates, not even the most extreme “overvalued, overbought, overbullish” conditions have been enough to derail the speculative inclinations of investors. Yet in most other ways, this speculative episode is simply a more extreme variant of others that have come before it, particularly the advances that ran to the 1929 and 2000 valuation extremes. In those episodes, as in this one, favorable market internals are serving, as they should, as the observable signature of a temporary speculative mood and a temporary willingness to ignore valuations.
Unfortunately, valuation extremes and speculative moods are always impermanent, and there’s every reason to expect current extremes to be followed by more than a decade of negative S&P 500 total returns. It’s that failure to distinguish temporary returns from durable ones that will likely end with most investors surrendering every bit of return they’ve enjoyed since 2000. Indeed, by the completion of the current cycle, I expect the S&P 500 to surrender its entire total return, in excess of Treasury bills, all the way back to roughly October 1997; an expectation that would not even require the most reliable valuation measures we identify to breach their historical norms.
Make no mistake – valuations are already offensive, and we expect that more extreme valuations will only be met by more severe losses. We expect the stock market to lose nearly two-thirds of its value over the completion of this market cycle. We also expect the S&P 500 to lose value, even after dividends, over the coming 10-12 year period. If the market advances further, it will not be evidence that valuations don’t matter, but only that they temporarily don’t matter while investors are enthralled with the positive outcomes of their own speculation. That will change when market internals deteriorate again (which unfortunately may not be obvious until after a steep initial leg down). Still, we’ve given up the expectation that extreme “overvalued, overbought, overbullish” syndromes will offer useful warning of that shift. It’s enough to be neutral here. With that, further speculation in a wickedly overextended market may not help us much, but it shouldn’t hurt us much either. In the meantime, my honest opinion is that Wall Street has gone completely mad.
Finally, it’s important to reiterate that unlike the 2000 valuation extreme, which was largely focused on a subset of extremely overvalued technology stocks, the current market extreme is the broadest episode of extreme equity market overvaluation in history..
..
..There’s no need to take a hard-negative outlook here, but don’t allow impatience, fear of missing out, or the illusion of permanently rising stock prices to entice you into entrusting your financial future to the single most overvalued market extreme in history.
Note: For more on price/revenue ratios, we’ve reprinted Bill Hester’s
article on the subject from 2007, just before the global financial crisis. I’ve added a brief epilogue at the end. Our hope is that this work encourages investors to review their risk exposures and tolerances in a historically-informed way.
- John P. Hussman, Ph.D.,
This Time Is Different, But Not How Investors Imagine It Is Different, November 2017</blockquote>
Context<blockquote>
'..[the] industry receiv[ing] the most subsidies .. is the financial sector via money for nothing from central banks..' - '..BIS dissidents..''..this long Credit cycle going back to the conclusion of WW II .. the “granddaddy of Bubbles”..' "Money" on the Move, November 11, 2017</blockquote>