Another Indication The Bull Market is Coming to an End!

[Packer16]

One thing not shown in the chart is net outflows from equity to MM and bond funds.  There has been a small amount of inflows but we are nowhere near the levels that we were at the other tops noted in your chart.

 

Packer

[bmichaud]

True. But I wonder what individual equity inflows were at the all-time high in 2007 prior to a 50% decline. I don't remember euphoria at the 2007 highs outside of the institutional manager world. And by institutional manager I mean hedge funds - mutual fund managers are lemmings that are fully invested at all times, thus their "market exposure" is erroneous.

[Palantir]

 

They do not rise prior to investor action - they rise during QE as investors sell/short safety in order to buy risky assets.

 

How do you know they rise as investors sell/short in order to buy risky assets? You keep saying, and you are not clear at all where you're getting this from.

 

Depends on what rates you are talking about. Treasury yields? Yes. Non-treasury yields in fact fell as investors took on risk from October 2011 thru September 2012....WITHOUT the help of QE. 

 

First you say treasury yields fell, and then you say non treasury yields fell? huh?

 

 

 

 

Which rates? Non-treasury rates? Heck no - everyone was risk off due to the euro crisis. Treasury yields? Yes, as investors sought safety.

 

Now you say the exact opposite - non-treasury rates didn't fall?  Again, how do you know that rates were only suppressed due to Euro crisis fears? You keep making a hypothesis that "rates are low because investors are scared", and keep repeating it as fact for some reason.

 

 

 

 

The Fed coming in and backstopping BAC and C (think Tepper) could have....fiscal stimulus could have. Didn't matter - sentiment became far too negative. QE was already in place. Likely the massive deficits drove it, b/c the deficits drove the huge margin expansion we've seen since then (have you seen expansionary deficits in Spain? no. Have you seen profit growth in spain? no.).

 

But what caused the change in sentiment, that drove risk taking and the "huge margin expansion" you refer to? It suddenly flipped for no reason?

[Palantir]

Further....

 

The ECB has not printed a single dime since July 2012 - all Draghi said was that he'll "do whatever it takes". Simply knowing a sovereign backstop was in place was enough to allow for risk-takers to come back in the market. Literally zero Euros flowed through the EU financial system "into" sovereign debt, bank debt, bank equities and broad equity indices. And the ECB balance sheet has actually contracted recently....

 

So if QE is purely psychological, then it must follow that QE is actually back-stopping something such as Draghi's yet-to-be-implemented OMT program. But wait - OMT actually backs the sovereign debt market. If you short Spanish debt to yields of 7%, you are going to get your lunch handed to you bc OMT-based printed Euros will actually buy unlimited amounts of SD at yields far lower than 7%.

 

What is QE backstopping in order to induce risk taking? It's certainly not backstopping the treasury market - yields RISE during QE. Is it backstopping junk bonds? Last I checked A) the Fed does not buy junk bonds and B) primary dealers do not buy junk bonds with reserves held at the Fed.

 

 

It's not about simply "backstopping" financial institutions, there is a lot more to it than building up bank reserves. Backstopping banks is only one facet of a broader injection of liquidity into the markets. As you note, the ECB has not printed a single dime, why on earth would there be risk taking then? Knowing a sovereign backstop is there is not relevant.

 

You keep saying "yields rise during QE", you are forgetting that QE is merely one part of a broader plan to suppress rates and inject liquidity, right after QE yields can rise somewhat, however it is not the relevant comparison, the relevant comparison is to rates PRIOR to QE1, before the Fed started buying assets.

[bmichaud]

From August 1, 2010 thru May 1, 2011 the TLT dropped -6.55%. Thus over the entire course of QE2, treasury yields ROSE - precisely the opposite of what the Fed tried to achieve.

 

From May 1, 2011 thru September 30, 2011 the TLT rose +28.65%. Thus during the "risk-off" phase triggered by the European debt crisis, treasury yields fell as investors sought safety. 

 

From August 1, 2010 thru May 1, 2011 the JNK rose +3.76%. As expected, investors sought risky assets as reserve balances rose during QE2, thus non-treasury yields fell.

 

From May 1, 2011 thru September 30, 2011 the JNK fell -11.52%. Obviously non-treasury yields rose during this risk-off phase.

 

 

9/30/11 thru 9/30/12: JNK rose +7.92%. Junk bonds rose more in a non-QE period than they did during QE2!!!

 

9/30/11 thru 9/30/12: TLT rose +2.81%.

 

 

CONCLUSION: QE is all in your head.

 

 

But what caused the change in sentiment, that drove risk taking and the "huge margin expansion" you refer to? It suddenly flipped for no reason?

 

I said what drove huge margin expansion - deficit spending. The market anticipates - thus the rally out of March 2009 was well in advance of deficit-driven margin expansion in anticipation of said margin expansion.

 

Had the Republicans had their way in early 2009 and actually balanced the budget, I promise you we would not have had the rally we did. QE's effect (whatever it may have been) paled in comparison to stimulus money finding its way into the Main Street's pockets (versus bank reserve balances at Fed banks).

[Packer16]

Another vehicle just starting to re-emerge is the CLO.  This will drive equity prices higher for at least 6 to 12 month if not longer.  They started to re-emerge in late 2012.  I agree that prices will decline but as these pipes become unclogged it will be awhile yet.

 

Packer

[Palantir]

With all  due respect, I think you are confused about the role of QE and its context in broader macroeconomic theory. I understand yields rose after QE, but the relevant point of comparison is before QE1 was announced, simply noting that yields rise during QE (which I am aware of)and fall inbetween QE 1&2 does not imply that QE is responsible for yields rising.

[bmichaud]

Why will that drive prices higher? That's a known event taking place - hasn't the market already accounted for that?

 

Were CLOs a driving force behind the tech bubble market peak, the 1987 peak, or any other market peak outside of 2007? I honestly don't know - but I see that argument a lot so I'm curious.

[bmichaud]

With all  due respect, I think you are confused about the role of QE and its context in broader macroeconomic theory. I understand yields rose after QE, but the relevant point of comparison is before QE1 was announced, simply noting that yields rise during QE (which I am aware of)and fall inbetween QE 1&2 does not imply that QE is responsible for yields rising.

 

Please help me, b/c I do not understand. You keep saying to look at yields prior to when QE1 was announced....

 

A) What yields are you referring to? And

 

B) What are you comparing them to?

[jay21]

Another vehicle just starting to re-emerge is the CLO.  This will drive equity prices higher for at least 6 to 12 month if not longer.  They started to re-emerge in late 2012.  I agree that prices will decline but as these pipes become unclogged it will be awhile yet.

 

Packer

 

Why do you think that CLOs will drive equity prices?

 

Also, I was happy to see JPM went to market with a RMBS recently.  Prime credit may be thawing! 

[Packer16]

CLOs will drive debt financing of deals which will increase firm enterprise multiples.  Just remind me in 18 months that if I use it justify high stock prices that I am getting long in the tooth.

 

Packer

[bmichaud]

Will they allow firms that  would otherwise be unable to obtain financing to acquire companies? Or they drive rates lower?

[Packer16]

What they will do is drive demand for high yield debt as inputs for the securitization to create tranches for yield hungry investors.  The loans will be originated by banks to be securitzed in the CLOs.  This will drive yields down for leveraged firms and provide cheap financing for takeovers.

 

Packer

[Kraven]

Why will that drive prices higher? That's a known event taking place - hasn't the market already accounted for that?

 

Were CLOs a driving force behind the tech bubble market peak, the 1987 peak, or any other market peak outside of 2007? I honestly don't know - but I see that argument a lot so I'm curious.

 

No, they were not. While CLOs have existed in some form since around 1997 it was a tiny part of the market. Old high yield bond CBOs did contribute in some respects to the telecom meltdown as they all owned tons of Worldcom, Global Crossing, etc.  The first CBOs were done by Drexel and First Boston (both claim first deal) and were done in the late 1980s. They did not cause anything then but were rather a response to the junk bond meltdown and a way to get inventory off the books.

 

I would not say CLOs themselves led to the 2007 crisis. I would say that honor is reserved more for ABS CDOs. They did not cause it but rather were the gasoline thrown on the fire. If not for the virtually unlimited appetite in that space the drive for mortgages of any kind would not have occurred.

[bmichaud]

That's what I was thinking. I think it is recency effect leading folks to conclude that you need shoe-shiner stock recommendations and a credit mania for a market peak - the tech bubble had crazy individual euphoria whereas the 2007 peak was void of the individual but heavy on credit speculation and liquidity.

 

 

[HJ]

It's the credit market that's underpinning risk appetite.  Structured finance plays the role of the multiplier in the non sovereign credit market.  It's the "multiplier" in modern banking system.  That market was completely shut down, but has been healing, slowly but surely.  Maybe QE3 is the final straw, maybe it would have happened anyway without QE3.  But the multiplier is finally back, gingerly for now, as it relates to auto finance, commercial real estate, and leveraged loans, at least in the US.  It's much more powerful than anything the Fed can do.

 

CLO's and CBO's before them are important because they allow for new financing in the leveraged credit market, which finances corporate level economic transactions.  In particular, they finance the more aggressive risk takers among the major economic players.  But for the return of CLO's, Berkshire will not buying Heinz, Dell doesn't even dream about an LBO.  Now, we can talk about the potential of aggregate credit market expanding again, provided there is good underlying reasons for those activities, when before, the only thing any major economic players can really think about is de-leverage.  They may still chose to do so, but at least they are no longer forced to by the financing market.

 

The modern telecom infrastructure is built on the back of leveraged credit market, same goes for Cable / Satellite industry, the merchant utility industry, any oil / gas explorers without an oil major at its back, Las Vegas and Atlantic City, Tenet, HCA, Kinder Morgan's pipelines, etc., etc.  Not to say the build outs won't occur anyway without leveraged credit, but meaningful industry restructuring / expansion would occur at snails pace if the only financing market available are banks lending at 4 x EBITDA. 

 

Public equity market risk appetite floats on top of all of the real economic activities underneath, which is finally no longer exclusively concerned with the availability of funding.

 

 

[bmichaud]

Good post. I agree with everything except I believe the market has priced this in with stocks projected to return less than 3% nominally over the next 7 years (per GMO).

[Packer16]

I agree on the broad market but specific segment most affected by leveraged finance probably have a way to go (radios/TVs, non-CBD real estate and oil and gas).

 

Packer

[JEast]

I have been hearing about a 'market reentry program' advertised on the radio during my lunch break for the last month.

 

http://www.mutualfundstore.com/blog/2013/february/marketreentry

 

Cheers

JEast

[Kraven]

I have been hearing about a 'market reentry program' advertised on the radio during my lunch break for the last month.

 

http://www.mutualfundstore.com/blog/2013/february/marketreentry

 

Cheers

JEast

 

I used to always chuckle about the Mutual Fund Store.  It's a store of . . .  mutual funds!  The founder, Adam Bold I think his name is, used to do a radio show.  Maybe he still does.  It used to kill me.  People would call in and ask him about various funds.  He'd clearly look it up on Yahoo Finance or something and say "uh . . .  uh . . . looks like it's near it's 52 week high . . ."  They do have a radio commercial with Joe Theismann I liked.  It went along the lines of Adam Bold asking Theismann if when he played football they ever did it without a plan.  Theismann scoffed "no, no, that would be crazy".  And likewise, just as in football one needs a plan in investing.  Who knew?

[Aberhound]

It is easy to come up with factors which could cause the bull market to continue. It might or might not depending on whether entreprenuers step up to the plate. Times like this when many see the worst are the best time to create new great businesses with enduring moats. There are lots of wealthy people with sufficient capital to start these businesses, one of the benefits of concentration of wealth.

 

With the collectivists in Europe enacting the most stupid economic policies in modern history there is and will continue to be a large movement of people and capital to North America. You could not ask for a better example to instead pursue freedom and individualism instead of state based systems. The strength of the US system with divided powers will prevent the collectivists from spreading their poison to the US. Smart businesses will encourage the movement and hire the discouraged European youth who hopefully have learned their lesson.

 

With the bond market in a massive bubble and there being an order of magnitude more money in the bond market compared to the stock market all the alternatives will be inflated in price as capital looks for a safer home. Capital flees risk before it seeks gain. It is a good time to raise capital if you have a good idea.

 

Innovation comes in waves based on space weather. The US and Canada are the most fertile ground to take advantage of such innovations. Innovations create hope. It will be increasingly difficult to keep the many technologies suppressed on the grounds of national security off the market. This may cause a double strength wave led by cheap energy.

 

Periods of stagnation and cartels both create pent up demand. The growing class of poor people is likely to change to a growing class of rising incomes which becomes self reinforcing. Hiring is triggerred by a rising real estate market. What is needed are entrepreneurs with the guts to break the cartels and unleash the demand.

 

Buffett is on a tear. Maybe he has a reason to be optimistic about the US.

[bmichaud]

Quick update on my anecdotal contra indicator...

 

In addition to a lengthy phone conversation yesterday, I swapped probably 20 emails today in response to vehement and repeated attempts to convince me that the market will not decline without the Fed tightening, and since that wont happen for a couple of years it is smooth sailing until then. A couple more nuggets - the dividend discount model is bunk because it is "not real cash flow", and corporate buy backs still add value even though shares are not actually declining hahahah!!!!! A shocking conversation to say the least, especially coming from someone who is relatively intelligent.

 

As Ericopoly said in late 2012 with regard to his excitement in anticipation of BAC's inevitable rise....I am currently quaking with greed!!! The bull case of cheap stocks relative to bonds, central bank tail risk removal and the QE put is permeating investor sentiment right now. It's palpable.

[dolce2think]

I think the most important for the valueinvestor - in terms of macro or "general market stuff" is to identify key risks, imbalances, that will eventually

need to correct. We don't need to try to make money on this, as the most difficult part would be the timing issue - but we need to be aware, so we don't

loose money by the unravelling effect. Where do you guys see the major issues right now?

 

I think, regarding the corporate profit margin discussion, that this is a key issue going forward. I am not totally convinced, that we will return to the

6% of GDP as Hussmann et. al. are saying; yet what I could see coming is, that commodity prices start rising again, and that this will push up the

costs (along with rising labour costs in EM) and that it cannot be fully rolled over on the topline. The reason I am saying this, is that a lot of money

has exited the commodities space since the peak in 2010/11 and with the current path taken by the FED, I don't think that the bonds may rise soon,

but that it eventually will lift the commodities...this could then also be the trigger for the feds tightening, since it has always been rising inflationary

pressures, that induced them to tighten. Stocks may peak even before that, if profit margins fall.

The question obviously here is, whether the commodities are still in a bull market - regarding the fundamentals of supply/demand. While a lot of

investment has been done especially in the run-up to 2008, and to some extent after it, I still don't see the major "oversupply" killer, that is

supposed to turn this into a long term bear market. It all depends on the chinese side, on their credit bubble, whether they keep growing an demanding stuff.

 

So, as 1999/2000 was a p/e bubble, 2007 was a housing/credit/leverage bubble, now we don't have the credit/bubble conditions yet - we might have

a peak in corporate profits. Also, we must take into account that the deleveraging has started, and eventually also the government will have to

start to balance - slowly, and this environment will mean slower growth ahead. Specifically, the FED will keep interest rates low - below inflation, or at

least below nominal growth, to accomplish the deleveraging, by slowly transferring the wealth from the creditors into the debtors.

[Packer16]

Gary Schilling has some data which shows we are about 50% done with deleveraging the US consumer. At this rate we will back to the average leverage in about 5 years.  This was further than I thought.

 

Packer

[meiroy]

 

 

Commodities will crush/go down considerably which would have a deflationary pressure against all that possibly-coming inflation. Bank reserve ratios will increase, etc. Plenty of the "unknown dynamic future" will happen. I wouldn't worry about it too much, just buy [objectively] cheap stuff.