Third Mania in Two Decades

This is a great observation by Hussman:

An annual volatility of 9% implies a daily volatilty of about 0.6%, which is like saying that a 2% market decline should occur in fewer than 1 in 2000 trading sessions, when in fact they’ve historically occurred more often than 1 in 50. The spectacle of investors eagerly shorting a volatility index (VIX) of 9, in expectation that it would go lower, wasn’t just a sideshow in some esoteric security. It was the sign of a market that had come to believe that stock prices could do nothing but advance in an upward parabolic trend, with virtually no risk of loss.

So the probability estimate of a minor decline had become off by a factor of 40; 1.6 orders of magnitude. Very far off, in other words. I think it is fair to be calling this a third mania in two decades. (From 1998-2008 you have 98-99, 06-07, and now.)

I also think there is something in particular about the younger boomer generation - that was raised by television - that is highly susceptible to buying into these momentum-driven bubbles. Our friend in New York has been flying off the handle because of these minor declines since late January.

Hussman on the Government Debt Bubble

This week's essay:

Sure, you can devalue those claims through inflation, but only if the debt is in the form of long-maturity bonds (which is why the recent discussion of issuing 50-100 year Treasury bonds seems understandable but also a bit nefarious). At shorter maturities, inflation just raises the interest rate that the government has to pay when the shorter-term debt is rolled over. Though the weighted-average maturity of Treasury debt is currently longer than normal, the average is still only 5.8 years, and half of the debt will have to be rolled over by 2019, at whatever interest rates emerge in the interim. Ultimately, debt implies a future transfer of purchasing power, and provides only a few choices. Either you raise adequate tax revenue, or you denominate the debt in long-term bonds and devalue them through inflation, or you default, or you violate the social contract made with those who don't hold paper claims (e.g. Social Security beneficiaries) in preference for those who do.

Had the borrowing resulted in productive investment, future output would be easily available to meet those claims. Instead, what’s going on is a quiet dilution of future living standards. That’s only going to be reversed by thoughtful policies, focused more on long-term productivity than near-term gains. Even massive debt-financed spending will not help unless the projects are intentionally designed to durably enhance the long-term productivity of the U.S. economy, to avoid duplicative capacity, and to relieve constraints that threaten to become binding in the future (personally, I remain convinced that renewable energy should be central to that list).

I've written that "a treasury bond is a certificate that money has successfully been expended on section 8 housing, or on make-work military 'jobs'."

Also, Hussman understands that another piece of the problem was the falling worker/retiree ratio.

More Investors Noticing Impending Bear Market

How a bull market ends - the positive feedback loop that rewards dip buying breaks down.

"In the case of 1987, the Dow Jones hit its high in late July and then for weeks and weeks investors sat there wondering where the reward was for their latest purchases. There wouldn’t be a reward. It was an electric shock instead, occurring ten weeks or so after the positive feedback loop ceased to hold up its end of the bargain"

Why quant "black box" strategies blow up as bear markets get started. (They're running short volatility trades using lots of leverage.)

"We are all doing this because we can all make a lot of money BEFORE they 'BLOW-UP'. And after they do 'BLOW-UP' nobody can take the money back from us." He then informed me why all these models actually 'BLOW-UP'. "Because despite what we all want to believe about our own intellectual unique-ness, at its core, we are all doing the same thing. And when that occurs a lot of trades get too crowded … and when we all want to liquidate [these similar trades] at the same time … that’s when it gets very ugly."

Hussman continues being "too early" in his warnings.

"While the measures of market internals that we use in practice are far more comprehensive, the evidence from leadership, breadth and participation above provides a fairly obvious signal of internal dispersion in the market. In our view, that dispersion is a strong indication that investors are shifting toward greater risk aversion. In an obscenely overvalued market with razor-thin risk premiums, a shift in the risk-preferences of investors has historically been the central feature that distinguishes a bubble from a collapse."

One of our favorite momentum investors is losing faith ("wrestling with selling all my stocks"):

"I don’t like what I’m seeing. Should I sell all my stocks and go 100% to cash? That’s the thought I wrestled with all weekend. I made a list of all the messes in the world — from slumping commodities to slowing China — and concluded the flow of money that has buoyed our stockmarkets since 2009 is evaporating and will no longer be with us. That means our markets must fall. Whether our markets will drop 23% in one day (e.g. 1987) or whether they just keep sliding I don’t know."

That brings us full circle back to the first essay: "investors sat there wondering where the reward".

Hussman On the Impending Bear Market

Latest Hussman:

"When one examines many market collapses in history, it is simply not the case that the bottom had to fall out of earnings or the economy. Yes, sometimes elevated profit margins retreated, but that’s really not what drives cyclical market gains and losses. Our own concern about elevated profit margins is not that earnings will be weak over the completion of the current cycle (though that increasingly appears likely), but that investors are using historically extreme profit margins and record earnings as if they are completely representative of decades and decades of future earnings, and are using those earnings figures as a sufficient statistic for valuation."

Hussman Reads Prechter Too

From this week's Hussman,

Don’t make the mistake of getting the relationship between monetary interventions and the risk-preferences of investors backwards. Monetary easing and other interventions can be very effective when they occur against a backdrop of risk-seeking investor preferences, but history shows that they regularly fail when they occur against a backdrop of risk-aversion among investors. The best measure of investor risk preferences is the uniformity or divergence of market internals across a broad range of risk-sensitive securities. Prechter describes the prevailing psychology of investors with the term “socioeconomic orientation,” and his observations on this, I think, are exactly correct:

“People keep asking, ‘What effect will the next central-bank plan have on the stock market’s behavior?’ This is the wrong question. The socioeconomic orientation turns the question around: ‘What effect will the next stock market move have on the central bank’s behavior?’ Just study [the chart above] and you can see that the authorities are not pushing the stock market around; the stock market is pushing the authorities around. Sadly, when markets push authorities around, authorities push people around. All it does is make things worse.”

Latest Hussman

Latest:

"Much of the investment world seems to view present conditions as a 'Goldilocks market' where economic growth is positive enough to avoid recession, but not fast enough to provoke the Federal Reserve to hike interest rates. Even if these views on economic growth and Federal Reserve policy are correct, it hardly follows that stock prices will advance. S&P 500 returns are only weakly correlated with year-over-year GDP growth and have near-zero correlation with year-over-year changes in earnings. Likewise, the stance of the Federal Reserve has much less power to distinguish investment outcomes than investors seem to believe, which they might realize even by remembering that the Fed was easing aggressively and persistently throughout the 2000-2002 and 2007-2009 market collapses."

Good Point by Hussman

New Hussman:

"The coming decade will be an underfunding disaster for corporate pension plans, endowments, and municipalities, most that still typically plan around an assumed rate of return closer to 8%. The most reliable measures we identify suggest that nominal total returns on a conventional asset mix are likely to be closer to 1% annually. Quantitative easing has already given investors, at least on paper, the gains that they would otherwise have waited years longer to achieve (again, at least on paper)."

Latest Hussman

Link

"What creates a temptation to ignore risk here is that the S&P 500 has recently advanced despite these conditions. Recognize that this has also periodically occurred in prior instances, but the average outcome is still substantially negative. In contrast, the broad market (see for example the NYSE Composite) has been in a sideways distribution pattern for nearly a year."

Hussman

"Though market momentum is typically slowing or flat, the occasional marginal new high can give the appearance of unrelenting strength even at the top"

Update: "Hussman's Ratio" of Margin Debt to Commercial and Industrial Loans

I've posted several times before [1,2,3, 4] about "Hussman's Ratio" of Margin Debt to Commercial and Industrial Loans, after he pointed out in December 2013 that,

"the amount being borrowed to buy stocks on margin is now 26% the size of all commercial and industrial loans in the entire U.S. banking sector."

Here is what the ratio looks like now:

The ratio spent much of the second half of the 20th century below five percent. It was not until the Fed induced bubble in the mid-1990s that it went parabolic, cracking 15% for the first time ever in September 1997.

Here are all the months when the ratio has been above 25 percent: February and March 2000; April through August 2007; October 2007; February through May 2011; March and April 2013; and September 2013 through December 2014. The most recent stretch, at sixteen consecutive months, is by far the longest ever. With the exception of the most recent (which remains to be seen), these were the worst possible times to buy stocks.

Keep in mind that we are deflating the margin debt series using commercial and industrial loans, which grow very swiftly themselves during credit bubbles.

By the way, here are the months where this series hit a local minimum: July 2012, February 2009, October 2002, October 1998, January 1991, September 1982, January 1975, October 1970.

The oscillations have been getting bigger over time. The 2007-2009 peak-to-trough was bigger than the 2000-2002 peak-to-trough.

I think the Federal Reserve and government's over-controlling of markets is conditioning investors to get maximum leveraged when these institutions are "supportive" and to dump everything when they are not.

Hussman On The Impending Crash

Today

"Fed easing is effective provided that risk-free cash is considered an inferior holding. Fed easing is useless if investors actually prefer to hold risk-free cash as a safe haven.

There’s certainly a feedback circle to this: the purely psychological belief that Fed liquidity is a magical risk-removing fairy dust can certainly support increased risk tolerance, but that tolerance should still be read directly out of market internals and trend uniformity. When investor preferences shift toward risk aversion, more liquidity doesn’t support stock prices. Yield-seeking speculation fails to emerge because low or zero interest rates on cash are preferred to the prospect of steeply negative returns. As the market collapses of 2000-2002 and 2007-2009 demonstrate, aggressive Fed easing does not prevent extraordinary market losses once investors have the risk-aversion bit in their teeth."

Update: "Hussman's Ratio" of Margin Debt to Commercial and Industrial Loans

I've posted several times before [1,2,3] about "Hussman's Ratio" of Margin Debt to Commercial and Industrial Loans, after he pointed out in December 2013 that,

"the amount being borrowed to buy stocks on margin is now 26% the size of all commercial and industrial loans in the entire U.S. banking sector."

Here is what the ratio looks like now:

The ratio spent much of the second half of the 20th century below five percent. It was not until the Fed induced bubble in the mid-1990s that it went parabolic, cracking 15% for the first time ever in September 1997.

Here are all the months when the ratio has been above 25 percent: February and March 2000; April through August 2007; February through May 2011; April 2013; and September 2013 through August 2014. The most recent stretch, at twelve consecutive months, is by far the longest ever. With the exception of the most recent (which remains to be seen), these were the worst possible times to buy stocks.

Keep in mind that we are deflating the margin debt series using commercial and industrial loans, which grow very swiftly themselves during credit bubbles.

By the way, here are the months where this series hit a local minimum: July 2012, February 2009, October 2002, October 1998, January 1991, September 1982, January 1975, October 1970.

Here is something that I'm noticing on my fourth look at the time series of this ratio: the oscillations are getting bigger. Granted, it's not a very big sample size, but the 2007-2009 peak-to-trough was bigger than the 2000-2002 peak-to-trough.

Hussman: "Yes, This Is An Equity Bubble"

Yes:

"[M]any investors realize that the most reliable valuation measures have never been higher except in the advance to the 2000 peak (and for some measures the 1929 and 2007 peaks), but they have started to treat these prior pre-crash peaks as objectives to be attained."

Update: "Hussman's Ratio" of Margin Debt to Commercial and Industrial Loans

I've posted twice before [1,2] about "Hussman's Ratio" of Margin Debt to Commercial and Industrial Loans, after he pointed out in December 2013 that,

"the amount being borrowed to buy stocks on margin is now 26% the size of all commercial and industrial loans in the entire U.S. banking sector."

Here is what the ratio looks like now:



The ratio spent much of the second half of the 20th century below five percent. It was not until the Fed induced bubble in the mid-1990s that it went parabolic, cracking 15% for the first time ever in September 1997.

Here are all the months when the ratio has been above 25 percent: February and March 2000; April through August 2007; February through May 2011; April 2013; and September 2013 through April 2014. The most recent stretch, at eight consecutive months, is the longest ever.

Keep in mind that we are deflating the margin debt series using commercial and industrial loans, which grow very swiftly themselves during credit bubbles.

By the way, here are the months where this series hit a local minimum: July 2012, February 2009, October 2002, October 1998, January 1991, September 1982, January 1975, October 1970.

This ratio is a good indicator. It is amazing that people are so bullish at a leveraged extreme like this. Anecdotally, the bullish macro wizards that I follow on Twitter are now very, very cocky. They have seen Hussman driven before them and heard the lamentation of his women.

Latest Hussman

It's hard to argue with this:

"Last week, Investors Intelligence reported that bullish sentiment surged above 60%, coupled with a 5-year high in the S&P 500 and valuations beyond 18 times record trailing earnings. The same combination was last seen the week of the October 2007 market peak, last seen before that in January and May 1999 (which we should emphasize was good for only a 5% correction in the short run before a choppy run to the 2000 peak, but would still leave the S&P 500 more than 40% lower three years later), last seen before that the week of the August 1987 pre-crash peak, and last seen before that in January 1973, just before the S&P 500 lost half of its value."

By definition, with market circumstances as described above, and credit spreads so narrow and investors so complacent (STLFSI), no one should be buying.

Why does this happen? Most people feel like they have to buy out of yield hunger or institutional imperative.

Latest Hussman

Yesterday's column,

Meanwhile, almost as if to put a time-stamp on the euphoria of the equity markets, IPO investors placed a $6 billion value on a video game app last week. Granted, IPO speculation is nowhere near what it was in the dot-com bubble, when one could issue an IPO worth more than the GDP of a small country even without any assets or operating history, as long as you called the company an “incubator.” Still, three-quarters of recent IPOs are companies with zero or negative earnings (the highest ratio since the 2000 bubble peak), and investors have long forgotten that neither positive earnings, rapid recent growth, or a seemingly “reasonable” price/earnings ratio are enough to properly value a long-lived security. As I warned at the 2000 and 2007 peaks, P/E multiples – taken at face value –implicitly assume that current earnings are representative of a very long-term stream of future cash flows. One can only imagine that recording artist Carl Douglas wishes he could have issued an IPO based his 1974 earnings from the song Kung Fu Fighting, or one-hit-wonder Lipps Inc. based on Q2 1980 revenues from their double-platinum release Funkytown.

Hussman: "Anatomy of a Textbook Pre-Crash Bubble"

Link

Here's some of the variables he talks about:

• Shiller P/E of 25x.
• S&P 500 P/S Ratio of 1.67x is highest since 2000.
• Median P/S (different than index average) is at a record.
• Total Market Cap/GDP highest since 2000.
• Margin debt at record high, margin debt/commercial & industrial loans highest since 2007.

Update to Hussman's Ratio

In December, I posted about Hussman's Ratio of Margin Debt to Commercial and Industrial Loans, which was then at an alarmingly high 26 percent. It has since climbed to 27.8 percent.



Here are all the months when the ratio has been above 25 percent: February and March 2000; April through August 2007; February through May 2011; September 2013 through present.

Keep in mind that this ratio deflates the margin debt time series using commercial and industrial loans, which grow swiftly themselves during credit bubbles.

Hussman Annual Report

Hussman has published his 2013 annual report showing year end portfolio. Some highlights:

• 19% Consumer Discretionary sector (Even though he's super bearish?)
• 6% Energy sector (Finally bought some E&P and services, probably at the top of the market for oil though.)
• 26% health care including 6.6% pharma!

And a GIGANTIC short call position - 47% of NAV! They are in the money calls.

Latest Hussman

Market comment:

"The primary beneficiary of QE has been equity prices, where valuations are strenuously elevated. QE essentially robs the elderly and risk-averse of income, and encourages a speculative reach for yield. Importantly, one should not equate elevated stock prices with aggregate 'wealth' (as higher current prices are associated with lower future returns, but little change in long-term cash flows or final purchasing power). Rather, the effect of QE is to give investors the illusion that they are wealthier than they really are. It is certainly possible for any individual investor to realize wealth from an overvalued security by selling it, but this requires another investor to buy that overvalued security. The wealth of the seller is obtained by redistributing that wealth from the buyer. The constant hope is to encourage a trickle-down effect on spending that, in any event, is unsupported by a century of economic evidence."