Courtesy of John P. Hussman, Ph.D.
All rights reserved and actively enforced. Reprint Policy
As of last week, the S&P 500 was priced to achieve an average annual total return of just 5.83% over the coming decade, based on our standard methodology. Prior to 1995, the lowest implied 10-year total returns priced into the S&P 500 in post-war data were:
November 1961: Implied 10-year total return 6.26%.
Actual 10-year subsequent return 6.16%
October 1965: Implied 10-year total return 5.89%.
Actual 10-year subsequent return 3.11%
November 1968: Implied 10-year total return 6.19%.
Actual 10-year subsequent return 2.51%
August 1987: Implied 10-year total return 6.29%.
Actual 10-year subsequent return 13.85%.
Note that in the 1987 case, the unusually strong 10-year return reflects a move to the extreme bubble valuations in the late 1990′s, which have in turn been followed by 13 years of market returns below Treasury bill yields. Once the market becomes overvalued, further gains are ultimately paid for by a period of sorry returns later. To expect normal or above-average long-term returns from current prices is to rely on the market bailing out the rich overvaluation of today with extreme bubble valuations down the road.
While investors can hope that today is similar to August 1987, a moment’s reflection about the market crash that occurred shortly after August 1987 might dampen that hope a bit, particularly because that instance also featured overbought, overbullish and rising-yield conditions.
As I emphasized last week, even if we had no concern at all about a second wave of credit strains, we would still be fully hedged here based on the present combination of rich valuations, overbought conditions, overbullish sentiment, and hostile yield pressures. Presently, we are also at the peak of concern about the potential for fresh credit difficulties to emerge, as we move into the first portion of the Alt-A / Option ARM reset schedule.
We will respond to the data as it emerges. This allows several possibilities. In my view, the most likely outcome is that we will indeed observe serious credit strains in the months ahead. That possibility adds to an already unfavorable syndrome of overextended market conditions, and this mix of factors courts…
In this issue: What Does Greece Mean to Me, Dad?
Dear Kids,
Ubiquity, Complexity Theory, and Sandpiles
Fingers of Instability
Washington DC, Albuquerque, and Guy Forsythe
To trace something unknown back to something known is alleviating, soothing, gratifying and gives moreover a feeling of power. Danger, disquiet, anxiety attend the unknown – the first instinct is to eliminate these distressing states. First principle: any explanation is better than none… The cause-creating drive is thus conditioned and excited by the feeling of fear… Friedrich Nietzsche
"Any explanation is better than none." And the simpler, it seems in the investment game, the better. "The markets went up because oil went down," we are told, except when it went up there was another reason for the movement of the markets. We all intuitively know that things are far more complicated than that. But as Nietzsche noted, dealing with the unknown can be disturbing, so we look for the simple explanation.
"Ah," we tell ourselves, "I know why that happened." With an explanation firmly in hand, we now feel we know something. And the behavioral psychologists note that this state actually releases chemicals in our brains that make us feel good. We become literally addicted to the simple explanation. The fact that what we "know" (the explanation for the unknowable) is irrelevant or even wrong is not important to the chemical release. And thus we look for reasons.
How does an event like a problem in Greece (or elsewhere) affect you, gentle reader? And I mean, affect you down where the rubber hits your road. Not some formula or theory about the velocity of money or the effect of taxes on GDP. That is the question I was posed this week. "I want to understand why you think this is so important," said a friend of Tiffani. So that is what I will attempt to answer in this week’s missive, as I write a letter to my kids trying to explain the nearly inexplicable.
What Does Greece Mean to Me, Dad?
Tiffani had been talking with her friends. A lot of them read this letter,…
Here’s an excellent discussion on the economy and China. We present many views here, and Pragcap’s are some of the most thoughtful and balanced. And if you haven’t yet, check out Op-Toon’s Review (fun images and satirical commentary). – Ilene
The United States government has made a curious series of interventionist moves over the course of the last 18 months. Some have been beneficial, but not surprisingly, few of these policies are actually helping the economy recover from the Great Recession.
As I’ve previously mentioned, Keynesianism can work. There is good government spending and bad government spending, despite the constant shrieking from Austrian economists with regards to all spending being bad. Giving money (on a silver platter) to banks who are not reserve constrained is exhibit A of bad spending. Spending money on a healthcare plan in the middle of a recession is a close runner-up. The banking bailouts not only set a terrible social precedent, but were also implemented with the belief that banks are reserve constrained – something that is entirely false.
The great recession was never a banking sector problem despite it being labeled as a “credit crisis”. In reality, this was a consumer driven crisis. The results prove this. The banks have recovered, but lending hasn’t improved. Why? Because this is a consumer driven recession. Banks aren’t reserve constrained. Finding willing borrowers, on the other hand, is a whole other matter….
The healthcare debate is a bit more messy. While the social aspects of healthcare spending are likely positive, you just have to wonder about the motives of the men pushing this plan when we are mired in the worst recession in 75 years. Is healthcare really our top priority when unemployment remains near 10%? More importantly, is this an efficient form of government spending when we could easily target job creation or other productive investments in the long-term growth of America (China’s high speed rail system comes to mind here). Meanwhile, we have an antiquated infrastructure. Where are the priorities?…
In a note to clients this morning David Rosenberg made an interesting comparison of today’s market to 2007. He says:
“So what does the current backdrop resemble in a modern-day sense? The summer and fall of 2007. Think about it. The S&P 500 has been jerking around on either side of 1,100 for five months now. The 10-year note yield has jumped 20 basis points from the nearby low with hardly any reason outside of negative technicals.
Go back to that period between May and October of 2007, and the S&P was just above or just below the 1,500 mark for over five months. Many didn’t know it then, and we should all be taking it into consideration now, but we were in a classic topping formation. Back then, as is the case today, the bond market was getting hit hard with the 10-year note yield surging 50bps, to 5.2%, and the universe of economists and strategists completely bearish on the Treasury market at just the wrong time. What goes around comes around.”
My initial reaction is to say, “this is pure datamining” but with the reflation trade, lack of regulation, rinsing and repeating of failed Keynesian policies, and the overall non-resolution of the credit crisis causes it’s fairly safe to say that we have officially returned to the status quo. Whether this is 2007 or 1992 is unclear in my opinion. What I do know is that we have resolved none of the problems that caused the credit crisis. Whether we are walking the edge of the cliff or on the launching pad of the next bull market remains uncertain. What is certain is that the Fed’s boom/bust policies are well intact and the U.S. economy will continue along its flawed path of bubbles = prosperity.
October saw U.S. consumers’ outstanding credit balances fall by 3.25%, the ninth straight month in a row balances have fallen. It seems clear now that Americans have learned that "credit" is not synonymous with "free money."
Tom’s right - this is completely outrageous! Our federal gov’t officials who participate in this sort of gifting should be thrown out, and the Constitution restored….. See an earlier post too, Our Chatty Cathy Congress. - Ilene
Buried in the law extending unemployment benefits and reauthorizing the tax credit for homebuyers was a “little” gift to any company that happened to lose money in the past five years. Here’s how she describes the largesse:
But tucked inside the law was another prize: a tax break that lets big companies offset losses incurred in 2008 and 2009 against profits booked as far back as 2004. The tax cuts will generate corporate refunds or relief worth about $33 billion, according to an administration estimate.
Before the bill became law, the so-called look-back on losses was limited to small businesses and could be used to counterbalance just two years of profits. Now the profit offset goes back five years, and the law allows big companies to take advantage of it, too. The only companies that can’t participate are Fannie Mae and Freddie Mac and any institution that took money under the Troubled Asset Relief Program.
Among the biggest beneficiaries are home builders, analysts say. Once again, at the front of the government assistance line, stand some of the very companies that contributed mightily to the credit crisis by building and financing too many homes.
Morgenson takes this travesty to task by focusing on the homebuilders. Fair enough. There are too many of them, they are financially in fine shape and based on recent history they appear to be managed by fools. Why they should receive such a gift is beyond comprehension.
There’s to my mind a bigger issue here, however. Why in an era in which the federal deficit is soaring beyond any comprehensible level and the absolute certainty that…
Size matters. And it particularly matters when the size of the financial system grossly exceeds the productive capacity of the underlying economy. Then problems arise. Surplus capital flows into paper assets triggering a boom. Then speculators pile in, driving asset prices higher. Margins grow, debts balloon, and bubbles emerge. The frenzy finally ends when the debts can no longer be serviced and the bubble begins to crumple, sometimes violently. As gas escapes, credit tightens, businesses are forced to cut back, asset prices plunge and unemployment soars. Deflation spreads to every sector. Eventually, the government steps in to rescue the financial system while the broader economy slumps into a coma.
The crisis that started two years ago, followed this same pattern. A meltdown in subprime mortgages sent the dominoes tumbling; the secondary market collapsed, and stock markets went into freefall. When Lehman Bros flopped, a sharp correction turned into a full-blown panic. Lehman tipped-off investors that that the entire multi-trillion dollar market for securitized loans was built on sand. Without price discovery, via conventional market transactions, no one knew what mortgage-backed securities (MBS) and other exotic debt-instruments were really worth. That sparked a global sell-off. Markets crashed. For a while, it looked like the whole system might collapse.
The Fed’s emergency intervention pulled the system back from the brink, but at great cost. Even now, the true value of the so-called toxic assets remains unknown. The Fed and Treasury have derailed attempts to create a public auction facility--like the Resolution Trust Corporation (RTC)--where prices can be determined and assets can be sold. Billions in toxic waste now clog the Fed’s balance sheet. Ultimately, the losses will be passed on to the taxpayer.
Now that the economy is no longer on steroids, the financial system needs to be downsized. The housing/equities bubble was generated by over-consumption that required high levels of debt-spending. That model requires cheap money and easy access to credit, conditions no longer exist. The economy has reset at a lower level of economic activity, so changes need to be made. The financial system needs to shrink.
The problem is, the Fed’s "lending facilities" have removed any incentive for financial institutions to deleverage. Asset prices are propped up by low interest, rotating loans on dodgy collateral. While households have suffered huge losses (of nearly $14 trillion) in…
I first wrote about the Muddle Through Economy in 2002, and the term has more or less become a theme we have returned to from time to time. In 2007 I wrote that we would indeed get back to a Muddle Through Economy after the end of the coming recession. If you Google the term, at least for the first four pages more than half the references are to this e-letter. I get a lot of flak from both bulls and bears about being either too optimistic or too pessimistic. Being in the muddle through middle is comfortable to me.
Last week I expressed my concern that we as a country are taking actions that could indeed "Kill the Goose" of our free-market economy. I rightly got letters asking me how I could maintain Muddle Through in the face of that letter. I have given it a lot of thought and research. How likely are we to muddle through in the face of $1.5 trillion and larger deficits? Today we take another look at Muddle Through. It should be interesting.
But first, two housekeeping items. I want to welcome the 150,000 members of the National Association of the Self-Employed to this letter. They have asked me to be a special consulting economist to their group, and they will send this letter each week to their members. Since its beginning in 1981, the National Association for the Self-Employed has pioneered support for micro-businesses and the self-employed, and been a forceful advocate for small business in this country. (www.nase.org) I am honored. I am pleased to add you to my 1 million closest friends. I hope you find it useful.
Second, I will be going to South America at the end of next week, to Buenos Aires, Montevideo, Sao Paulo and Rio. I will be speaking in those cities and traveling with my new Latin American partner, Enrique Fynn of Fynn Capital (based in Uruguay). If you would like to find out about this tour or what services he can help you with, you can go to www.accreditedinvestor.ws and sign up and Enrique will get in touch with you. And as always, if you are an accredited investor, you can go to that website and one of my partners in the world will get…
Timothy D. Naegele is the managing partner of Timothy D. Naegele & Associates. He has an undergraduate degree in economics and practices law in Washington D.C. and Los Angeles with his law firm that specializes in banking law, federal law, financing, Internet law, legislation and litigation. He has an extensive legislative and financial regulatory background, having served as counsel to the U.S. Senate Committee on Banking, Housing, and Urban Affairs, as chief of staff to U.S. Senator Edward W. Brooke, and as special consultant to the Federal Deposit Insurance Corporation and to the States of California and Maine. He has been involved in all phases of the practice of law with respect to financial institutions, including authoring the Anti-Tying Provision of the Bank Holding Company Act Amendments of 1970 and other important pieces of legislation. Mr. Naegele also served as a Captain in the U.S. Army, assigned to the Defense Intelligence Agency at The Pentagon, where he received the Joint Service Commendation Medal.
Today, Mr. Naegele continues practicing law, and finds time to share his thoughts on current events in popular journals. He is listed in Who’s Who in America, Who’s Who in American Law, and Who’s Who in Finance and Business. He has written extensively over the years. See, e.g., naegele.com/whats_new.html#articles.
Interview
Question: You worked on Capitol Hill for three and a half years—first as an attorney with the U.S. Senate Banking Committee, and then as chief of staff to former Senator Edward W. Brooke of Massachusetts, the first African-American senator since Reconstruction following our Civil War, with Barack Obama being the third[1]. And then you worked as a “K Street” lawyer after that, for a total of 19 years. What was it like?
Answer: It was fabulous. I came to Washington near the end of the Vietnam War because I had an Army commission, and I was assigned to the U.S. Army Element of the Defense Intelligence Agency at the Pentagon for two years, which was a wonderful experience.
Question: What did you learn there?
Answer: That the Pentagon and our military are probably the most efficient and effective organs of American government. People might laugh at that, but it is true.
Question: After that, you worked as an attorney with the U.S. Senate Banking Committee?
Nouriel Roubini used to be known Dr. Doom. These days, however, he insists he is a "realist."
What does that mean? Well, it means that he doesn’t think we’re in for a V shaped recovery but he doesn’t think we’re going L shaped either.
Appearing on CNBC’s Squawk Box this morning, he said we’re headed for an anemic, U-shaped recovery. Why not a V? Here are his reasons:
1. Labor market is still awful, labor income and consumption down.
2. U.S. consumer is shopped out; they save more, consume less.
3. Corporate sector- glut of capacity. Utilization is 69%
4. Financial system is damaged, credit growth is limited, can’t finance residential investments
5. Fiscal stimulus will be a drag, and lead to crowding out of product spending
6. Overspending countries like U.S. are now spending less, and oversaving countries like China, Japan, Germany are not increasing their private domestic consumption to compensate for falling U.S. demand.
Improvement in first time unemployment claims is slowing. Actual, not seasonally manipulated data, including an adjustment for the usual weekly upward revision, shows that the year to year rate of change is on the cusp of a possible upside breakout, which would be good news for stock market bears if it happens.
Initial Unemployment Claims Chart- Click to enlarge
Here’s why it’s mind blowing. I’ve plotted it below on an inverse scale with the S&P 500 overlaid.
Unemployemt Claims and Stock Prices - Click to enlarge
Major US Markets including (NYSEARCA:DIA), (NYSEARCA:SPY), (NASDAQ:QQQ), and (NYSEARCA:IWM) dropped over 3% each on Italian bond fears and an increased worry that Europe will not be able to bail out its 4th largest economy. Furthermore, the iShares MCSI Italy Fund (NYSEARCA:EWI) wiped out over 9% today, further illustrating the dire situation in Italy and the European Union: ...
The second economic disappointment of the day comes from the Dallas Fed, which dropped from -2.0 to -11.4 on expectations of -9.0- this was the 4th consecutive negative print month. The report was, in a word, horrible, with just 2 of the 15 constituent indices posting an increase, and the bulk solidly in the red, led by Unfilled and New Orders which dropped 16.8 and 11.2, respectively: not good for economic growth. On the employment side there was nothing good either, with both employment and hours worked declining by -...
Bloomberg reports that Diana Containerships (NASDAQ: DCIX) files to offer stock up to $172.5M. Diana Containerships says that Diana shipping will also buy $20M of stock.
Top 5 RisersStockRatingAnalysisVLOSTRONGBUYAn increasingly positive growth rate of past earnings, along with improving expectations for long term growth, make Valero a good prospect for high returns.KROSTRONGBUYKronos Worldwide has been gaining recognition from analysts as a good canditate for achieving higher than expected earnings along with higher overall projected valuation.SFIBUYiStar is one of the top candidates projected to achieve both higher than previously projected earnings in the short run and a higher earnings growth rate in the long run.AMATSTRONGBUYApplied Materials has been...
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February is now past, and the Biotech Porfolio is loaded with winners and a miss (PLX). MRK is down a bit, but I expect that trade to recover, and one could be more agressive and double down on it, or play another round at the Jan13 $30 options for roughly the same price. Below is the summary, and note the grey boxes are ones that did not fill. I am still a fan of BMRN, and like DEPO as well. Now let's look at a few others.
Table 1. PSW Biotech Plays Since January 2011
 
Our newest play is Momenta Pharmaceuticals (MNTA), who is pursuing a three-part business model which includes complex generic equivalents in partnership with the Sandoz division of Novartis, proprietary compounds, and follow-on- biologics (FOB). It seems that this company is tied up in competition/litigation wit...
Philip R. Davis is a founder Phil's Stock World, a stock and options trading site that teaches the art of options trading to newcomers and devises advanced strategies for expert traders...
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The United States government has made a curious series of interventionist moves over the course of the last 18 months. Some have been beneficial, but not surprisingly, few of these policies are actually helping the economy recover from the Great Recession.
The healthcare debate is a bit more messy. While the social aspects of healthcare spending are likely positive, you just have to wonder about the motives of the men pushing this plan when we are mired in the worst recession in 75 years. Is healthcare really our top priority when unemployment remains near 10%? More importantly, is this an efficient form of government spending when we could easily target job creation or other productive investments in the long-term growth of America (China’s high speed rail system comes to mind here). Meanwhile, we have an antiquated infrastructure. Where are the priorities?…
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Philip R. Davis is a founder Phil's Stock World, a stock and options trading site that teaches the art of options trading to newcomers and devises advanced strategies for expert traders...
Ilene is editor and affiliate program
coordinator for PSW. She manages the Favorites backup site
(