is our 81st report on the consequences of the stock market mania
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The articles below are
reprinted from previous issues of Crosscurrents
and are chosen for their timeliness
Why The Stock Market Should
Crash In 2015
REPRINTED FROM THE DECEMBER
29th ISSUE OF CROSSCURRENTS
- CHARTS UPDATED THROUGH MARCH
9, 2015 -
Perhaps the most salient point we can make about
U.S. equity prices is the extent of leverage that has been required to
support current valuations. Clearly, leverage in the form of margin
debt was the cause of the collapse in 1929, as even a ten-percent correction
was sufficient to completely wipe out the most leveraged investors.
Once the rush for the exits commenced, there was no stopping it.
The experience was so daunting that it altered the mind set of investors
for decades to come. The suppression of memory lasted until stocks
once again went a bit bonkers in 1987 and margin debt briefly extended
as high as 2% of total stock market capitalization, double the average
of the previous three decades. However, a super bull secular cycle
for stocks had commenced only five years earlier and was still in place,
thus the crash had a limited impact despite the violent moves of October.
In fact, the last line of your Editor’s December 3, 1987 commentary read,
“Only one course of action is dictated. Buy stocks.” The next
three days were huge moves up and the bull was once again in fine form.
And once again, the mind set of investors was altered,
but this time, any fears of vulnerability were replaced by the confidence
of invulnerability as the Federal Reserve stepped in and promised to take
whatever measures were necessary to preserve the markets. In fact,
the Greenspan Put was born. In this manner, excessive leverage became
acceptable and by March 2000, in the midst of a veritable mania for technology
stocks (the first circled highlight on our featured chart), margin debt
once again extended to extraordinary levels. Over the next 30 months,
as stock prices were halved, margin debt fell by 54.6%. But the cycle
of madness easily repeated only seven years later and after margin debt
soared to new records, stocks collapsed by half while margin debt fell
52.1% in only 19 months. And of course, the Fed then stepped in again
and since that time, we have been graced by no less than four rounds of
accommodative policies expressly designed to drive asset prices as high
as they need to be for full employment and the end of poverty.
But a strange thing has happened on the way to
this contrived nirvana. The upper class has wound up with a far larger
share of wealth, the middle class has fallen on much harder times and poor
Americans are much worse off; incomes and assets have dwindled and the
number of Americans requiring food stamps hit new records for many months.
As for full employment, the labor participation rate is still near 35 years
At the same time, risk as defined
by the “DANGER SIGNAL” on our featured chart,
has been at its highest level
since 1929 for the last three years.
Something is dreadfully at odds with how economic
prospects are now measured by the various pronouncements we hear from government
and the way they would traditionally be implied by the very same statistics
in the past. There seems to be no such thing as bad news and whatever
we hear takes on a positive spin by the application of propaganda.
Andrew Huszar has recently apologized (see http://bit.ly/13Vuzxo)
for his 2009-2010 management of QE, noting that it has done next to nothing
for the man in the street while being “the greatest backdoor Wall Street
bailout of all time.” Stanley Druckenmiller, one of the great hedge
fund investors of all time said “This is fantastic for every rich person.
This is the biggest redistribution of wealth from the middle class and
the poor to the rich ever.”
Worst of all, our government is now so complicit
in the scheme that there appears to be little hope for whatever remains
of the middle class. On December 11th, the House passed a bill repealing
the Dodd-Frank requirement that risky derivatives be pushed into the larger
banks subsidiaries, heeding the repeated suggestions of JPM’s CEO Jamie
Dimon who has railed constantly about anything that might be the slightest
bit harmful to big banks (see http://bit.ly/1zpzXFU).
The upshot is that most of us will be on the hook for inevitable cataclysmic
derivative losses down the road. The truth of the circumstance is
that the blackest and bloodiest of all Black Swans is lurking out there.
Heaven forfend that swan swims in the direction of America’s favored classes.
Our law makers will continue to play loose with our future because it suits
those who contribute the most to their election coffers and it suits everyone
in the upper class, which includes most of those who make the laws in our
country. The median net worth of U.S. Congresspersons is now over
We can only repeat what we have said on so many
occasions, that stock market risk and indeed, systemic risk of the entire
financial system is at levels that preclude one iota of sanity. We
are off the rails, totally bonkers and totally ignorant of what our future
inevitability holds. Above, we present an updated look at a
signal so patently clear that we termed it way back in the March issue
as our “The Chart of the Year.” Below, the same circumstance from
another perspective. Any way you slice it, we are now in the midst
of a third fantastic phase of mind blowing exposure to risk. Ironically,
despite the enormous gains of the last five-and-a-half years, traditional
mutual funds cannot compete. Active management requires individual
stock selection utilizing tried and true methodologies for valuations,
but as we have shown before many times, with time horizons compressed as
they are today, there is no need to value stocks because they are probably
only going to be held for weeks, perhaps only days, perhaps only hours
or even minutes. Playing momentum, rather than value, has resulted
in a self fulfilling strategy. Prices go up, reinforcing momentum
players to buy more and the cycle simply repeats and repeats.
Active managers cannot compete if they keep cash
on the sidelines as they traditionally have done, thus cash reserves have
been minimized for the last five years. Until this new regime dictated
by momentum and the abandonment of valuation commenced, cash reserves averaged
8.3% over time, from a minimum of roughly 4% when stocks were hot to as
high as 12% when stocks were anathema. Since 2000 and the permanence
of manic behavior, cash reserves have averaged only 4.3%. And in
the last 26 months, cash reserves have never exceeded 3.9%. The Shiller
P/E, also known as CAPE (cyclically adjusted ten-year P/E) is at 27.35,
topped only in 1929 and 2000, coincident with two of the greatest downside
reversals in stock market history. Coupled with margin debt at levels
greater than anytime in history except 1929, the coincidence is too striking
We are at the exact same circumstances
at the major market peaks
of 1929, 2000 and 2007.
Groupthink has provided a consensus
that excessive risks are acceptable,
despite a century of history
that shows the opposite is true.
We crashed in 1929, 2000 and
Clearly, the same catalysts
for a crash are in place today.
The Decennial Cycle
ALSO REPRINTED FROM THE DECEMBER
29th ISSUE OF CROSSCURRENTS
The fifth year of the so-called Decennial Cycle
has been so impressive that analysts flock to it like mana falling from
the sky. We were once in the same camp, so impressed that we maintained
a bullish stance in 1995 partly due to what we saw as fantastic consistency.
However, in reality, all we saw was coincidence. Given the fifth
year of a decennial cycle does not coincide with the presidential or any
other relevant cycle, why should it have any impact at all? Thus,
contrary to the consensus analyses that we saw for the year ahead in 2005,
we relied on all the other evidence, called for a significant decline during
the year but allowed “….we believe the calendar year should finish slightly
higher.” We were wrong by one day as the Dow Industrials closed higher
on the next to last day of trading but closed a few points lower on the
final day of trading of 2005.
Looking at the year ahead in 2015, we see nothing
constructive on the horizon. Amazingly, we have already seen several
bullish comments from analysts relying on this faux cycle for stocks in
2015. Faux cycle? Yes, faux cycle. History has shown
that stocks are up on average roughly seven of every ten years, thus a
string of a dozen consecutive plus years for any timeframe we might measure,
such as the fifth year of the Decennial cycle, is not all that unusual.
In fact, from 1985 to 1999, the Dow finished higher every year but one.
The previous fantastic performance
of years ending in 5 appears
to be due to nothing but coincidence.
At some point in 2015, we expect
prices to be at least 20% lower.
ALSO REPRINTED FROM THE DECEMBER
29th ISSUE OF CROSSCURRENTS
Godzilla grew to monstrous size and gobbled up
everything in its way, trampling on automobiles and destroying buildings
in its path. If you will allow a bit of artistic license, the Stockzilla
that ruled the world at the momentous peaks of 2000 and 2007 had a similar
effect. The beast toppled the economy into recession on both occasions
and nearly caused a complete financial collapse in the latter instance.
The peaks came seven years and seven months apart and we suppose it is
conceivable we might again stretch to the same time extent before we see
Stockzilla unleashes the final act of his destruction. Although that
would equate to the possibility of higher prices until as late as Thursday,
May 7, 2015, the only circumstance we see that even remotely suggests the
top might still be 92 trading sessions away is the consensus.
As of Christmas day, total dollar trading volume
(DTV) was running at a rate of $66.6 trillion, 2.5% higher than the previous
record in 2010. For every dollar the country generated in gross domestic
product, $3.85 were traded in stocks. If you thought the tech mania
in 2000 required the last iota of frenzy, then consider that DTV is more
than double the rate of trading in the glory days of that tech madness.
Frankly, we are continually astonished that renewed pictures of the mania
are routinely ignored like it is all in the normal course of events.
It’s not just strange.
It’s not just bizarre.
This is utter insanity and
eventually can only unravel as it has before.
Above, we see just how phenomenally trading has
inflated. When we first went over the data, it was so far removed
from normal that our first notion was we must adjust for inflation.
Unfortunately, that really didn’t change much as the picture was still
uncomfortably….shall we say monstrous? Although the perspective at
lower right is identical, we felt it best to show both to accentuate just
how far Stockzilla has traveled to rule the markets today.
The great secular bull market for stocks erupted in 1982. At the
previous peak for DTV in 2010, stock trading per capita was as high as
$228,415. As of today, stock trading per capita is still $208,850.
The statistics are astonishing. Adjusting for inflation back to 1950
clearly illustrates how Stockzilla now dominates the landscape. The
great secular bull market commenced in 1982 and until 1999, just before
the tech mania bubble popped, trading averaged a mere one-eighth of today’s
level. In that same period, trading averaged 84% of median income.
Today, it averages 387% of median income and was as high as 464% of median
We are in the midst of the
third veritable mania in the last 14 years.
How will it end? The
same way the last two ended.
Stockzilla is here and is doing
what he knows best.
Truly In The Land Of Oz
REPRINTED FROM THE JANUARY
30th ISSUE OF CROSSCURRENTS
The most distressing aspect of the so-called bull
market for stocks is that earnings are not being used to improve the companies
but are instead being put to use for the worst of reasons. A few
months ago, Bloomberg reported that 95% of the earnings for companies in
the venerable S&P 500 index were devoted to stock buybacks and dividends,
not investments in the future (see http://bloom.bg/1xVD8V1).
This is not just a one-off event. The article
also shows the proportion of cash flow used for stock buybacks has nearly
doubled over the last decade, obviously at a cost to capital improvements.
It is any wonder that the labor force participation rate is the lowest
it’s been since 1978? In this era of central bank largesse, there
is no basis nor justification for companies to spend money on their future.
The Factset Buyback Quarterly provides several additional points to consider
Nearly 75% of the S&P 500 constituents participated in buybacks during
the third quarter, so we know this is the rule, not an exception.
The total spent on share repurchases over the trailing 12 months was $567.2
billion, a year-over-year increase of 27%. Now we know how stocks
can rise despite suffering outflows from domestic mutual funds for years.
Dating back to 2007, outflows from domestic equity mutual funds total $633
billion. Apparently, the principal drivers of the bull market in
stocks are the S&P 500 companies themselves! If this is not the
ultimate in irony, we can’t imagine what is. Then again, given an
environment in which executives prosper from option grants, there is every
incentive to raise the price of their shares by any means.
Thus, for the corporation, it matters not if the
shares are theoretically overvalued or not. Spending cash from the
corporate treasury on capital improvements entails risk. Demand is
a powerful tool. By spending cash on the company’s stock, higher
share prices are guaranteed. Shareholders are certainly not going
to complain. And those executives at the top with generous option
grants and directors will not complain. And best of all, buying back
shares ensures profitability improves. What an imbecilic development
Corporate wizards can now produce
a bull market and manufacture money at will.
We are now truly in the land
The Bubble Diverges
REPRINTED FROM THE JANUARY
30th ISSUE OF CROSSCURRENTS
Demand via 10-week inflows for domestic mutual
funds has obviously not been responsible for the bull market. Our
line is below zero far more often than above. Curiously, the previous
highs in 10-week demand from inflows into domestic mutual funds have all
tended to fall around the end of each year. However, as of now, the
10-week average displays a huge negative divergence from the prior peaks.
We believe this is a very significant development; a growing recognition
of an excessively overvalued market.
Again, we point to a commentary from John Hussman
As we illustrate below, total stock market capitalization versus GDP is
well over double the historical average of 62.4% and nearly triple what
the average was for 70 years from 1926-1995 (see lower line). Since
that point, much higher valuations have been tolerated (see upper line)
but not for long as the two tremendous bear markets of 2000-2002 and 2008-2009
A return to the norm since
1996 equates to prices 16% lower than today.
A return to the historical
norm equates to a 55.2% collapse.
price forecasts are available only to subscribers. If interested,
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