Quite a sight this morning to see Mr. Carney, former Bank of Canada head, now leading the Bank of England, announcing new policies he says are designed to help financial instability risks building from over-valued housing and high household debt levels in the UK. Here is a direct video link.
Better late than never to be sure. But as all ears hang on Mr. Carney’s eloquent words and educated assurances, there is some irony to be found in the below big picture chart showing that ultra-loose monetary policies the past 5 years (which were led by Mr. Carney) have left Canada today with the most over-valued home prices in the world. Hand in hand of course, with the most indebted households.
As Mr Carney explains in the clip, studies have shown that when home prices ultimately correct from over-valued periods “you end up with a recession that is much deeper…recessions associated with housing crashes are about 3x as deep as average recessions.” So as commodity prices continue to slump amid a sea of over-supply and weak global demand, the Canadian economy is the least prepared to absorb the downturn than it has been in least a couple of decades. Too bad policy makers and bankers are so adept at closing stables long after horses have run wild. I look forward to the day when the most dominant news stories are no longer about the ‘brilliance’ of central bankers.
Meanwhile corporate earnings, that had achieved unprecedented levels (70% above historic norms) coming out of the lean cost structures of the 2008 Recession (See Big holes in bullish case), have been steadily losing steam as shown in this next chart below courtesy of Pimco this week graphing the S&P price on top versus S&P earnings growth (or near lack there of over the past year)on the bottom.
And as for all the talk about a big rebound in 4th quarter earnings? So far corporations have pre-announced negative to positive outlook changes 10.6 to 1 as shown below. But then maybe the bulls are right: who needs earnings or customers, when markets have the Fed? Party on Garth!
Digging into some of the rules of “progressive capitalism,” with Cambridge University Chancellor Lord David Sainsbury. He discusses whether he expects pushback on the push for reform. Here is a direct video link.
Pope Francis has also recently targeted capitalism in his new papal proclamation, calling unfettered capitalism the “new tyranny.” Here is a direct video link.
David Rosenberg turned bullish in the past year as his firm searches for a buyer now that assets under admin have recovered from their 2008 losses (also see: David Rosenberg turns bullish, earns $3.1m). Hugh Hendry capitulated last week and said he had caved to business model pressure (unhappy clients) and bought back into equities. Each day of higher and higher stock prices are having the usual impact in coercing mass psychology to the bullish “this time is different” belief. With investor sentiment surveys registering cycle highs of 55% bulls and only 15% bears, there are very few left today that are willing to offer a sober view. For those still open to considering thoughts other than the “Central Banks are in so stocks can only go higher”, former OMB director David Stockman offers an excellent summary of relevant facts in this clip.Here is a direct video link.
“A new wave of problems could be approaching the mortgage industry. U.S. borrowers are increasingly missing payments on home equity lines of credit they took out during the housing bubble, and that could be another hit for the banks.” Here is a direct video link.
Given the advent of new regulation reducing profits from some of their criminal and unethical practices as well as the rash of litigation and record fines they have been dolling out for securities violations of late, another wave of loan losses will be hitting banks at a difficult time.
Bubble television is rolling out all the usual bull artifacts to justify why stocks keep going up: Abbey Joseph Cohen (Ms. tech stocks for the long-run of 1999 and commodity stocks for the long run of 2008) and Warren Buffet (now Mr. S&P 500 closet indexer, see: Buffett’s return-free-risk round trip) et al. But for those that prefer rational gauges and a reasonable shot at protecting and growing their savings over time, there are glaring holes “in the stocks are attractively priced” story today.
The historically reliable Shiller PE (price/10 year average real earnings) is today at 25, giving US stocks in 2013 the distinction of being the most notoriously priced since the Tech bubble peak of 2000 (where it was 44) and the leverage bubble peak of 1929(where it was 32) as compared with Shiller PE’s between 5 and 8 in secular bottom lows in 1921, 1932, 1942 and 1982. See this chart for a big picture view.
Analysts (at least any that are sentient) know perfectly well that the Shiller PE at 25 suggests that at present values stocks are priced to earn negative returns over the next 7-10 years. But since they need to sell stock investing to the public at every price they reach for different ways to parcel valuation data. One quick fix tool is to divide the current S&P index price by its “trailing 12 month earnings” (TTM). On this measure the current S&P price to TTM clocks in at 18.6 compared with a historic average since 1870 of 15 and a reading of 6ish at secular bear lows on this metric in 1920, 1950 and 1980.
Not to be put off, bullish analysts next stoop for that infamously delusional indicator: the Price/forward 12 month estimated earnings ratio. This one is a particular laughing stock for a few reasons. First of all sell side analysts are well documented to be horribly over-optimistic at forecasting earnings. They literally place a ruler under last quarter’s earnings trend and draw a straight line up. In this way they have over-estimated earnings growth every single quarter except at recession bottoms where they finally flip their ruler down and turn bearish just as momentum finally turns up. As a recent example, analyst consensus was expecting S&P earnings growth of 10% in the 3rd quarter of 2013, and the actual growth came in at just 4%. In any event, their current consensus estimate for 12 month forward S&P earnings is an all time high $119.30 which at 1803 for the S&P works out to a P/E forward ratio of 15.11 which they argue is only average not expensive.
But as John Hussman explains so well this week in An Open Letter to the FOMC, using forward-extrapolating-rules-of-thumb for earnings estimates is particularly dangerous today because of a spate of unusual phenomenon the past 4 years (wage reduction and labor suppression out of the great recession, productivity increases and stock buybacks rather than fixed investment) which have led to the highest ever recorded corporate profits as a percentage of GDP ever, as graphed in this chart:
The historical mean for corporate profits after tax is 6% of GDP. Today this ratio sits 70% above average at more than 10%. So those forecasting higher corporate earnings from here are assuming that this time is different and corporations can only make more and more while governments and households earn and have less and less. They assert that this time trees profits will grow to the sky.
Based on historical mean reversion patterns though, present outsized profits would need to contract by more than 15% a year over the next 4 years to restore their long-term equilibrium with economic growth. We will then see just how “attractive” today’s record high equity prices will measure by then.
My daughter was studying for a history test on the 1920′s this weekend, last night we watched this documentary together. I had not seen this one before. Can’t help but recognize familiar themes with recent trends in financial markets. One notable difference is that in 1929 the FOMC was warning that margin abuse and an over-valued stock market were dangerous for the real economy. Today the Bernanke/Yellen Fed point proudly to the overbought stock market as proof of all their good work. Here is a direct video link.
One of the most infamous and relentless modern day Perma-bulls, Jeremy Siegel is featured on CNBC this morning pronouncing US stocks as fairly priced with US markets at all time nominal highs–now up 32% over the past 12 months–even as corporate revenue and earnings continue to plunge. Of course after writing his signature book “Stocks for the Long Run” at the peak of the secular bull in 1999, Siegel has been trying to justify and defend his devastating record ever since. In his book preface, he thanks the sell side brokerage firms for all their financial support and patronage in furthering his writing and speaking career. And the sell side loves him to be sure.
“I believe the stock market will do better in 2008 than it did in 2007, when it chalked up a 5.5% return, the fifth year in a row that the market went up. Year-ahead forecasts for the stock market are notoriously difficult, but I believe that a 10% to 12% gain is possible, on the heels of a recovering financial sector. Financial stocks plummeted almost 20% last year, and this was the reason why the market had a mediocre year. Outside of financials, the S&P 500 Index had double-digit returns. A revival of financial stocks would spur good market gains this year.”
A little math worth appreciating here: since the last cyclical bear ended in March 2009, US stocks have rallied 170% –59% of that just over the past 24 months on Q’ever promises from the US Fed. Before the QE gift of the past 12 months, which has emboldened so many Perma-bulls to think they are genius once more, the S&P had gained just an average of 1.67% year between 2000 and 2012. Even including the past year’s magical ramp, the S&P has now averaged just 3.2% a year (before any fees) since the secular began in 2000 on the launch of Siegel’s reckless book. (The Canadian stock market has gained even less (1.22%/year),being today still some 12% lower than its June 2008 peak). So stocks have averaged less than cash and bonds for 14 years with heart-stopping volatility that has included two 50% drops.
Most important of all and what no bull wishes to acknowledge: it will now only require an average little run of the mill bear market decline of -25% from here to wipe out all of the S&P’s price gains since 1999. Genius? Welcome to our secular bear.
As we consider the funding deficits prevalent in pension plans today we should appreciate that large deficits persist even though US stocks have soared in a dream of their own over the past year as shown in the chart below, where the S&P price level is plotted as against macro economic indicators as well as high yield bond prices. (These 3 economic indicators are supposed to be highly correlated.)
One does not need to be clairvoyant to predict how much worse savings deficits will measure once stock valuations revert to their historic mean–some 40%+ lower than present levels. As the commentator notes in the video clip, higher fixed income rates when they come will definitely help income flows into pensions as money comes due and can be rolled over at higher yields. But at the same time, the typical pension mix (and retirement portfolio recommended by financial types) is 60% equity and 40% fixed income today. So when the 60% of the money in equities plunges in value anywhere within historic norms (-25% to -50%) a jump up in income earned on the fixed income side will not be able to offset the overall capital declines and funding deficits will once more compound in the wrong direction.
Today HSBC’s Chinese preliminary purchasing managers’ index slipped to 50.4 in November from 50.9 in October. The reading just above 50 implies a weak expansion among manufacturers, and is a sign that growth in the third quarter is fading. The much anticipated rebound in exports remains elusive: new export orders slumped to 49.4 from 51.3. Things the US economy is demanding like energy equipment are largely being made at home, with clothing now coming more from Mexico and cheaper labor parts of Asia beyond China. See: Waking up from the Chinese Dream
Despite intense marketing initiatives and central bank injections to the financial system, consumer spending in the developed world continues to be subdued. See: Target’s profit plunges on weak consumer spending. Here is a direct video link.
Cash-strapped, North American families are focusing their spending more on necessities and automobiles (responding to the 0 down, 0 interest for 8 years financing campaigns, as auto dealers scurry feverishly to bring forward even more demand from the future and capitalize on it today). Cars that are not made in China. Nor is the world grabbing up much of what is made in Canada either for that matter: today the Loonie is plunging again as the Bank of Canada reiterated that “significant slack” remains in the economy and growth is being held back by sluggish business investment and exports.
Global banks are still sitting on mountains of bad debts that will never be repaid. The extend and pretend phase permitted by central bank liquidity bought some time but has done nothing to clean out and reset the system. Meanwhile the regular folks who foolishly took advice from the reckless loan sellers continue to pay the price, literally stuck in limbo like this debtors village in Hungary. Here is a direct video link.
Back in the mid-2000′s I remember some financial “experts” talking about the “brilliant strategy” of borrowing in other currencies in order to get lower mortgage rates than were available in one’s home currency. Lower rates allowed people who could not afford a house to buy one! It also allowed those who could only afford a small house to buy a more expensive one…great idea for those who were selling the products…made for a much larger pool of buyers. Predictably catastrophic idea for those did the borrowing and buying though. As the loan based currencies strengthened, the borrowers were thrown into default. Meanwhile the bankers who collected the commissions and bonuses upfront made off like bandits. Literally.
Which brings us to the problem with high risk, self-destructive financial advice, products and strategies, they often look great at the outset. They may even appear to be working for a while, maybe even a few years. While they appear to work, people want to believe and ignore probable outcomes allowing the architects and sales force to look brilliant and extract huge financial rewards up front. Then when high risk concepts and assets blow up, tragedy hits the people who bought. And the public purse is tapped for funds to help clean up the mess. It would be great if we could nip this vicious circle in the bud one of these times. But that requires people to stay sober, manage risks and take protective steps for themselves before the losses hit.
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“Juggling Dynamite, #1 pick for best new books about money and markets.” Money Sense
“Park manages to not only explain finances well for the average person, she also manages to entertain and educate, while cutting through the clutter of information she knows every investor faces.” Toronto Sun