Tag: overvalued markets

Rare Honesty From A Corporate CEO

Guest Post by Dave Kranzler

In my view, the mood of these markets is in stark contrast with the many unknown from our current economic and political landscape, both here and abroad. For me, it’s a major disconnect, and it concerns me.  – James Tisch, Loews CEO (call transcript sourced from from Seeking Alpha)

James Tisch shared some extraordinarily candid observations about the financial markets on Loews Corp’s Q4 earnings conference call on Monday.   I say “extraordinary” because I do not believe I have ever heard, in well over 30 years of capital markets experience, any corporate CEO – or any corporate officer – ever speak honestly about the condition of the financial markets.

With regard to the amount of capital and credit made available by the Fed:

In the credit markets, spreads on the high yield securities are approaching historically tight levels, while key credit metrics such as leverage and coverage ratios are showing signs of weakening. The leverage loan market has been overrun by such massive inflows of capital that you could probably get loan to buy a fleet of zeppelins at this point in time.

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FED LUNACY IS TO BLAME FOR THE COMING CRASH

This week John Hussman’s pondering about the state of our markets is as clear and concise as it’s ever been. He starts off by describing the difference between an economy operating at a low level versus a high level. He’s essentially describing a 2% GDP economy versus a 4% GDP economy. We have been stuck in a low level economy since 2008. And there is one primary culprit for the suffering of millions – The Federal Reserve and their Wall Street Bank owners. They are the reason incomes are stagnant, the labor participation rate is at 40 year lows, savers can only earn .25% on their savings, and consumers have been forced further into debt to make ends meet. Meanwhile, corporate America and the Wall Street banks are siphoning off record profits, paying obscene pay packages to their executives, buying off the politicians in Washington to pass legislation (TPP) designed to enrich them further, and arrogantly telling the peasants to work harder.

In economics, we often describe “equilibrium” as a condition where demand is equal to supply. Textbooks usually depict this as a single point where a demand curve and a supply curve intersect, and all is right with the world.

In reality, we know that economies often face a whole range of possible equilibria. One can imagine “low level” equilibria where producers are idle, jobs are scarce, incomes stagnate, consumers struggle or go into debt to make ends meet, and the economy sits in a state of depression – which is often the case in developing countries. One can also imagine “high level” equilibria where producers generate desirable goods and services, jobs are plentiful, and household income is sufficient to demand all of that output.

The problem is that troubled economies don’t just naturally slide up to “high level” equilibria. Low level equilibria are typically supported and reinforced by a whole set of distortions, constraints, and even incentives for the low level equilibrium to persist. In developing countries, these often take the form of legal restrictions, price controls, weak property rights, political and civil instability, savings disincentives, lending restrictions, and a full catastrophe of other barriers to economic improvement. Good economic policy involves the art of relaxing constraints where they are binding, and imposing constraints where their absence allows the activities of some to injure or violate the rights of others.

In the United States, observers seem to scratch their heads as to why the economy has shifted down to such a low level of labor force participation. Even after years of recovery and trillions of dollars directed toward persistent monetary intervention, the economy seems locked in a low level equilibrium. Yet at the same time, corporate profits and margins have pushed to record highs, contributing to gaping income disparities.

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LEMMINGS LOOK LIKE A PACK OF INDIVIDUALISTS COMPARED TO WALL STREET

Since most of you are too lazy to read Hussman’s brilliant analysis every week, I’ve picked out the key paragraphs from this week’s letter. For the really lazy, I’ve bolded the key sentences. The lemmings on Wall Street are still confident as they march in lockstep towards the cliff.

 

“A group of lemmings looks like a pack of individualists compared with Wall Street when it gets a concept in its teeth.”– Warren Buffett

I had very vocal concerns about valuation during the tech bubble and the housing bubble, well before they burst. But it was a specific combination: extreme valuation coupled with fresh deterioration in market internals – the same combination we observe presently – that provided us with timely evidence that market conditions had shifted to urgent risk at what in hindsight turned out to be the very beginning of the 2000-2002 and 2007-2009 collapses. Those collapses wiped out the entire total return of the S&P 500 – in excess of Treasury bills – all the way back to May 1996, and June 1995, respectively, despite aggressive Fed easing in both instances. Don’t imagine that the current bubble will avoid a similar completion.

At present, the S&P 500 is an average of 114% above the historical norms of the most reliable valuation measures we identify (and the importance of using historically reliable measures can’t be overstated). Even this obscene overvaluation might not be of urgent concern, however, were it not for the fact that our measures of market internals and credit spreads also remain unfavorable at present – as they have been since late-June of last year (see Market Internals Suggest a Shift to Risk Aversion). Notably, the broad market – such as the NYSE Composite – has been in a low-volume sideways distribution pattern since then. In the absence of a jointly favorable shift in market internals and credit spreads, my impression is that the best characterization of market conditions at present is as a broad but possibly incomplete top formation, after a nearly diagonal half-cycle advance, and preceding a potentially violent retreat over the completion of this cycle.

As we observe conditions at present, market internals and credit spreads continue to suggest a subtle shift toward risk aversion. In that environment, awful outcomes occur more often than not. They may not happen immediately, but they tend to happen quickly. The late MIT economist Rudiger Dornbusch characterized the process well: “The crisis takes a much longer time coming than you think, and then it happens much faster than you would have thought.”

About 8% of market history falls into the present set of market conditions (essentially characterized by extreme overvalued, overbought, overbullish conditions that are coupled with deterioration in market internals or credit spreads on our measures). To the extent that air pockets, free-falls and crashes have reasonably identifiable commonalities, this 8% of history captures what we view as the essential features.

In any event, present conditions are not favorable (or even flat) on our measures, and despite week-to-week variation, the average outcome of present conditions has been wicked.

Read all of Hussman’s Weekly Letter