Earlier this week, we showed the just-released cover of the latest issue of The Economist.
The message is unequivocal:
“Did the bell just ring, or is this the ultimate contrarian indicator?,” we asked sarcastically, on the way to showing you a veritable collage of charts.
Our point was clear. If there are two options for describing that cover, one being “mainstream publication gets it wrong (again) and we’re nowhere near bubble territory,” and the second being “it’s so obvious even The Economist gets it,” we’d err on the side of the latter.
What’s going on here is so crystal clear that the only people who don’t seem to get it are eternal optimists, technical analysts, and of course, retail investors who are having a hard time coming to terms with the idea that their returns since 2009 are not the product of investing acumen, but rather simply the result of trillions in liquidity injections by central banks and the proliferation of passive vehicles that both allow retail investors to ride the CB wave and, worryingly, contribute to making that very same wave bigger. On that latter point, you should read “The Wave Paradox,” from which the following excerpts are taken:
Right, so I’ve got a theory I like to call the “wave paradox.”
Maybe it’s nonsense, maybe it’s got some merit, but whatever the case, it’s starting to seem like a lot of ostensibly “smart” folks are expressing the same idea only using less colorful language than I typically employ.
The concept is simple: market participants of all stripes are no longer able to discern whether they are capitalizing off the prevailing dynamic or creating the dynamic that they’re capitalizing on.
This can be posed as a question: “Am I making good decisions or are the decisions I’m making only turning out good by virtue of my having made them?”
[…]
“The combination of global credit growth and QE has created such a sustained bull market in many asset classes that investors are inevitably concluding that their best trade is simply to close their eyes and go long the market in the cheapest way possible,” the above-mentioned Matt King goes on to write, in the same note mentioned above. “ETFs in principle offer a panoply of potentially uncorrelated factors, but in practice trading volumes have been overwhelmingly concentrated on the major indices.”
I wrote more on this a couple of days ago in “How We Got Here,” a post in which I noted that legions of retail investors have come to believe they suddenly became geniuses in early 2009.
Everyone who felt utterly betrayed just six months prior (everyone whose pretensions to “understanding” markets vanished with Lehman and with their 401ks) not only regained their confidence, but in fact, by some divine intervention, was bestowed with investing acumen the likes of which no active manager on the planet could match.
Of course that’s not true.
But the longer we persist in accommodation, the more retail investors forget to what they owe their good fortune — the more everyone rewrites history in their own minds in order to pretend as though these charts are a coincidence:
The communication loop between central banks and markets perpetuates this. You are part of the reaction function.
There are any number of problems implicit in that arrangement, not the least of which is that it transforms policy into a referendum. There are no clearly identifiable anchors. The goal posts aren’t fixed. Or, as Deutsche Bank’s Kocic puts it, there’s an absence of “rigid reference point[s], like a well specified reaction function, objectives, and triggers.”
So this is just a kind of rolling plebiscite. Clearly, that creates substantial risks in terms of encouraging mass myopia. Thanks to near-daily speeches and media appearances by Fed officials, this is quite literally a real-time information exchange between markets and policymakers. No one can see outside of this information exchange and if you’re a trader, there’s really no utility in trying.
In this way, transparency introduces risk in a paradoxical way. As Kocic writes, “transparency as a way of stabilizing the markets has become a tool of suboptimal control, one that reinforces the future risk in order to diffuse it – it is a tactics of delaying, rather than reducing risk.”
And so here we sit, with what The Economist calls “the bull market in everything.” For their part, FT thinks the current state of affairs may be justified by this:
That shows a synchronized upturn in global manufacturing and it’s part and parcel of the whole “coordinated” global recovery narrative/meme. But as our buddy Kevin Muir recently noted, that’s paradoxically not bullish for one very simple reason:
Contrary to popular belief, this is not good for stocks. CB’s are going to put away their blue tickets and leave stocks up here on their own.
— The Long View (@HayekAndKeynes) October 3, 2017
FT acknowledges this in their piece.
So with that as the setup, we present excerpts from the FT post followed by excerpts from the article in The Economist that accompanies the cover shown here at the outset and which has been making the rounds since it was released.
Excerpted from a longer post in FT
Among the duties of a journalist, scepticism ranks behind only honesty, and not by much. Financial journalists, especially, must be gimlet-eyed, given the technology, money and manpower commanded by the forces of disinformation. The incentives are tilted towards scepticism, too: few members of the commentariat have ever won a prize for applauding capitalism. Being the first to point out that something has gone badly wrong, on the other hand, can make a career.
It is only with trembling fingers, then, that this column declares: the stock market is roaring, and that makes perfect sense.
The US market is up 20 per cent since Donald Trump was elected, and world markets have performed slightly better. Other risk assets, such as high-yield and emerging market bonds, are giddy too. The rise is supported, first, by synchronised global growth. Manufacturing surveys in the US, Europe, Japan, and South Korea are strong. Company performance has been impressive in the US in particular. Earnings growth in the first and second quarters was in the double-digits (though the numbers were flattered somewhat by energy companies reaping higher oil prices). A higher proportion of companies than usual are beating analysts’ earnings expectations, and are beating them by an unusually high margin.
All this good news contains the seeds of its own extinction, of course, in the form of higher interest rates. Central bankers are restive, and if unfunded hurricane relief and tax cut packages are passed in the US, they could become positively twitchy. For now, however, this threat remains firmly in the future. With the possible exception of the UK, inflation remains sedate across developed economies. The one stain on this otherwise pristine tapestry is valuations. Risk assets are very expensive by historical standards.
Excerpted from a longer piece in The Economist
IN HIS classic, “The Intelligent Investor”, first published in 1949, Benjamin Graham, a Wall Street sage, distilled what he called his secret of sound investment into three words: “margin of safety”. The price paid for a stock or a bond should allow for human error, bad luck or, indeed, many things going wrong at once. In a troubled world of trade tiffs and nuclear braggadocio, such advice should be especially worth heeding. Yet rarely have so many asset classes–from stocks to bonds to property to bitcoins–exhibited such a sense of invulnerability.
Dear assets are hardly the product of euphoria. No one would mistake the bloodless run-up in global stock markets, credit and property over the past eight years for a reprise of the “roaring 20s”, or even an echo of the dotcom mania of the late 1990s. Yet only at the peak of those two bubbles has America’s S&P 500 been higher as a multiple of earnings measured over a ten-year cycle. Rarely have creditors demanded so little insurance against default, even on the riskiest “junk” bonds. And rarely have property prices around the world towered so high. American house prices have bounced back since the financial crisis and are above their long-term average relative to rents. Those in Britain are well above it. And in Canada and Australia, they are in the stratosphere. Add to this the craze for exotica, such as cryptocurrencies. and the world is in the throes of a bull market in everything.
Where’s the beef?
Asset-price booms are a source of cheer, but also anxiety. There are two immediate reasons to worry. First, markets have been steadily rising against a backdrop of extraordinarily loose monetary policy. Central banks have kept short-term interest rates close to zero since the financial crisis of 2007-08 and have helped depress long-term rates by purchasing $11trn-worth of government bonds through quantitative easing. Only now are they starting to unwind these policies. The Federal Reserve has raised rates twice this year and will soon start to sell its bondholdings. Other central banks will eventually follow. If today’s asset prices have been propped up by central-bank largesse, its end could prompt a big correction. Second, signs are appearing that fund managers, desperate for higher yields, are becoming increasingly incautious. Consider, for instance, investors’ recent willingness to buy Eurobonds issued by Iraq, Ukraine and Egypt at yields of around 7%.
[…]
In the end, however, there may be no escape for investors from the low future returns and even losses that high asset prices imply. They and regulators should take a leaf out of “The intelligent Investor”, and make sure that they have a margin of safety.
If memory serves, it was The Economist that featured a cover pic of a bulked up George Washington over the caption “King Dollar” for its January or February issue this year.
It was December last year… perfect timing.