Juggling Dynamite

Unlike most, billionaires have more money than they can spend in a lifetime.  Hence they have a higher risk tolerance for losses and tend to hold a lot of assets of all kinds.  This has made them ideally situated to benefit from the $9 trillion of central bank injections into financial markets over the past 14 months.  At the same time, these same forces have increased the correlation between global asset classes as well as social and economic vulnerability to price declines.  Historically, such extreme imbalances have been followed by giveback periods of one kind and another.

“It took nearly 20 years for the wealth of billionaires to double. Then just last year the wealth of billionaires went up more than 50%,” says Morgan Stanley’s Ruchir Sharma. “It’s staggering.” pic.twitter.com/a3DfpwNtnI

— Squawk Box (@SquawkCNBC) May 19, 2021

An insightful article in the FT today courtesy of John Hussman (see The Myths behind the current stock market bubble) considers the belief system widely held today that central bank liquidity can support extreme and irrational asset valuations indefinitely:  “Years of intervention have cast central banks as tools of self-reinforcing speculation. Mere phrases such as “Fed support” now suffice as complete investment strategies.”  While today is certainly not the first time that this misplaced faith has been widely held, the current episode is so extreme that only 2000 and 1929 offer a comparable data set:

In 1934, Graham and David Dodd described the errors that contributed to the 1929 extreme, and the collapse that followed. They observed that investors had abandoned attention to valuations in favour of prevailing trends, while “the rewards offered by the future had become irresistibly alluring”. Moreover, the backward-looking success of passive stock ownership had encouraged investors to ignore price as an investment consideration. Graham and Dodd lamented: “It was only necessary to buy ‘good’ stocks, regardless of price, and then to let nature take her upward course. The results of such a doctrine could not fail to be tragic.”

It is widely acknowledged that corporate profits are one of the most reliably mean-reverting financial series (aka capitalism).  With this fact in mind, the chart below offers some illumination.  The lower left shows S&P 500 prices divided by profit margin-adjusted price to earnings since 1928, and the lower right shows US stock prices divided by revenues since 1947.  Suffice to say permanently high plateaus have been non-existent and past episodes of euphoric pricing have brutally punished those who held high.

Viktor Shvets explains very well the formidable deflationary impulses that central banks are trying to offset with inflationary monetary experiments.  Important observation:  many of the same people who denounce fiscal spending deficits as reckless debt creation support the monetary policies that inflate asset prices and the debt/leverage now threatening our highly inter-related financial system.

What will the economy really look like when things normalize? Lots of people are, of course, anticipating a sustained rise in inflation, even beyond this burst in prices right now. Our guest this week is skeptical. We speak about the new landscape with Viktor Shvets, a Managing Director at Macquarie, on why he doesn’t see the disinflationary trends changing anytime soon. He also argues that the next crisis could originate in the mania for cryptocurrencies.  Here is a direct audio link.