Thursday, November 16, 2017
Bubble Watch X
The title of this post is pronounced, "Bubble Watch Ten", not "Bubble Watch Ex". So don't sound uncool in public by calling it Bubble Watch Ex...
So the bears keep saying we are in overvalued territory and we will see a huge correction soon. On the other hand, we got guys like Dan Loeb really bullish. As usual, there are a lot of smart guys on each side.
This got me thinking a lot about why the bears have got it so wrong for so long (so far... they will eventually be right! I remember (before my time, but I read about it) how Joe Granville, one of the prominent technicians of the 1970's called for a crash in the market with the Dow at 800. He was proven correct; only problem is the market crashed from 2700 to 2200, so it didn't help at all that he was short from 800. Oops.)
What bubble?
One of the first things that come to mind when hearing all this bubble talk is that, to me, the stock market still doesn't feel at all like a bubble. OK, there may be some pockets of excess. But in general, I'm not getting the sense of a bubble. Nobody asks me about stocks. Nobody brags about their stock winnings. I am not reading about people quitting their jobs and playing the market to make a living (one of my biggest dollar wins on the short side ever was when I short Apple a while back when articles about people quitting their jobs and living off of their Apple stock gains started popping up, and they were on TV laughing at the skeptics saying that they 'just don't get it' (I am hearing/reading that now about Bitcoin, though! Japanese housewives, young people doing nothing but trading bitcoin and convinced they will never have to work again).
I don't hear any of that talk relating to the stock market. At all.
Plus, here's the other thing. People keep talking about how great the market has performed in recent years as another sign of a bubble.
But the problem with that, to me, is that a lot of that is just regaining what we lost during the crisis. If a stock tanks 50% and then doubles the next day, is the stock really overbought? I dunno.
Check out this long term chart of the S&P 500 index. I made it a log chart so we don't go, oh my god, it's parabolic! I do believe that parabolic patterns tend to collapse, but it is useless over long time periods.
And ignore the font and background color stuff... I was just playing with Excel, which I haven't used in a long time. But due to various issues (OneDrive being one of them), I have gone back to using Microsoft products and am trying to relearn this stuff. Google sheets is great, but very buggy and frustrating to deal with.
Anyway, if you look at the 1929 bubble, the market went far above it's previous peak. Just eye-balling, the market sort of peaked out at around 10 in 1910 or so, and then rallied to 31 in 1929. That's more than a triple of the old high. Before black monday the S&P 500 rallied to 330 before crashing, and the old high was around 100, so again, the market more than tripled before tanking. During the 1999/2000 bubble, the market went to 1500. If you use the old high of 330, the market rose by 4.5 times. if you use the 1993/1994 area high of 500, the market basically tripled that.
During the Nikkei bubble, the Nikkei rose from 8,000 (the early 1980's high) to 40,000 for a five-bagger in less than a decade. But a five-bagger off the old high, not bear market low.
Where are we now? The previous high was around 1,500 for the S&P, and it's now at close to 2,600. So it hasn't even doubled. And that's a high from 17 years ago. Even using the recent pre-crisis date of 2007, that's more than 10 years.
S&P 500 Index -> 4500!
I am no expert on bubbles, but to me, this is not a bubble. I would call this stock market a bubble if we tripled the old high, or if the S&P went to 4500 or something like that.
Yeah, you heard it hear first. S&P 500 index at 4500. That's what I would call a bubble.
This is sort of consistent with my idea that the market P/E would have to get to 50x for me to be convinced that the market is in bubble territory. You can read my old posts on why that is (based on interest rates. And don't forget, I use what I consider to be 'normalized' interest rates, not current levels).
So, if you ask me, I see no bubble at this point. At all.
Real Fed Funds
The other thing that popped into my head the other day was the comment, "Never short the market with negative real fed funds rate!". For no reason at all, this comment popped into my head and I couldn't get it out. This kept bugging me. The idea made a lot of sense, but I wasn't sure exactly where it came from. Of course, we all know not to "fight the fed", so this is a version of that, I suppose.
So when I got the time, I decided to just plot the real fed funds rate, and below is the chart:
And here's the thing. It seems like in recent history, the market has basically never gone into a serious bear market or crash with the real Fed Funds rate in negative territory. This makes logical sense. A negative FF rate means money is easy, and when money is easy, asset prices tend to go up. Shorting into that, I guess, is like fighting a tsunami with a teaspoon. Why would anyone do that?!
People keep saying that owning stocks at these levels is speculating, not investing. And yet, some of the folks who say that lose money when the market rallies, which means they are short. I don't know about you, but for me, shorting is speculating and has nothing to do whatsoever with investing. People seem not to understand the asymmetric risk/return involved in shorting versus just owning stocks.
Static versus Dynamic Models
Here's the other baffling thing. Much of the world seems still to be stuck in the world of static economic models. If something goes up, they must go down. If an expected return is low, the price must eventually decrease (ignoring the fact that expected return can remain low for a long, long time).
This all reminded me of an old book that confused a lot of conventional thinkers, and I think people who haven't read it should read it. Even now:
The Alchemy of Finance
(for some reason, my Amazon bookstore is dead... oh well. I haven't looked at it in a while and now it's just totally gone. I must have missed an email or two from Amazon (probably thought it was spam and ignored it)).
30 years later, it seems like economists still think the old way and haven't really modernized. I suppose there have been new developments in behavioral economics, but I don't really see much of it when people talk about the market and economy; they all still sound like they did back in the 1980's.
But then again, I guess it doesn't really matter all that much, because most people we see or hear about are asset gatherers and spend most of their time telling people what they want to hear. They don't really care as long as they can gather assets. The ones incorporating new models and making money won't talk about it.
Anyway, I think the Soros book is very timely right now as we probably are in the midst of some sort of virtuous circle. I admit this can't go on forever and things will eventually turn.
But figuring out when it will turn is something nobody will be able to do. If I had to guess, you know what I would say. I already made a case in previous posts that a market P/E of 50x or more would indicate to me a clear and present danger of a serious bubble. And now with the added analysis of a S&P 500 index at 4500 (this is not a forecast or projection!), that to me would also indicate a serious possibility of a bubble.
This Time is NOT Different
The bears always say, "This time is not different. Bulls like to think this time it's different". Well, I dunno. I am not necessarily bullish (I am a market perma-agnostic!), but I too agree that this time is not different.
I believe the market would have to get to bubble levels before we are at risk of a serious bear market. Also, in addition to the market and P/E levels I mention above, I will now also keep an eye on the real Fed Funds rate as the market has never in the past entered a serious bear market or crash with negative FF rates.
So no, this time is not different at all. And if it's not different, we shouldn't see a big bear or crash any time soon (famous last words! I know the market will start to tank right after I hit the "publish" button, but that's OK!).
So the bears keep saying we are in overvalued territory and we will see a huge correction soon. On the other hand, we got guys like Dan Loeb really bullish. As usual, there are a lot of smart guys on each side.
This got me thinking a lot about why the bears have got it so wrong for so long (so far... they will eventually be right! I remember (before my time, but I read about it) how Joe Granville, one of the prominent technicians of the 1970's called for a crash in the market with the Dow at 800. He was proven correct; only problem is the market crashed from 2700 to 2200, so it didn't help at all that he was short from 800. Oops.)
What bubble?
One of the first things that come to mind when hearing all this bubble talk is that, to me, the stock market still doesn't feel at all like a bubble. OK, there may be some pockets of excess. But in general, I'm not getting the sense of a bubble. Nobody asks me about stocks. Nobody brags about their stock winnings. I am not reading about people quitting their jobs and playing the market to make a living (one of my biggest dollar wins on the short side ever was when I short Apple a while back when articles about people quitting their jobs and living off of their Apple stock gains started popping up, and they were on TV laughing at the skeptics saying that they 'just don't get it' (I am hearing/reading that now about Bitcoin, though! Japanese housewives, young people doing nothing but trading bitcoin and convinced they will never have to work again).
I don't hear any of that talk relating to the stock market. At all.
Plus, here's the other thing. People keep talking about how great the market has performed in recent years as another sign of a bubble.
But the problem with that, to me, is that a lot of that is just regaining what we lost during the crisis. If a stock tanks 50% and then doubles the next day, is the stock really overbought? I dunno.
Check out this long term chart of the S&P 500 index. I made it a log chart so we don't go, oh my god, it's parabolic! I do believe that parabolic patterns tend to collapse, but it is useless over long time periods.
And ignore the font and background color stuff... I was just playing with Excel, which I haven't used in a long time. But due to various issues (OneDrive being one of them), I have gone back to using Microsoft products and am trying to relearn this stuff. Google sheets is great, but very buggy and frustrating to deal with.
Anyway, if you look at the 1929 bubble, the market went far above it's previous peak. Just eye-balling, the market sort of peaked out at around 10 in 1910 or so, and then rallied to 31 in 1929. That's more than a triple of the old high. Before black monday the S&P 500 rallied to 330 before crashing, and the old high was around 100, so again, the market more than tripled before tanking. During the 1999/2000 bubble, the market went to 1500. If you use the old high of 330, the market rose by 4.5 times. if you use the 1993/1994 area high of 500, the market basically tripled that.
During the Nikkei bubble, the Nikkei rose from 8,000 (the early 1980's high) to 40,000 for a five-bagger in less than a decade. But a five-bagger off the old high, not bear market low.
Where are we now? The previous high was around 1,500 for the S&P, and it's now at close to 2,600. So it hasn't even doubled. And that's a high from 17 years ago. Even using the recent pre-crisis date of 2007, that's more than 10 years.
S&P 500 Index -> 4500!
I am no expert on bubbles, but to me, this is not a bubble. I would call this stock market a bubble if we tripled the old high, or if the S&P went to 4500 or something like that.
Yeah, you heard it hear first. S&P 500 index at 4500. That's what I would call a bubble.
This is sort of consistent with my idea that the market P/E would have to get to 50x for me to be convinced that the market is in bubble territory. You can read my old posts on why that is (based on interest rates. And don't forget, I use what I consider to be 'normalized' interest rates, not current levels).
So, if you ask me, I see no bubble at this point. At all.
Real Fed Funds
The other thing that popped into my head the other day was the comment, "Never short the market with negative real fed funds rate!". For no reason at all, this comment popped into my head and I couldn't get it out. This kept bugging me. The idea made a lot of sense, but I wasn't sure exactly where it came from. Of course, we all know not to "fight the fed", so this is a version of that, I suppose.
So when I got the time, I decided to just plot the real fed funds rate, and below is the chart:
And here's the thing. It seems like in recent history, the market has basically never gone into a serious bear market or crash with the real Fed Funds rate in negative territory. This makes logical sense. A negative FF rate means money is easy, and when money is easy, asset prices tend to go up. Shorting into that, I guess, is like fighting a tsunami with a teaspoon. Why would anyone do that?!
People keep saying that owning stocks at these levels is speculating, not investing. And yet, some of the folks who say that lose money when the market rallies, which means they are short. I don't know about you, but for me, shorting is speculating and has nothing to do whatsoever with investing. People seem not to understand the asymmetric risk/return involved in shorting versus just owning stocks.
Static versus Dynamic Models
Here's the other baffling thing. Much of the world seems still to be stuck in the world of static economic models. If something goes up, they must go down. If an expected return is low, the price must eventually decrease (ignoring the fact that expected return can remain low for a long, long time).
This all reminded me of an old book that confused a lot of conventional thinkers, and I think people who haven't read it should read it. Even now:
The Alchemy of Finance
(for some reason, my Amazon bookstore is dead... oh well. I haven't looked at it in a while and now it's just totally gone. I must have missed an email or two from Amazon (probably thought it was spam and ignored it)).
30 years later, it seems like economists still think the old way and haven't really modernized. I suppose there have been new developments in behavioral economics, but I don't really see much of it when people talk about the market and economy; they all still sound like they did back in the 1980's.
But then again, I guess it doesn't really matter all that much, because most people we see or hear about are asset gatherers and spend most of their time telling people what they want to hear. They don't really care as long as they can gather assets. The ones incorporating new models and making money won't talk about it.
Anyway, I think the Soros book is very timely right now as we probably are in the midst of some sort of virtuous circle. I admit this can't go on forever and things will eventually turn.
But figuring out when it will turn is something nobody will be able to do. If I had to guess, you know what I would say. I already made a case in previous posts that a market P/E of 50x or more would indicate to me a clear and present danger of a serious bubble. And now with the added analysis of a S&P 500 index at 4500 (this is not a forecast or projection!), that to me would also indicate a serious possibility of a bubble.
This Time is NOT Different
The bears always say, "This time is not different. Bulls like to think this time it's different". Well, I dunno. I am not necessarily bullish (I am a market perma-agnostic!), but I too agree that this time is not different.
I believe the market would have to get to bubble levels before we are at risk of a serious bear market. Also, in addition to the market and P/E levels I mention above, I will now also keep an eye on the real Fed Funds rate as the market has never in the past entered a serious bear market or crash with negative FF rates.
So no, this time is not different at all. And if it's not different, we shouldn't see a big bear or crash any time soon (famous last words! I know the market will start to tank right after I hit the "publish" button, but that's OK!).
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