This is a free form post without alot
of preparation so I'll likely be all over the map. It's amazing to me that those expecting that we have cheated a bear market are seemingly without any concern for risk. The Bloomberg
article link I referenced pretty much echos Wall Street's consensus of a blase attitude. I find blase a perfect word for this environment. One definition of blase is uninterested due to frequent exposure. The great deceiver is working its magic. Lulling people into a false sense of security. Of course, that's nothing new. I find a quote from the incredibly wise god of knowledge, John Galbraith, is very appropriate at this time in the cycle.One of the things you must understand about 1929 and the antecedent years, as about any speculative episode, is the danger... in attributing intelligence to the simple fact that people are associated with large sums of money or large financial operations. We don't ask whether they're intelligent. We say, they're associated with all this money, so they must be intelligent. We attribute intelligence to association with financial operations. And only afterwards do we discover that error and that the people involved can be extremely successful in gulling themselves. That they can be in effect, and I use the word advisedly, marvelously stupid.
I used to be quite an optimist... I thought that by keeping the memory of the 1929 crash alive we would have a warning against the kind of feckless, fatuous optimism which caused people to get in and shove up the markets and shove it up more and get carried away by the illusion of ever-increasing wealth. I've given up on that hope because we've had it happen too often again since.
-- John Kenneth Galbraith
It's pretty clear what Galbraith is saying: most people on Wall Street don't get it to put it mildly. The human condition is alive and well. It has found a permanent home amongst us. Is that such a shock? I'm sure most of you have heard of Pareto's Principal more commonly called the 80-20 rule. I take a liberal interpretation and apply it to most everything in life.
20% of my time is most productive where I accomplish 80% of my work.
20% of clients provide 80% of profits for most companies
20% of information is relevant and 80% is worthless20% of people are really good at what they do and 80% are at best average
20% of one particular item comprises 80% of my overeating. ie
, Chocolate chip cookies.Ok
, I don't know any of those to be true but it sounded good. But, it's not hard for me to believe many on Wall Street are, well OK Galbraith said it. Why do people give deference to Wall Street professionals? I suspect it's a little bit of human nature and it's a little of of the good old boys club. And, the club has attempted to keep the general public in a state of bliss. Ignorant bliss that is. As humans, we tend to promote people beyond their level of competence. Yes, the Peter Principal
absolutely exists as a societal phenomenon as well. I've heard so much baloney from supposed "experts" in many fields that I tend to be from Missouri. In other words, prove it. I'm not sure if science teaches one to be dubious or if dubious personality types chose science because within it lies an attempt at deducing plausibility. I tend to think there are quite a few personality types and professional disciplines, not just science, which encourage one's ability to find clarity. Might I add, MBAs
so commonly coveted on Wall Street, isn't one of them. As Jim Simons
, possibly the greatest quantitative investor and hedge fund manager ever, is famous for stating, "We don't hire MBAs
." Now I'm not slamming MBAs
because I've thought from time to time of getting mine. Although it isn't because I felt like I would achieve prajna
by doing so. It was because certain fields covet MBAs
and it might help me get to where I wanted to go in the game of business. Although, I'm not sure where I want to go anymore. About all I do know is that I want to head to Krogers
and take advantage of their Super Bowl special on Chips Ahoy! cookies.
So back to equity markets. This recent rally was really odd. Many characteristics, if taken at face value, are very worrisome. Remember, investing in equity markets is a battle. That implies investors are facing an enemy. And, they surely are. The smart money is always telling the dumb money how great an investment is right at the time they are looking to offload their shares. Those unwilling or unable to see the markets in such a light will always be fleeced by market participants who are more sophisticated. For that reason, what I see makes me very cautious of the market's deceptive cunning.
A brilliant market maven from nearly a century gone past once said the direction of the market could not be manipulated but the extent of the trend could. After seeing stock action in the late 1990s, commodities and certain equities today, including the recent post where I highlighted the insanity of Chinese and Russian equities, I'm starting to believe the markets are moved by the modern day equivalent of stock pools. Stock pools were a legal way of collaborating amongst traders to drive investments to astronomical levels in the 1920s. In other words, the historical equivalent of massive trading firms such as Goldman, Morgan Stanley, Merrill and other top hedge funds could sit around a table and effectively decide what they were going to invest in and then go jam the price to the moon and do it legally. The benefit is that they could create a frenzy, suck in other investors via the wonderful emotion of greed and all share in its profits before dumping. Hard to believe it, but yes it was legal. In hindsight there are those who say stock pools didn't hurt individual investors. Some have even written papers defending such statements but that's completely absurd. I give those making such an argument the "Big Baloney" award. When those same pools were liquidating into the hands of Ma and Pa American in 1929, how can you defend such a practice? Eventually, the government saw through this and the Securities Act outlawed stock pools post 1929. But, where there is a will, there is a way and that leads us to today.
How does one create volatility in an environment of low volatility? Pump up trading returns? By collaboratively attempting to invest in the same assets as other big money players. In other words, hot money following hot money. So, while I have no reason to believe such collaboration takes place on a personal level, there is absolutely no doubt in my mind that quantitative methods, algorithmic trading and extreme amounts of liquidity have recreated a similar environment to the stock pools of yore. If I'm hedge fund or professional trading firm, I can measure what other large trading firms are doing and follow suit in the same spirit as stock pools operated. And, I can do it legally. What has that left us with? Extreme volatility
where the big money roams. Commodities, commodity related stocks, small caps, transports and many of the market
leaders I've written about. Now, I'm a firm believer in history. That leads me to believe the greater the bull market, the greater the bear market. Because of this insanity, I'm more confident than ever we will have a very serious correction in global equities. The insanity of valuations and rapid price rises are no different today than heading into 2000. I've talked about the cyclicality
of earnings and the unsustainability
of such cyclicality
. That means the S&P PE of about 18 is extremely misleading. And, many other valuation metrics of equities are frightening to me. I wonder if a serious selloff
caused by this type of action could create an economic calamity by itself. In other words, a self fulfilling prophecy of reduced asset wealth causing reduced spending which eventually reduces the wealth of the sum whole. Or, better known as the Paradox of Thrift
I have written about either here or elsewhere. Such an event would have global implications.
I am a firm believer there are many incomprehensible factors that drive stocks. I don't buy the Random Walk theory at all. That implies human behavior is random. So, has your behavior today been random? I mean truly random. Do you string together random words in your line of thought? Bob jello run accomplish fun computer candle? Of course not. Another "Big Baloney" award. Those calling for a 10% correction simply don't understand markets. Or maybe if they work on Wall Street, they fear losing investors by being bearish as many were and did in 2000. Were and did meaning were bearish and did lose a tremendous amount of investors. If you are a major investment firm and you lose hundreds of billions in assets by stating your bearishness, you lose a guaranteed income stream of management fees totaling billions of dollars annually. Even if you are a smaller firm, the losses could be devastating. In other words, are certain organizations more interested in keeping investment funds flowing into their coffers and guaranteeing their own success at the expense of other's life savings? A sad question but one can compartmentalize when it is convenient. Now, I have no specific evidence or certainty of any such action and I have no idea if such an act would ever happen. I am simply saying it is plausible. In other words, if I can see such risks, are you telling me a legion of professionals cannot? Or is Galbraith right? Someone has to be right on this topic.
When will a serious drop happen? That's the big question. Well, I was quite confident in the May 2006 high with a dripping fall from late 2007 to October of 2007. Or put another way, 1488 days from the bull market beginning till a drop started in earnest. That would have been November of 2006 as I wrote about last year. To date, as it pertains to commodities, small caps, technology, transports and many international markets, that peak has held. But, obviously, my time frame is wrong because the only major international markets which are down are in the Middle East. The problem we now experience is that central banker's ability to goose the economy is limited. The velocity of corporate money is just about squat as I've said on here time and again. But, that doesn't mean asset prices will collapse tomorrow. They almost certainly will correct at some point. Failure to recognize this means you believe in the "free lunch theory
". Now seriously, how many times have you had a free lunch?
Let's do a brief reminder here. On a historical note, one must remember a massive rally was had during the Great Depression. And, I do mean massive. Well beyond anything post 2000. To the tune of 400% versus the rally of less than 100% we've seen this cycle. In addition, corporate earnings in the 1970s were greater than the 1990s yet stocks suffered murderous and frequent declines. I'll say it for the hundredth time, the stock market is not the economy. People blathering that global growth is great and therefore equities will continue higher are clueless. The last time we had such a long period of synchronized global growth, it was followed by what many called the second Great Depression in the U.S. More baloney.
There is no doubt my original cycles work was flawed in some way. Gee, what a surprise. My quantitative models are very accurate at determining risk but cycles are more of mysticism and, frankly, educated guessing. I don't mean the dreaded four year cycle or other commonly mentioned cycles either. Those are wrong too often and are too obvious. Hence, why I never write of them nor called for a bottom in 2006 as everyone on Wall Street did. Now they are calling for a four year cycle bottom in year five? Huh? Did I miss that math class? Let's back up. Nothing at all has changed in the cycle analysis except the ultimate finality which I expected to be in November. The same macro events are unfolding but haven't unfolded. We've also exceeded any upside target on the S&P which I placed at 1360-1400. I was quite dubious we'd actually even make new highs post May but we have.
Last year I amended my estimated timing for a top to be near the end of the first quarter of 2007. Maybe that will happen and maybe it won't. What one is attempting to do by predicting cycle tops is basically predicting the future. If I could do that, I would be lying on a beach on the South Pacific with every winning lottery ticket. Before the bulls gloat they should think about one fact. If all is well, why have stock market returns in the U.S. been awful comparatively? It has nothing to do with the U.S. headed for the dung heap or the Red Army taking over the world. It is because U.S. assets are still overpriced coupled with many macro issues at hand. Of all bull market advances of any significance since 1900, this qualifies as one of the weakest as measured as a function of time. (Extra points for anyone who can derive a time function of historical bull market returns. It's too damn time consuming to consider, but I'd love to see it if anyone else has done so.) So, while we have had a long bull market, it has been incredibly weak sans commodities. One could take that fact optimistically and say we have alot
further to advance but the probabilities of that statement are not in your favor. In fact, they aren't even close to being in your favor. More upside? Maybe. But a big picture explanation which is more plausible is that after five years, we have only be able to make minimal upside movement and that should be an extremely ominous warning sign. After the impulse rally in 2003, the major average returns are awful. Many believe the bears have been gored by the bulls and most reasonable experts have reduced their call for any correction to 10%. I believe a bloody and lengthy decline is still in the cards. Remember, the market is the great deceiver. It is extremely cunning and failure to respect it almost always
leads to financial ruin.
Along the same line of thought, it is interesting that a recent BusinessWeek
has a short blurb about financial industry insiders selling options and stock at a frenetic pace. This isn't a minor slice of the finance industry but a study of over 1,000 companies as I recall. Remember my post last year where I said the finance industry was peaking? And, how I am personally steering clear of finance companies as an investment? Now, that has not come to pass but it's ironic how that statement is now being backed up by what appears to be extremely bearish behavior by finance industry executives. While stock buy backs aren't a sign of future returns in many situations, mass selling across an entire industry taken in context of the current cycle should not be interpreted as "general diversification" of their portfolios as the press constantly blathers. More baloney. Remember my post in the summer of last year where I noted insiders were selling at a frenetic pace in the oil industry? That coupled with my quantitative analysis meant much lower energy prices regardless of what the "experts" were saying
. Any Peak Oilers
ever expect to see $50 oil again? Before I kick the bucket, we will see $15 oil again.
I find it interesting that the finance industry is likely topping right about the time when some delirious Wall Street types have actually said manufacturing doesn't matter anymore. More baloney. So much baloney, they've likely pegged that statement at the peak of their industry and a trough in industrialization. When I say trough, I mean some time in the not too distant years, not literally today. Some in the financial press and on Wall Street have even gone so far as saying we should move our remaining manufacturing to China. Good God, Wall Street never ceases to amaze me with their brilliance. And what qualifications do they have to say we should move all manufacturing overseas? Do you know what that statement says? Manufacturing is not a differentiator
. Manufacturing technology is not a competitive advantage. Manufacturing adds no innovation or competitive advantage to a business. Manufacturing is only about how little you can pay someone to build something. The Wall Street economy of pushing around paper is the future of human industriousness. That is so goddamn stupid I can't believe I am even writing about it. I might also add in that same vein the U.S. is still the dominant manufacturing powerhouse globally. Manufacturing output in the U.S. is at record levels and while employment is down in manufacturing, it's down in every country. I even read where it is down in China. That's called productivity and should be expected. Some day we might not have anyone working in certain manufacturing sectors. But, that doesn't mean manufacturing won't be a powerhouse industry or those sectors won't still be manufacturing yet doing so with entirely automated factory floors. In fact, that will be the day when shipping jobs overseas for even the most mundane manufacturing tasks has zero ROI and manufacturing will be done locally to support end markets. In other words, all mundane, highly human capital intensive manufacturing that has gone overseas will come back to the U.S. I mean really. What the hell does Wall Street know about making anything? If you want to talk about making something, talk to Toyota, P&G, Boeing, Intel, BASF
, Siemens, DuPont, Hitachi or Caterpillar. Wall Street pushes around paper for a living. How does what they do add to the industriousness or advancement of humanity? How does that make them an expert in manufacturing or most anything else? (Now, I must preface this by saying I am not lumping everyone in the finance industry into this statement. I'm talking about the propaganda
machine we call Wall Street.)
I spent two hours this weekend running through some calculations and I keep coming up with 2,732 days from the 2000 peak as a new time series for an new end to this bull market. That is September of 2007 if I calculated correctly. Of course, it is done using a Ouija Board and any real decline of declines could start pronto. But, I doubt it. Any declines we see now will likely be followed by subsequent rallies. The fly in the ointment is the Chinese and Russian equity markets. They are screaming absolute tops are near. I suppose money could continue to flow into American and European investments through September thus propping up asset prices. If that happens and developing markets don't follow suite, we will likely see a strengthening dollar along with it. How far American and European markets can rise is debatable. Small caps in particular are extremely overvalued. People think they will have time to react to any decline and they may. But, in 1998 small caps fell nearly 40% and it happened very quickly. Not days but people usually react to their investments by waiting. They see stocks going back up in prior dips over a cycle and expect it to happen again. So, by the time the pain is severe enough, they are usually selling near the bottom. That said, one needs to remind themselves that markets can go higher and lower than makes rational sense. In that same theme, it's interesting to me that Wall Street is so enthusiastic with the 2006 rally. The S&P is a few percentage points above the May 2006 high and most every other index is right at the May 2006 highs. Yet, this recent rally has people enthusiastic. About what? A zero percent return and extreme risk since May? More baloney. Risk adjusted returns in the U.S. equity markets are pathetic. The market is playing tricks with their minds. Fear of being left behind is deceiving them.
I hate to sound so, well, bearish, but I see nothing to convince
me that we are able to escape an asset repricing. As a little bit of sanity checking, I arbitrarily went back to look at equity prices in the 1950s. A time of great prosperity and innovation for Americans with minimal global competition which should be reflected in equity valuations. Today we hear about how cheap the markets are. More baloney. Most industries had a PE of less than 10 during the 1950s. Transports had a PE of about 4 for years. Transports have been run off of a cliff this cycle. Let's just say the PE isn't 4. Yeah, yeah. Chinese imports, high energy prices driving transports, blah, blah, blah. Industries with the highest PEs
appear to be tobacco and oil from what I looked at. The reason? Investors were willing to discount future earnings as relatively guaranteed. Isn't that almost funny? Today, we buy Google at a price to book of 11 and a price to sales of 16 and a PE of 70 with no dividend. You or someone like you is willing to pay for 70 years worth of earnings and get paid nothing other than stock appreciation to own a glorified search engine. A technology that has been around as long as half of the readers of this blog. I don't care if people are willing to drive Google to 1,000. That just means people are insanely foolish or momentum traders are on a pump and dump mission where the retail investor would be left holding the bag.
With that, happy trails!