is our 85th report on the consequences of the stock market mania
we first published this website on January 15, 1999.
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The articles below are
reprinted from previous issues of Crosscurrents
and are chosen for their timeliness
REPRINTED FROM THE APRIL 30th
ISSUE OF CROSSCURRENTS
When the World Trade Center was brought down in
September 2001 with the loss of 2977 innocent lives, we were convinced
the world had changed. We claimed the birth of a super bull market
for gold, whereby the growing possibility of terror attacks on the world’s
citizenry and perhaps eventually the financial markets, would likely require
a resurgence of the safest and most immutable currency ever known to mankind.
While we have not seen a new high for gold since August 2011, gold is still
up 364% since 911 compared to only 85% for the Dow Industrials.
The dark legacy of terror we feared has thus far
been confined to the incidence of terror attacks on the world’s citizenry,
still accelerating at an alarming pace. Our first chart below illustrates
a dramatic escalation in just the last two years. There were 117
separate incidents of terror in 2015 and 30 in just the first four months
of 2016. At the current pace, there will be 90 attacks for the full
year. In a word, harrowing. There were only three attacks in
April. The first on April 20th targeted a security team responsible
for protecting government VIPs in Kabul, Afghanistan. The attack killed
64 people and wounded 347 and was the Taliban's biggest attack on an urban
area since 2001. Three days later, attackers hacked a university
professor to death in the city of Rajshahi, Bangladesh. ISIS claimed responsibility
for the attack stating he was assassinated "for calling to atheism."
Two days later, two gay rights activists were hacked to death in the capital
of Bangladesh, Dhaka. An Al-Qaeda affiliated group claimed responsibility
for the attack and stated the two were killed for “practicing and promoting
homosexuality in Bangladesh.” Shockingly, by recent standards, April
was a quiet month.
A recent Pew poll showing “much disdain” for ISIS
from nations with significant Muslim populations seems encouraging at first
glance but when one looks just a bit more deeply, the perspective completely
changes. Below, this is perhaps the scariest chart on this page;
despite the large percentage of unfavorable opinions of ISIS, we are quite
concerned with the percentage of those with favorable opinions.
While the chart indicates very few citizens in Lebanon, Jordan or Israel
may have a favorable opinion of ISIS, wouldn’t any number be too many?
In Senegal, there are as many
as 1.5 million who favor ISIS.
In Malaysia, another 3.2 million.
In Pakistan, only 28% of Pakistanis
see ISIS as “unfavorable.”
The survey claims 62% of the
a total of 112.9 million Pakistani
have a favorable opinion of ISIS!
Now consider that Pakistan
is thought to have
a nuclear arsenal of between
The Pew poll illustrates between
63 million and 287 million
ISIS supporters in just 11 countries.
We believe the threats of future
have not even been remotely
discounted by the financial markets,
a solid reason for our great
Frankly, the pictures are terrifying. The
primary reason attacks have increased so substantially is that they have
been effective in recruiting more terrorists. The objective seems
simply to murder as many citizens as possible. In fact, the loss
of life has been horrific. Immediately above, although the biggest
bar includes the 911 terror event, a closer examination clearly implies
the specter of a rising trend in the number of victims killed.
Even more depressing, terrorism
is clearly not confined
to only the Islamist extremist
terror attacks shown in these charts.
There are more than 300
terrorist groups designated by
national governments and inter-governmental
The list shown at http://bit.ly/1Kret0Y
excludes groups that might be widely considered terrorist, but who are
not officially designated as such. However, all one needs is to peruse
this list to comprehend this rapidly growing phenomenon and how it may
impact all of us in the years ahead, quite possibly reaching the world’s
financial markets. Several years ago, in our traditional year end
look at the year ahead, we assigned odds to terror attacks as a possibility
for driving stock prices. While there is no science that can determine
fair odds vis-à-vis terror attacks, stock prices were clearly impacted
Prices will be impacted significantly
if the financial markets are
ever the target of terror.
REPRINTED FROM THE MAY 30th
ISSUE OF CROSSCURRENTS
We have been tightly focused on margin debt for
quite awhile and given how our analysis aptly caught the massive dangers
stocks were exposed to at both the March 2000 tech mania top and the October
2007 major peak, we see no reason to shift our focus. We are students
of history and in 1968, out of sheer curiosity, we took on the task of
researching certain aspects of the madness of the Roaring Twenties.
This left an indelible impression. There will never be another period
like the years 1926-1929. At the top, New York stock exchange margin
debt equated to 11% of total market capitalization. Since then, the
highest margin debt has been relative to total market cap was last year
at 2.15%. Compared to 1929, it may not sound like much, but it’s
fully double the average from 1935-1999.
Our current analysis typically measures total margin
debt versus GDP, which we believe gives us an even better picture of the
dynamics at work. Obviously, the larger margin debt is versus GDP,
the more speculation is concentrated in stocks. During the tech mania
of 1999-2000 and the housing and stock manias of 2007, margin debt approached
but never quite made it to 3% of GDP. However, in April of 2015,
margin debt actually got to the 3% level relative to GDP, the worst measurement
since the madness of 1929 and solid evidence of the third mania for stocks
within the last 15 years.
We repeat, there will never be another period like
the years 1926-1929 but there likely will also never be another 15-year
stretch that witnesses three separate stock manias. The situation
for risk is as dire as we have seen in over five decades of observation.
It’s not only the massive exposures, it’s valuations, which have remained
at extremely elevated levels since roughly 1998, when the tech mania really
began to take off, with only a brief time out into the 2009 lows.
You can find a chart of Shiller’s cyclically adjusted p/e (“CAPE”) going
back to 1880 at bit.ly/1pOuH9F.
The chart below lays out the best case for a substantial
price decline. Since the major indexes peaked a full year ago in
May 2015, we believe a bear market is already in progress. While
our indicator has moved off the low of $272.7 billion established in June
2015, the current measurement of $200 billion is nonetheless enormous and
has only been exceeded 19 times. All of the higher measurements have
come in the period since December 2013. The last month in which liquidity
was positive was May 2002. Given our chart data has a limited history,
one might be excused for believing negative liquidity episodes such as
those pictured were the rule rather than the exception. One would
be wrong. The three instances of extreme negative liquidity shown
here are the only instances we have found dating back over five decades.
The chart below contains some of the same basic
information as our first chart but presents a different perspective, perhaps
even more emphatic. What the picture tells us is simply this; when
the mutual fund cash-to-assets ratio plunges and margin debt rises, the
odds greatly favor a significant price reversal in the form of a bear market.
The first two occurrences resulted in bears that cut prices in half.
Although we are not looking for a similar downside move at this time, we
also cannot entirely rule it out. The obvious problem is that the
gap between the cash ratio and margin debt is so much greater than it has
ever been. Also of concern is the fact that the cash-to-assets ratio
has been so low for so long. Clearly, we understand that the rapid
growth of exchange traded funds (“ETFs”) has made a difference. ETFs
carry very little cash, near zero in most cases. In rising markets,
the only way equity mutual funds can compete is to keep their cash ratio
as low as possible in order to have more invested. However, this
has been an awful strategy. The downside has been far greater exposure
to risk and the results have been two horrific bear markets and another
now likely in progress. Ironically, the perception that mutual funds
could only compete with extremely low cash levels to perform well enough
and secure new investment was quite flawed. Despite the popularity
and rapid growth of ETFs, they remain a minor player in the overall scheme,
capturing just 14% of all monies invested in both equity ETFs and equity
mutual funds. By following the 86% portion of the pie invested in
equity mutual funds, we can obtain a much clearer picture of the potential
for reward and the risk for the downside.
Below, you can see just how awful the fund manager
strategy of keeping cash ratios low has worked. Not only do you see
the tremendous drawdowns of capital in the two previous bear markets but
also obvious is even after the passage of 16 years, the last six of which
have been a bull market, stocks as measured by the broad based S&P
500, are only nominally higher when adjusted for inflation. The top
tick monthly close of February 2015 was a mere 2.1% higher than the actual
monthly close of July 2000. Again, adjusted for inflation, the index
is currently 1.5% lower than it was 16 years ago. Could there be
a worse condemnation of fund manager strategy of retaining as little cash
as possible? Worse yet, as the red bars clearly illustrate, risks
in the form of margin debt have risen at a much faster pace, even when
we adjust for inflation. At the peak last summer, margin debt was
32.5% higher than the 2000 peak and remains 16% higher at this time.
Below, we devised this indicator several years
ago. After tinkering with our spreadsheets for many weeks, it appeared
that a 12-month differential in total margin debt was a pretty good predictor
of bad times ahead. Of course, the point can be made that the differential
is coincidental, rather than predictive, but no matter, we’ll take it.
At the very least, whether predictive or coincidental, it is a valuable
perspective. The first drop into negative territory came in December
2000 with the S&P 500 at 1328. The next monthly close was 2.9%
higher but that’s all she wrote. From that point, stocks began a
horrendous decline and didn’t bottom out until February 2003, 38.5%
lower. The second trip to negative occurred in April 2008 with the
S&P 500 trading at 1386. Again, the next monthly close was up,
this time a mere 1%, followed by a humongous 47.5% collapse in only nine
months, arguably the second worst crash in stock market history.
The third dip into negative was October 2011 and it proved uneventful,
however it came near the tail end of a 9.6% correction from an April 2011
peak. In this case, margin debt had peaked and was falling along
wih stock prices.
The annual percentage
change for total margin debt actually traded at
negative 1.2% last September
and it is patently clear
that stock prices have gone
nowhere since the May 2015 top.
At minus 6.6%,
the indicator appears to be
signaling extreme danger ahead.
We should not be surprised
to see both
margin debt and stock prices
to drop like a rock from here.
The charts clearly imply a
Program Trading Still
REPRINTED FROM THE JUNE 27th
ISSUE OF CROSSCURRENTS
The rape of the market by so many modern technologies
having to do very little if anything with investing, was accentuated on
April 29th as the New York Stock Exchange said they would no longer report
statistics for program trading.
We have railed against program trading since 1987
and have commented at length in this newsletter regarding the many new
mechanical approaches to trading now used for profit at the expense of
individual investors. At the very least, it is peculiar that the
NYSE announced it has ended all reporting of program trading statistics,
when said programs has accounted for roughly 30% of all volume over the
last decade. In fact, programs accounted for almost half of NYSE
volume one week back in September 2012, .
Media coverage of HFT and all other forms of program
or mechanical trading has been conspicuously absent for years. There’s
simply no rationale for exchanges or purveyors to educate the public, since
understanding these processes can only serve to illustrate how the public
gets ripped off as programs often trade ahead and get the best bids and
There has been some speculation from time to time
that the Federal Reserve supports U.S. stock prices by stepping in to actively
buy stocks when prices go in the wrong direction. There are precedents,
as Japan’s central bank has shown by repeatedly buying stocks on the Nikkei
index for years. Two months ago, the Bank of Japan announced it may
double its ETF holdings from 3.3 trillion Yen to as much as 7 trillion
(roughly $70 billion).
Given the background of a seven-year
bull market despite
net outflows of more than
$639 billion from domestic equity mutual funds,
the possibility of the Fed’s
participation cannot be easily dismissed.
If the Fed is indeed buying,
clearly they are utilizing programs.
We are troubled that the NYSE
has concluded that
this information is now presumed
to be unimportant.
Maybe we’re just a bit too
but we firmly believe the
more information we have,
the more equipped we are to
judge the environment.
Program trading hasn’t gone
away—it still exists.
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Alan M. Newman, July 25, 2016
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prepared from data obtained from sources believed reliable, but not guaranteed
by us, and is not considered to be all inclusive. Any stocks, sectors
or indexes mentioned on this page are not to be construed as buy, sell,
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