Burning down the house (encore)

I vividly recall the mania of previous bull peaks; most recently 2007/08. As risk markets roared away from any reasonable connection with earnings trends, consumer demand or economic growth, participants became increasingly intoxicated and enamored with the fire. The structure was burning as the majority held capital in the flames on the promise of warmth. It is painful to watch this demented cycle prey once more on the weak and ill-informed.

Today as global debt pushes through a mind-boggling 100 trillion (up more than 30 trillion since the credit crisis first exploded in 2007) and margin debt surges to the highest levels ever recorded (chart below), financial conditions are even more treacherous on nearly every risk measurement than 2007 and even 2000. And still the risk-sellers are confidently herding followers toward the warmth of the blaze.
Margin and S&P March 2014
Last week famed Hedge Fund Manager Seth Klarman offered this warning in his client note:

“When the markets reverse, everything investors thought they knew will be turned upside down and inside out. ‘Buy the dips’ will be replaced with ‘what was I thinking?’ . . .  Anyone who is poorly positioned and ill-prepared will find there’s a long way to fall. Few, if any, will escape unscathed.”

See also this excellent overview: 7 signs we’re near a market top

“The market is wearing no clothes

Just like the emperor, the market is wearing no clothes. Right now, many people see only what they want to believe. It’s been a long time since investors felt full-throated fear, and many have forgotten what it feels like. The panic to buy will be replaced by the urgency to get out at any price. No one can know what will cause perceptions to change, but they will.

At the moment, emerging markets are in deep trouble, and what is happening in Ukraine didn’t help. Nevertheless, the CEOs of several major brokerage firms have urged investors to “go long” emerging markets because they are so “cheap.” Once again, these well-educated salesmen are wrong. Emerging markets will recover one day, but not soon. Urging investors to buy on the dip is disgraceful.”

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