Here is a Tweet discussion leading up to the correct answer which will likely surprise many.
Goldilocks vs the Bears @LizAnnSonders @hussmanjp @biancoresearch @TheBubbleBubble @JeffSnider_AIP @Hedgeye
Is Goldilocks in the room or out of the room? That’s not even the right question.https://t.co/Ppw7kdere2 pic.twitter.com/kbKEvrL8FC— Mike “Mish” Shedlock (@MishGEA) March 12, 2018
Yes, valuation is high; but historically (since 1958) it’s had no consistent correlation to subsequent one-year returns (either for CAPE or trailing P/E) pic.twitter.com/TCHENi3uSG
— Liz Ann Sonders (@LizAnnSonders) March 13, 2018
Did anyone say CAPE correlates to 1-year or even 3-year returns? @Hedgeye @LizAnnSonders @hussmanjp No one knows when it matters, but we do know the higher it gets the worse the final results. There does not have to be a definable catalyst. Sentiment can change for no reason.
— Mike “Mish” Shedlock (@MishGEA) March 13, 2018
Also, I believe that writing off these valuation indicators (because they’re not short-term timing tools) is a way of trivializing the very real risk that asset bubbles pose to our economy and society. This is disingenuous. The coming mean reversion will prove this to be true.
— Jesse Colombo (@TheBubbleBubble) March 13, 2018
About Catalysts.
Think back to 2006. People lined up on the streets overnight for the right to enter a lottery to buy a Florida condo. A week later: no lines. Vanished. There was no trigger or event. What happened? Sentiment changed. The catalyst is “sentiment” not an event.— Mike “Mish” Shedlock (@MishGEA) March 13, 2018
Well said. The same will happen this time around too, because “This time ISN’T different.”
— Jesse Colombo (@TheBubbleBubble) March 13, 2018
Gaga Over Real Estate
Thinking back to 2005, I recall this magazine cover.
Gaga Over Real Estate
Things do not get any better than Time Magazine going “gaga” over real estate, right on the cover.
The media reflects the mood.
I wrote about it at the time and accurately called the top even though sentiment is extremely hard to judge.
- March 2005: It’s a Totally New Paradigm
- June 2005: Home $weet Home Top Call
- September 2006: Updating the Arrow after Home Prices Drop
Gaga Over Tax Cuts
In January 2018, nearly everyone was giddy over Trump tax cuts and business investments that are not likely to happen.
In February, investors were so convinced stocks could not drop that they were shorting the VIX more and more every time the VIX rose.
Things finally snapped.
Inflation Sentiment
With nearly everyone so hell-fire convinced inflation is on the way, I propose Inflation is in the Rear-View Mirror.
Before anyone shouts that I have lost my mind, please read the discussion about what inflation really is and how things work in the real economy.
If the Fed reverses course will it be as bullish as before or will investors react as if the curtain was pulled on the Wizard of Oz?
Peak Equity Sentiment?
Have we seen peak sentiment in equities this cycle?
I do not know the answers to those questions, nor does anyone else, but valuation speaks for itself, as noted in Sucker Traps and the Arithmetic of Risk.
The VIX
In regards to the VIX massacre, what happened? Inflation fears? Rate hikes? Anything?
You can conjure up a catalyst, but what really happened is there was a sudden sentiment sentiment change regarding the notion that being short volatility was a guaranteed smart thing to do.
Junk Bond Whales
Junk bonds and equities are correlated. They both represent risk assets.
Four days ago I noted that a Mutual Fund Whale Goes “All In” On Junk Bonds.
Just like the VIX speculators, the junk bond whales have no concerns about valuation.
How does BST do market timing? The fund uses a computer program.
Bear in mind, many of the securities in the ETF are extremely illiquid. A credit manager informed me that “up to 90% of the bonds in HYG don’t trade on a daily basis.”
What can possibly go wrong?
Buy the Dip!
With “buy the dip” so overwhelmingly pervasive, there does not have to be any catalyst for a sustained decline.
I strongly suspect there will not be one.
- Does anyone recall a catalyst in November of 2007, one month ahead of the Great Recession? If there was one, what was it?
- Does anyone recall Bernanke’s denial on the housing bust?
- Does anyone recall Greenspan’s worry the economy was overheating in summer of 2000, right before the dotcom bust?
Regarding question three, the FOMC minutes show Greenspan was concerned about overheating right before the dotcom crash.
hmmm.
What will change this time?
Sentiment.
The same thing that changed in 2007 with equities, 2006 with housing, and 2000 with dotcom stocks.
The pool of greaters fools will eventually run out, and it won’t take a recession or a drop in earnings (although both are coming).
Here’s something to think about: Perhaps the pool of greater fools has already run out. If it has, when will you know?
Mike “Mish” Shedlock
Thanks – Buy more
“What Event Will Sink the Stock Market?” That would be when the pool of US-centric fools, that think the current situation is the same as 2000 or 2007, finally throw in the towel when the DOW breaches 40-50K. The private wave doesn’t end until 2032. Who believes the smart money will be investing in govt bonds anytime soon?
What causes the crisis? A rising dollar and rates. What causes the dollar and rates to rise? That would be the anticipation of sovereign defaults, which will lead to a G20 meeting to jigger the system and replace the dollar as the reserve. Until then, stocks can’t crash because govt bonds aren’t an option.
I feel we are in uncharted waters and should take nothing for nothing for granted. To assume we will move forward without a glitch is extremely optimistic. With the passage of time, things change and evolve. This transformation can be seen in both society and the economy. A question we must ask is just how relevant today’s comparisons are with prior economic cycles?
The situation today is in many ways “historically unique” due to the rampant expansion of credit in recent decades. Recently I found myself pondering the line, “outwit and outlast” that is often used during the popular hit television show Survivor. It occurred to me the winners in both life and investing often reflect these qualities and that this game is far from over. More on this train of thought in the article below.
link to brucewilds.blogspot.com
Mmmm. wasn’t 2000-2009 a Secular Bear that investors had to experience?
link to s3-us-west-2.amazonaws.com
But what will cause sediment to change? A big drop with no follow up bounce? I don’t think it’s knowable until it happens.
Like to get Hussman and Sonders together to discuss TIME LINES. If you consider the demographic most deeply invested in stocks and their TIME LINE (planners worry about the Baby Boom bubble, in twenty years they will all be dead) The shrinking size of the American family will tend to funnel wealth down to their heirs (and the doctors and lawyers and healthcare facilities, and finally the stock market promoters) To take a responsible view of wealth takes a real effort.
“What Event Will Sink the Stock Market?” QE. That which causes the boom, causes the bust.
Dow is back to where it began on January 1. Something is amiss …
All of those scenarios are based on the notion that the market is semi rational and somewhat predictable in its cycles. I believe we’ve injected too much money into the economy by borrowing from the future and there will be a reckoning for how we manage our finances in America but even that will happen in a semi rational and predictable manner and not all at once. What I remember from all of these recent crashes is a couple of signs pointing to sell and a billion bots reacting to it on autopilot and faster than anyone could predict. My fear is that the trigger will be the bots that buy and sell freaking out and selling everything for what they believes it’s worth – which could be nothing to a program. I could be naive in the role that they play in trading today but I wish we had more rules and safeguards against AI executing a whole bunch of transactions the world can’t take back.
You are starting to become just another John Hussmann, spending years arguing against a steady moving bull market.
While I agree sentiment was and still is, to some extent, the moving factor of the market both up and down historically. But what is to be said of the market today where computers and algorithms are a major player in market movement. Computers don’t have sentiment, well at least not yet.
My hypothesis. The business models of the front-running FAANG group of companies unravels in a darkening climate of falling profitability and unsustainable interest rates. Anything north of 2.8% is precarious.
And then of course there’s share buybacks; probably the most important of the three actually – I mean $800 billion dollars, dear God. That’s four times the cash actually in the stockbroker’s hands at any one moment.
link to themaven.net
(It’s the same dynamic with international landlords in the property markets of the world’s major cities; and the Fed can’t buy houses!)
(Plus, the Fed of course makes for one hell of an ammunition supply line)
You already heard my position regarding the catalyst in the stock market. Margin borrowing. In the run up to July 2007, and then a short lived rebound in October, Margin debt was increasing at an unprecedented rate. And exactly the same thing has happened right up to this moment. Margin debt has soared to 666 billion dollars in January, it was only 606 billion last October. You’re not suppose to get 50 billion increases in margin debt in a single quarter. Look at the data, there’s no precedent for it.
link to finra.org
Then there is M&A. Broadcom was lining up an record setting $100 billion dollars of new bank credit that would have poured into the market to purchase Qualcomm shares. That might have single handedly reversed this late decline. As it is, much of that value was already priced into the value of Qualcomm. Just goes to show the level of sentiment on the side of banks. Would they entertain the acquisition deal if it was put to them now? I don’t think so.
link to channelnewsasia.com
I’m in complete agreement with you Mish, although I’d cast the ultimate formula as “Sentiment + Credit Card = Cycles.” What actually happens is sentiment gets so out of hand in a boom that the fools of tomorrow show up with the rest of the fools of today. Then everyone gets nervous of course, because suddenly relatively few are buying (because most who would have bought in the near term have already done so). A peak forms, people get nervous, sentiment changes, and then once the credit card companies themselves lose confidence, it’s all over and the market goes into freefall.
There’s actually a very good analogy to this dynamic of sentiment in historical warfare. An army begins to gain a lot of territory against the enemy, and this brings dangerously high morale among the troops. They advance too far. The supply lines can no longer reach them. They run out of ammunition. Suddenly they are the ones in retreat, and sometimes lose more ground than they gained in the first place, sometimes their retreat is cut off and they’re encircled. Then the war is over. This happened both to Napoleon and Hitler in Russia.
You can imagine bulls and bears warring it out this way. The bulls over advance, and the bears have them. If the bulls had just played it cool, borrowing a little bit to buy one at a time, who knows how long they could keep the credit cycle going. Maybe that’s in part why this one is so particularly large. Up until February 2016 it’ was a relatively cautious advance for the bulls.
link to s3-us-west-2.amazonaws.com
Maybe this time is different? CPUs are not overly sentimental and are good at working within the parameters provided for them. When that fails the markets break and are suspended until human traders come to their senses again and the machines can get back on buying the dips and smoothing out the markets to function within ‘reasonable’ expectations of their inevitable continuous rising.
If I recall correctly, the Fed was jacking up interest rates and gas was moving up past $4.00/gallon in 2007. Neither of those were shocks, as they had been edging up for awhile. But they did add to a growing sense of unease.
I’m bearish, but not that gloomy! Assets will fail, sure, but the currency will fail shortly after as the Fed goes hell for leather with the printing press.
…. or, “The first cut is always the cheapest.”
“Buy the dip” is, fundamentally, just another way of saying “frontrun the Fed.”
Belief that the last thing that will “go down,” is “assets,” as those are what the people the Fed is protecting, are most concerned about. So, while there may be no food in stores, no salaries, no cops, nor any law enforcement; outside of small enclaves consisting of Fed officials and their closest associates; “assets” will be pumped up until the bitter end.
Eventually, “assets” will fail too; but before that happens everything, and everyone, else will first have been tossed in woodstoves and burned for heat, to keep those the Fed protects from being uncomfortable in their propped-up New York condos come winter.
If Toys R Us announcing they are closing all 800 stores isn’t a sign of economic distress that I don’t know what is. And you can’t blame this all on Amazon or online retailers either. Looks to me like the middle class is tapped out.
It is hard for me to remember 2007 events within one month. I do recall when Bear Stearns had to pledge extra collateral. It was in the summer of 2007 and people in the news were calling it a “modern day run on the bank.” Someone overheard me at lunch discussing that with a friend in a restaurant. Next thing I know the eavesdropping couple was calling their broker.
I expect the trigger this time will also be that someone big will suffer big leveraged losses. I expect the Fed will address the issue quickly; however, the Fed may not be able to undo the damage to confidence.
Am I bending over to pick up pennies before that steamroller arrives? No.
Why did the market top in November? The catalyst was in June? September?
“Does anyone recall a catalyst in November of 2007, one month ahead of the Great Recession? If there was one, what was it?”
Bear Stearns CDO losses.
Excerpts copied from Wikipedia:
On June 22, 2007, Bear Stearns pledged a collateralized loan of up to $3.2 billion to “bail out” one of its funds, the Bear Stearns High-Grade Structured Credit Fund, while negotiating with other banks to loan money against collateral to another fund, the Bear Stearns High-Grade Structured Credit Enhanced Leveraged Fund. Bear Stearns had originally put up just $25 million, so they were hesitant about the bailout; nonetheless, CEO James Cayne and other senior executives worried about the damage to the company’s reputation…
A September 21 report in the New York Times noted that Bear Stearns posted a 61 percent drop in net profits due to their hedge fund losses. With Samuel Molinaro’s November 15 revelation that Bear Stearns was writing down a further $1.2 billion in mortgage-related securities and would face its first loss in 83 years, Standard & Poor’s downgraded the company’s credit rating from AA to A…