Overlooking Overvaluation
Guest post by Hussman Funds.
In the day-to-day focus on the “fiscal cliff,” our own concern about a U.S. recession already in progress, and the inevitable flare-up of European banking and sovereign debt strains, it’s easy to overlook the primary reason that we are defensive here: stocks are overvalued, and market conditions have moved in a two-step sequence from overvalued, overbought, overbullish, rising yield conditions (and an army of other hostile indicator syndromes) to a breakdown in market internals and trend-following measures. Once in place, that sequence has generally produced very negative outcomes, on average. In that context, even impressive surges in advances versus declines (as we saw last week) have not mitigated those outcomes, on average, unless they occur after stocks have declined precipitously from their highs. Our estimates of prospective stock market return/risk, on a blended horizon from 2-weeks to 18-months, remains among the most negative that we’ve observed in a century of market data.
On the valuation front, Wall Street has been lulled into complacency by record profit margins born of extreme fiscal deficits and depressed savings rates. Profits as a share of GDP are presently about 70% of their historical norm, and profit margins have historically been highly sensitive to cyclical fluctuations. So the seemingly benign ratio of “price to forward operating earnings” is benign only because those forward operating earnings are far out of line with what could reasonably expected on a sustained long-term basis.
It’s helpful to examine valuations that are based on “fundamentals” that don’t fluctuate strongly in response to temporary ups and downs of the business cycle. The chart below compares historical price/dividend, price/revenue, price/book and Shiller P/E (S&P 500 divided by the 10-year average of inflation-adjusted earnings) to their respective historical norms prior to the late-1990’s market bubble – a reading of 1.0 means that valuations are at their pre-bubble norm.
Where has all the risk gone?
A few points on risk and size by Golem XIV.
People always say Follow the Money. You might do better to Follow the Risk.
Risk is the pollution created by the process of making money. So where you find people making one you will surely find them hiding the other. You’ll find both at the banks.
Banks have managed to convince the regulatory authorities – their regulatory authorities, and I use the word ‘their’ advisedly – to convinced them to count the creation and storing of risk as part of the banks contribution to the nation’s GDP. I wrote about how our governments count risk creation and storage of as part of the bank’s GVA (Gross Value Added) in What the Banks Contribute to GDP. Our government’s reasoning is that risk is an unavoidable by-product of the financial industry so the industry should get credit for dealing with the stuff. But imagine counting the creation and storage of radioactive waste as part of the value added of the nuclear industry? Would it not seem perverse to celebrate increases in the amount of waste being stored and see it as evidence of what a wonderful industry it was, rather than ask why they produced so much in the first place? Would it not seem odd to talk glowingly (sorry) of the increases in radiation levels being stored, and reward the industry accordingly, rather than ask if there might not be a safer, less radioactive way of generating power? It seems to me this is the situation we are in with banking.
Remember Japan?
People are obsessed with the Euromess and the Fiscal Cliff. What about Japan? A few reflections via Caixin Online.
Every time I come to Japan to attend a conference, I am reminded of what a depression looks like in the 21st century. This time is no different: shops are not busy, restaurant owners wait anxiously outside for customers and are usually disappointed, empty taxi cabs roam the streets. Two decades after its property bubble began to deflate, Japan remains mired in deflation and contraction.
The economic statistics tell the horror story best. Japan’s nominal GDP in 2011 was 9 percent lower than in 2007 and 2.5 percent lower than in 1992! In 1992, the national debt was only 20 percent of GDP. It is now 230 percent. Essentially, 200 percent of GDP in fiscal stimulus hasn’t turned the economy around.
The depression dynamic begins with declining incomes. People then spend less to cope. Shops and restaurants become emptier. The weak demand depresses business profitability and investment. The former depresses the stock market, and the latter labor income. Both pressure people to spend even less.
Few people pay attention to Japan’s problems nowadays. Financial markets pay a lot of attention to the United States’ economic problems. But its nominal GDP rose 7 percent between 2007 and 2011 and is likely to rise another 4 percent in 2012. Japan could at best achieve zero growth in nominal GDP in 2012. The performance gap between the United States and Japan is 20 percent in nominal GDP since 2007. America’s national debt has doubled since 2007 and reached 100 percent of GDP in 2012. Its trend isn’t sustainable either. But Japan’s debt problem is more advanced in depth. Its debt crisis should occur before the United States’.
The Data That Won It For Obama
Guest post by Azizonomics.
I wondered during the final debate whether Mitt Romney might steal a phrase from Ronald Reagan and ask Americans if they were better off than they were four years ago. It has worked for the Republicans before, and all the polling data pointed to the idea that voters were looking at the economy as the top issue.
Yet Romney did no such thing. Perhaps that was because by a number of significant measures, many Americans are better off than they were three or four years ago when America was mired in the epicentre of a global economic crisis. While America is in many cases just catching up to ground lost in the 2008 crash, and while many significant and real doubts remain about the underlying fundamentals of the American and global economies, the American economy has reinflated since early 2009.
Next – Fiscal Cliff
Obama has another four years, but the Fiscal Cliff is soon here. So, what is the fiscal cliff. Here a quick explanation if you still haven’t heard about “IT”. From Wikipedia.
The United States fiscal cliff refers to the effect of a series of enacted legislation which, if unchanged, will result in tax increases, spending cuts, and a correspondingreduction in the budget deficit.[1] These laws include tax increases due to the expiration of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 and the spending reductions (“sequestrations”) under the Budget Control Act of 2011.
The year-over-year changes for fiscal years 2012-2013 include a 19.63% increase in revenue and 0.25% reduction in spending.[2]
Some major domestic programs, like Social Security, federal pensions and veterans’ benefits, are exempted from the spending cuts. Spending for federal agencies andcabinet departments, including defense, would be reduced through budget sequestration.
The deficit for 2013 is projected to be reduced by roughly half, with the cumulative deficit over the next ten years to be lowered by as much as $7.1 trillion. However, it is also projected to cause a double-dip recession in the first half of 2013.[3]
The Budget Control Act of 2011 was passed under the political environment of a partisan stalemate, in which Democrats and Republicans could not agree on how to reduce the deficit. It was thought that the blunt cuts of budget sequestration and sharp revenue increases would be mutually undesirable to both parties and provide an impetus and deadline to bring the sides together to solve the deficit problem.
Why are we bailing out the banks? – Part Four – What happens now?
Another must read by Golem XIV.
In part one of this series I suggested that the simple reason we were bailing out the banks and simultaneously cutting public spending was because,
If the banks were to be wound up it is their [the wealthiest 10%'s] credit/debt backed ‘money and the assets held in it, which would burn to ash….So the simple reason our rulers insist on bailing out the banks is that by doing so the wealthy and the powerful are simply bailing out themselves and guaranteeing the continuation of a system which suits them perfectly.
In part two I argued that while the simple selfishness answer is true there are also theoretical justifications (albeit flawed ones) for the bail and cut policy.
The two aspects of their policy ‘bail and cut’, they will insist are not contradictory at all. Simply put, they will say they are loosening or increasing the money supply (QE) in order to invest in growth (classic Keynesian) while simultaneously cutting those expenditures which they feel do not generate growth and which are in fact ‘drains’ on productivity – in their view any ‘public’ expenditure (Classic Free-market). Growth, for them, equals the free-market/private sector, while drains on growth equal government, public spending….Basically – Private Debt good, Public Debt bad.
China So(u)cks
While people debate the Eurozone “miracle”, China continues to show weakness. This time the socks industry is feeling the pinch, and remember, we all have to wear socks. From The Guardian.
The foolish man built his house upon sand; the wise man built his house on a rock. The ambitious entrepreneurs of Datang chose a sturdy nylon and wool foundation. “People always need socks,” points out Xu Leile, whose company clothes the feet of the British and US armies, European hikers and pampered pet dogs.
Thanks to Xu and hundreds more like him, “Sock City” – north-west of Tie Town, east of Sweater Town – epitomised China‘s economic success story. The obscure settlement in eastern Zhejiang province became an export-driven boomtown, producing as much as a third of the world’s sock supply and thriving even through the financial crisis in 2008 and the subsequent global recession.
Summertime Blues
Somehow something feels not right, especially with the emerging markets slowing down. From The Economist.
The global economy expanded by just 2.8% in the year to the second quarter, according to The Economist’s measure of world GDP (see chart). That is the slowest rate since the end of 2009, when recovery from savage recession in the wake of the financial crisis was getting under way. The most perturbing aspect of the current slowdown is that the weakness is so widespread, affecting emerging economies as well as rich countries.
The most fragile economy in the rich world is that of the troubled euro area, where GDP shrank by 0.2% (an annualised decline of 0.7%) in the second quarter, leaving it 0.4% smaller than a year earlier. Beset by fears about a possible Greek exit and a bigger bail-out for Spain (which this week received a rescue request of its own, from Catalonia’s regional government), the euro zone is sliding ever deeper into the mire. A composite index of output in manufacturing and services from Markit, a research firm, based on purchasing-manager reports in July and August, is pointing to a further fall in GDP in the third quarter. (Full article here).
Spain’s new headache – Deposit Flight from the Banks
With actually nothing fixed in Spain, people in Spain are now replicating the Greek behavior. Money is flowing out of the country. From the Telegraph.
Data from the European Central Bank shows that outflows from Spanish commercial banks reached €74bn (£59bn) in July, twice the previous monthly record. This brings the total deposit loss over the past year to 10.9pc, replicating the pattern seen in Greece as the crisis spread.
It is unclear how much of the deposit loss is capital flight, either to German banks or other safe-haven assets such as London property. The Bank of Spain said the fall is distorted by the July effect of tax payments and by the expiry of securitised funds.
Julian Callow from Barclays Capital said the deposit loss is €65bn even when adjusted for the season: “This is highly significant. Deposit outflows are clearly picking up and the balance sheet of the Spanish banking system is contracting.”
Death of Equities Exaggerated-Explaining Equity Valuation
There has been quite a few articles lately proclaiming the death of the Equities culture.
With PIMCO’s Gross getting full attention with his “extreme” views, below is an in depth explanation of Equities Returns.
Full report below, courtesy of Ben Inker.
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