Examining The Most Hated Bull Market Ever

Authored by Lance Roberts via RealInvestmehtAdvice.com,

From last week:

“The seemingly “impervious” advance since the election last November, has had an interesting “stair step” pattern with each advance commencing from a breakout of a several month 3%-ish consolidation range. Furthermore, each advance then pushes to a 3-standard deviation extreme, black circles, of the 50-dma before beginning the next consolidation trading range.”

The last leg higher has been directly responsive to the ramp up in the political “marketing surge” surrounding “tax cuts and tax reform.” With the House having already passed their respective budget resolutions, late Thursday, the Senate passed a budget blueprint for the next fiscal year. With both of the “budget resolutions” in place, it was seen as clearing a hurdle to the goal of overhauling the tax code.

This is not new, of course, as the entire rally for the markets since the election has been driven by hopes of lower taxes, despite disaster, floods, fires and Central Bank threats of liquidity extraction.

The bulls are clearly in charge which keeps us allocated to towards equity risk currently.

Do not be mistaken, this “rally” IS all about tax cuts. Despite many who are suggesting this has been a “rational rise” due to strong earnings growth, that is simply not the case as shown below. (I only use “reported earnings” which includes all the “bad stuff.” Any analysis using “operating earnings” is misleading.)

Since 2014, the stock market has risen (capital appreciation only) by 35% while reported earnings growth has risen by a whopping 2%. A 2% growth in earnings over the last 3-years hardly justifies a 33% premium over earnings. 

Of course, even reported earnings is somewhat misleading due to the heavy use of share repurchases to artificially inflate reported earnings on a per share basis. However, corporate profits after tax give us a better idea of what profits actually were since that is the amount left over after those taxes were paid.

Again we see the same picture of a 32% premium over a 3% cumulative growth in corporate profits after tax. There is little justification to be found to support the idea that earnings growth is the main driver behind asset prices currently.

We can also use the data above to construct a valuation measure of price divided by corporate profits after tax. As with all valuation measures we have discussed as of late, and forward return expectations from such levels, the P/CPATAX ratio just hit the second highest level in history.

The reality, of course, is that investors are simply chasing asset prices higher as exuberance overtakes logic and their actions prove the case.  According to data from FactSet, stock-based exchange-traded funds have seen nearly $16 billion in inflows over the past week, which represents an acceleration from recent positioning. Over the past month, about $31.3 billion has gone into stock-based ETFs. The chart below of data from ICI shows much of the same with monthly equity ETF inflows surging since the election.

The same is seen when we also add in equity mutual funds for a look at total equity asset flows.

Not surprisingly, those actions have been backed by their massive elevation in bullish sentiment.

As UMich noted:

“Consumer sentiment surged in early October, reaching its highest level since the start of 2004. The October gain was broadly shared, occurring among all age and income subgroups and across all partisan viewpoints.

 

There is an unmistakable sense among consumers that economic prospects are now about as ‘good as it gets."”

Most hated bull market ever…hardly.

Historically speaking, you only witness such exuberance in the latter stages of an expansion, not the beginnings of one. The latest survey indicates that consumers do not anticipate an economic downturn anytime in the foreseeable future, which from a contrarian perspective may be a clear warning sign.

Clearly, the expected benefits of tax cuts and reforms is leading investors to overpay for something today they are hoping will become fairly valued tomorrow. In other words, instead of prices catching “down” to market fundamentals, investors are hoping fundamentals will “catch up” to prices.

Unfortunately, there isn’t a previous case in history where this has been the case.

Also, when we look at 20-year trailing returns, there is sufficient historical evidence to suggest total, real returns, will decline towards zero over the next 3-years from 7% annualized currently. 

(These are trailing 20-year total real returns, not forward)

Re-read that last sentence again and look closely at the chart above. From current valuation levels, the annualized return on stocks by the end of the current 20-year cycle will be close to 0%. A decline in the next 3-years of only 30%, the average drawdown during a recession, will achieve that goal. 

For investors, this is crucially important. In the article “Apathy & The Death Of Your Financial Goals,” I discussed the reality of the damage caused by market drawdowns. As I stated:

“Crashes matter, a lot.” 

While investors may “get back to even,” eventually, following a crash, the shortfall from their actual financial goal continues to build.

This is why using some method of risk management, such as a simple moving average crossover, can help alleviate some of the financial damage caused by drawdowns.

• YES! You will miss out on some gains in the market.


• YES! Sometimes you will be “stopped out” and have to “buy back in.” 


• YES! You will be much more successful in obtaining your financial goals long-term.

After all, isn’t that why you invest in the first place?

What I can assure you of is that you WILL be wrong from time to time and you WILL lose money. But that is the inherent nature of investing. It is a “RISK” based endeavor.

However, I can absolutely guarantee that trying to “passively index” in the current market environment will absolutely wind up screwing up your long-term goals.

Think about it this way. IF investing was as easy as just buying a bunch of stuff and sitting on it, then why are so many Americans dependent on Social Security for retirement? Via Jared Dillian:

• 19.7% of retirees get 100% of their income from Social Security.


• A full third (33.4%) depend on it for 90% of their income.


• And 61.1% get at least half their income from Social Security.

The federal government’s unfunded 75-year liability for Social Security and Medicare combined is $46.7 trillion.

Are you absolutely sure you want to rely on the Government for your retirement?

Think about it the next time someone tells you to just “buy and hold.”

GDP Is Bogus: Here's Why

Authored by Charles Hugh Smith via OfTwoMinds blog,

Here"s a chart of our fabulous always-higher GDP, adjusted for another bogus metric, official inflation.

The theme this week is The Rot Within.

The rot eating away at our society and economy is typically papered over with bogus statistics that "prove" everything"s getting better every day in every way. The prime "proof" of rising prosperity is the Gross Domestic Product (GDP), which never fails to loft higher, with the rare excepts being Spots of Bother (recessions) that never last more than a quarter or two.

Longtime correspondent Dave P. of Market Daily Briefing recently summarized the key flaw in GDP: GDP doesn"t reflect changes in the balance sheet, i.e. debt.

So if we borrow money to pay people to dig holes and then fill them with the excavated dirt, GDP rises to general applause. The debt we took on to fund the make-work isn"t accounted for at all.

Here"s Dave"s explanation:

Once I learned about accounting, I figured out why the GDP metric wasn"t sufficient. What is missing?

The balance sheet.

Hurricanes are a direct hit to your nation"s balance sheet. The national income statement goes up because of increased spending to replace lost assets, but the "equity" part of the national balance sheet ends up taking a hit in direct proportion to the damage that occurred. Even if you rebuild everything just the way it was, your assets remain the same, while your liabilities have increased.

We know this because we use the balance sheet equation: equity = assets - liabilities. Equity is another word for wealth.

Before hurricane:

wealth = (house + car) - (home debt + car debt)

After hurricane, you rebuild your house, and buy a new car, using borrowed money:

wealth = (house + car) - (2 x home debt + 2 x car debt)

Wealth (equity) has declined by the sum (home debt + car debt)

So when you see pictures of a hurricane strike, you can now look through all that devastation and see the impact on the balance sheet. National equity (wealth) just dropped by the amount of damage inflicted by the hurricane. Whether it is ever rebuilt doesn"t actually matter; that equity is just gone. Destruction is always a downside for equity - even if there is a temporary positive impact on the income statement.

Isn"t it interesting that the mainstream economists, who don"t use banks, debt, or money in their models, largely ignore balance sheets and instead just looks at the income statement alone? Its almost as if the entire education system was organized so that people paid no attention to banks, debt, and money. Who do you think might benefit from our flock of PhD economists ignoring the extremely profitable debt-elephant in the room, and its purveyors, the banks?

Thank you, Dave, for an explanation we never see in the mainstream. And here"s a chart of our fabulous always-higher GDP, adjusted for another bogus metric, official inflation:

*  *  *

If you found value in this content, please join me in seeking solutions by becoming a $1/month patron of my work via patreon.com. Check out both of my new books, Inequality and the Collapse of Privilege ($3.95 Kindle, $8.95 print) and Why Our Status Quo Failed and Is Beyond Reform ($3.95 Kindle, $8.95 print, $5.95 audiobook) For more, please visit the OTM essentials website.

Would You Pay $2,500 For One Hour With An Equity Analyst? This I-Bank Seems To Think So...

Wall Street equity analysts are paid "yuge" salaries to employee the finance skills they picked up from their business school professors to value various corporate securities and asset-backed securitization structures, among other things.  And while their valuations of those securities have served as a frequent source of comic relief for many of us over the years, no bastardization of basic financial concepts tops recent attempts by the financial elites of the world to place a value on their own services.

As evidence of that fact, we present to you "Exhibit A" from a Bloomberg article published earlier today suggesting that Morgan Stanley, who is still trying to figure out how much their equity research is worth to clients after nearly a year of internal cogitation, is considering asking hedge fund clients for $2,500 for the extreme pleasure of spending just one hour with one of their esteemed research analysts.

Fund managers will have to pay about $2,500 for an hour-long, one-on-one meeting with some of Morgan Stanley’s equity analysts once Europe’s MiFID II financial rules kick in, according to people with knowledge of the plan.

The fee is on top of the annual rate Morgan Stanley plans to charge some clients for basic access to its equity research portal once the regulations come into force in January, the people said, asking not to be named as the negotiations are private. The bank also quoted a small client $25,000 annually for five users for basic equity research access and five total hours of analyst time, another person said.

Of course, any I-banking summer intern could easily spot the outlier in Morgan Stanley"s proposed $2,500 hourly billing rate when matched up against comps from the legal industry.  According to the National Law Journal, even the priciest partners at the best law firms can only command hourly billing rates equal to roughly half of what Morgan Stanley wants.

Meanwhile, the "median" partner at any given law firm only gets paid about one-fifth of Morgan Stanley"s proposal.

As McKinsey & Co. recently pointed out, the end result is that new European regulations designed to separate research and trading revenue for investment banks will likely cost them more than $1 billion as clients become pickier about what they pay for. 

Of course, ultimately the market will set a clearing price for the "value add" of equity analysts...and we"re almost certain it"s going to surprise some folks.

Despite Yellen's "Uncertainty", VIX Crushed Back To A 9 Handle

US equity markets are ramping higher (aside from Small Caps) this morning as it appears the word "uncertain" - uttered ubiquitously by Fed Chair Yellen in the last two days - has a different meaning in stock-land...

VIX hammered to a 9-handle, sending stocks soaring...

Oh, and decliners are outpacing advancers...

Headlines: Everything is awesome. pic.twitter.com/XH4Vg3V3D1

— Sven Henrich (@NorthmanTrader) July 13, 2017

An Absurd Unintended Consequence Of Abnormally Low Rates

By Chris at www.CapitalistExploits.at

Market dislocations occur when financial markets, operating under stressful conditions, experience large widespread asset mispricing.

Welcome to this week’s edition of “World Out Of Whack” where every Wednesday we take time out of our day to laugh, poke fun at and present to you absurdity in global financial markets in all its glorious insanity.

While we enjoy a good laugh, the truth is that the first step to protecting ourselves from losses is to protect ourselves from ignorance. Think of the “World Out Of Whack” as your double thick armour plated side impact protection system in a financial world littered with drunk drivers.

Selfishly we also know that the biggest (and often the fastest) returns come from asymmetric market moves. But, in order to identify these moves we must first identify where they live.

Occasionally we find opportunities where we can buy (or sell) assets for mere cents on the dollar – because, after all, we are capitalists.

In this week’s edition of the WOW: An Absurd Unintended Consequence Of Abnormally Low Interest Rates

Even the dullest amongst us have heard about compound interest.

The story goes like this: you can become wealthy - not rich, but wealthy - by foregoing those lattes, $100 haircuts, and saving a decent portion of your income. You earn interest on those savings and let it compound.

By the time your hips are giving in and your bladder has begun to leak it"s all turned into a decent little stash while the Jones" next door who"ve spent their lives upgrading the Lexus every year and holidaying in Hawaii will be asking you for a loan to pay for the leaking roof.

This all works when you can actually earn interest on your money.

And so ever since our central bank overlords with their well intentioned but entirely destructive policies have driven rates through the floor the ability to achieve yield has been destroyed.

The distortions globally are truly breathtaking.

Take a look at this:

In the world of illiquid private assets such as venture capital and private equity asset prices are determined largely by:

1. The valuation based on the last successful financing round


2. Any liquidity event (trade sales, IPOs)


3. Or... "belly-upedness"

Last month the WSJ ran an article about Investindustrial, a European private equity fund run by one Andrea Bonomi who, while running an existing fund, just raised gobs of new money ($800m to be exact) and launched a new fund to buy the assets of the old fund.

Wait! What??

The story, according to the WSJ, goes like this:

"Buyout firms face increasing competition from patient investors like sovereign-wealth funds. One has found a way to play them at their own game: Investindustrial, a European buyout firm, is creating a new fund to buy €750 million ($800 million) of assets it already owns.

Investindustrial, founded by Italian dealmaker Andrea Bonomi, has decided on this novel course of action as it responds to greater competition for assets from institutions such as sovereign-wealth funds, which don’t have restrictions on how long they can own companies. The competition is pressuring buyout firms to devise new ways to own companies."

Maybe...

Let"s put ourselves in the shoes of Bonomi and ask a few of questions.

How would you solve a "valuation issue" as well as a "liquidity issue" when, after looking for buyers for your funds" assets, the intersection of willing buyer and that of your private equity fund"s NAV doesn"t intersect where it "should"?

If you could turn fictional paper profits into real ones with a liquidity event, would you?

If you could earn fees on both the buy and sell side of a transaction, any transaction, would you?

If you couldn"t find a buyer at the valuations you"ve been reporting to your LPs, pray tell, how would you solve both the "valuation" and "liquidity" problem?

Looks to me like Andrea is taking the mickey, but hey, if he can find fools investors willing to go along with it then who am I to be a buzz kill?

Tip of an iceberg...

Now consider pension funds who, in order to maintain their funding, need to deliver a particular return. Returns, I might add, which the liquid market are quite simply not providing them.

Remember, pension funds invest the vast majority in "safe" investments and are therefore predominately invested in fixed income markets, which brings me all the way back to the chart I started this discussion with. Yikes!

As you can see by going to zero or negative interest rates, the true market price of risk isn"t just distorted, it"s largely completely unknown at this point.

Since the market can"t function through proper price discovery mechanics quite literally every asset price globally - whether it be equities, bonds, real estate, and even cash - is distorted.

Ask any money manager what method they"re using to price risk premiums at and they"re all lost. Nobody really knows and yet we have to price assets somehow.

Private equity assets, for their part, provide these guys with an ability to extend maturities and on the face of it reduce volatility. After all, how volatile is an asset which only changes hands once every 5 to 10 years and one which has done nothing but go up as investors have been pushed further and further down the risk curve?

As Bloomberg recently pointed out:

"According to The Pew Charitable Trusts, allocations to alts by pension funds have gone from just 11 percent in 2006 to almost 30 percent today."

And as Credit Suisse in a research note mention:

"In 1980, there were only 24 private equity firms and deal volume only modestly exceeded $1 billion. Today, there are more than 3,000 U.S. private equity firms and assets under management for buyout funds are roughly $825 billion, up from $80 billion in 1996 and less than $1 billion in 1976.12 Two of the largest private equity firms, The Carlyle Group and KKR & Co, each have more than 720,000 employees in their portfolio companies, which means they both employ more people than any U.S. listed company except for Wal-Mart Stores, Inc."

Private equity ticks many of the required boxes for pension funds.

• Reduced volatility (until you have to sell),


• Higher returns.

And that, my friends, opens a whole new can of worms because, as the demographic pig moves through the python, redemptions will increase, meaning asset sales will need to be taking place. And this right at a time when global liquidity is contracting. But that is a fun topic for another edition of World Out Of Whack.

Question for the day

Cast your vote here and also see what others would do

- Chris

"Low and expanding risk premiums are at the root of nearly every abrupt market loss." — Raghuram Rajan, the governor of the Reserve Bank of India, who is one of the few economists who foresaw the financial crisis

--------------------------------------

Liked this article? Don"t miss our future missives and podcasts, and

get access to free subscriber-only content here.

--------------------------------------

An Absurd Unintended Consequence Of Abnormally Low Rates

By Chris at www.CapitalistExploits.at

Market dislocations occur when financial markets, operating under stressful conditions, experience large widespread asset mispricing.

Welcome to this week’s edition of “World Out Of Whack” where every Wednesday we take time out of our day to laugh, poke fun at and present to you absurdity in global financial markets in all its glorious insanity.

While we enjoy a good laugh, the truth is that the first step to protecting ourselves from losses is to protect ourselves from ignorance. Think of the “World Out Of Whack” as your double thick armour plated side impact protection system in a financial world littered with drunk drivers.

Selfishly we also know that the biggest (and often the fastest) returns come from asymmetric market moves. But, in order to identify these moves we must first identify where they live.

Occasionally we find opportunities where we can buy (or sell) assets for mere cents on the dollar – because, after all, we are capitalists.

In this week’s edition of the WOW: An Absurd Unintended Consequence Of Abnormally Low Interest Rates

Even the dullest amongst us have heard about compound interest.

The story goes like this: you can become wealthy - not rich, but wealthy - by foregoing those lattes, $100 haircuts, and saving a decent portion of your income. You earn interest on those savings and let it compound.

By the time your hips are giving in and your bladder has begun to leak it"s all turned into a decent little stash while the Jones" next door who"ve spent their lives upgrading the Lexus every year and holidaying in Hawaii will be asking you for a loan to pay for the leaking roof.

This all works when you can actually earn interest on your money.

And so ever since our central bank overlords with their well intentioned but entirely destructive policies have driven rates through the floor the ability to achieve yield has been destroyed.

The distortions globally are truly breathtaking.

Take a look at this:

In the world of illiquid private assets such as venture capital and private equity asset prices are determined largely by:

1. The valuation based on the last successful financing round


2. Any liquidity event (trade sales, IPOs)


3. Or... "belly-upedness"

Last month the WSJ ran an article about Investindustrial, a European private equity fund run by one Andrea Bonomi who, while running an existing fund, just raised gobs of new money ($800m to be exact) and launched a new fund to buy the assets of the old fund.

Wait! What??

The story, according to the WSJ, goes like this:

"Buyout firms face increasing competition from patient investors like sovereign-wealth funds. One has found a way to play them at their own game: Investindustrial, a European buyout firm, is creating a new fund to buy €750 million ($800 million) of assets it already owns.

Investindustrial, founded by Italian dealmaker Andrea Bonomi, has decided on this novel course of action as it responds to greater competition for assets from institutions such as sovereign-wealth funds, which don’t have restrictions on how long they can own companies. The competition is pressuring buyout firms to devise new ways to own companies."

Maybe...

Let"s put ourselves in the shoes of Bonomi and ask a few of questions.

How would you solve a "valuation issue" as well as a "liquidity issue" when, after looking for buyers for your funds" assets, the intersection of willing buyer and that of your private equity fund"s NAV doesn"t intersect where it "should"?

If you could turn fictional paper profits into real ones with a liquidity event, would you?

If you could earn fees on both the buy and sell side of a transaction, any transaction, would you?

If you couldn"t find a buyer at the valuations you"ve been reporting to your LPs, pray tell, how would you solve both the "valuation" and "liquidity" problem?

Looks to me like Andrea is taking the mickey, but hey, if he can find fools investors willing to go along with it then who am I to be a buzz kill?

Tip of an iceberg...

Now consider pension funds who, in order to maintain their funding, need to deliver a particular return. Returns, I might add, which the liquid market are quite simply not providing them.

Remember, pension funds invest the vast majority in "safe" investments and are therefore predominately invested in fixed income markets, which brings me all the way back to the chart I started this discussion with. Yikes!

As you can see by going to zero or negative interest rates, the true market price of risk isn"t just distorted, it"s largely completely unknown at this point.

Since the market can"t function through proper price discovery mechanics quite literally every asset price globally - whether it be equities, bonds, real estate, and even cash - is distorted.

Ask any money manager what method they"re using to price risk premiums at and they"re all lost. Nobody really knows and yet we have to price assets somehow.

Private equity assets, for their part, provide these guys with an ability to extend maturities and on the face of it reduce volatility. After all, how volatile is an asset which only changes hands once every 5 to 10 years and one which has done nothing but go up as investors have been pushed further and further down the risk curve?

As Bloomberg recently pointed out:

"According to The Pew Charitable Trusts, allocations to alts by pension funds have gone from just 11 percent in 2006 to almost 30 percent today."

And as Credit Suisse in a research note mention:

"In 1980, there were only 24 private equity firms and deal volume only modestly exceeded $1 billion. Today, there are more than 3,000 U.S. private equity firms and assets under management for buyout funds are roughly $825 billion, up from $80 billion in 1996 and less than $1 billion in 1976.12 Two of the largest private equity firms, The Carlyle Group and KKR & Co, each have more than 720,000 employees in their portfolio companies, which means they both employ more people than any U.S. listed company except for Wal-Mart Stores, Inc."

Private equity ticks many of the required boxes for pension funds.

• Reduced volatility (until you have to sell),


• Higher returns.

And that, my friends, opens a whole new can of worms because, as the demographic pig moves through the python, redemptions will increase, meaning asset sales will need to be taking place. And this right at a time when global liquidity is contracting. But that is a fun topic for another edition of World Out Of Whack.

Question for the day

Cast your vote here and also see what others would do

- Chris

"Low and expanding risk premiums are at the root of nearly every abrupt market loss." — Raghuram Rajan, the governor of the Reserve Bank of India, who is one of the few economists who foresaw the financial crisis

--------------------------------------

Liked this article? Don"t miss our future missives and podcasts, and

get access to free subscriber-only content here.

--------------------------------------

Is Public Equity A Broken Concept?

Submitted by Nick Colas of Convergex

Is Public Equity A Broken Concept

David Einhorn’s proposal to GM that it split its stock into dividend and capital appreciation shares got us thinking about the bedrock principles of public equity ownership.  Other catalysts for this examination: recent IPO SNAP’s lack of shareholder voting rights, the reluctance of venture capitalists to list their “Unicorns”, and the dearth of IPOs generally.  The critical question here is “Does the traditional one-size-fits-all model of publicly-held equity still work in a world that increasingly values customization?”  Further, will other social and economic trends force a change in this structure, such as aging demographics in the US population and the investment-heavy nature of major technological developments like autonomous cars, workplace automation, and artificial intelligence?  Bottom line: “public equity” needs to be a fluid concept that responds to the changing needs of both providers and users of capital.

If it is true that we learn the most from our mistakes, then I would posit that we can glean a lot of useful information from analyzing troubled industries rather than just focusing on commercial “Winners”.  For example, I have studied the US auto industry for the last 25 years as both a sell side and buy side analyst, and more recently in the context of the macro work I do in these notes.  It has been an education that has served me very well, even if the group has historically presented limited long term investment potential.

Here is a summary of everything I know about this auto industry:

• Demand is economically sensitive and volatile in major markets like the US, Europe and Japan. Since it takes years to design a new vehicle and that process is expensive, automakers have high fixed costs.  This leads to significant variability in earnings over a typical economic cycle and the threat of bankruptcy in a bad downturn is real.  “Hot” product offerings can mitigate this pressure, but not reliably so.


• There is too much supply. The auto industry employs a lot of people both in final assembly and in the supply chain.  These tend to be good-paying jobs, which means governments are perennially throwing money at car companies to set up shop in their jurisdiction.  Moreover, those same governments don’t ever want to see a plant close.  This makes capacity very sticky, and in some places like Europe there are still too many auto plants.


• Those two factors make it very hard to earn a decent return on capital over a cycle. Boom times bring excellent free cash flow, but those earnings are later consumed by the lean years.  As a result of both industry structure (point #2) and company-specific earnings volatility (point #1), public equities in the sector tend to have very low normalized valuations.

I was therefore intrigued by investor David Einhorn’s proposal, made public today, to split GM’s stock into two pieces: a dividend paying equity and a capital appreciation “stub”.  To be clear, I have no idea if it would improve the company’s equity market valuation.  You can read a description here and see the slide deck from his firm, Greenlight Capital, as well: http://www.zerohedge.com/news/2017-03-28/david-einhorns-presentation-how-gm-can-unlock-between-13-and-38-billion-value

Einhorn’s proposal got me thinking about the nature of public equity capital.  His thesis is that GM’s equity does not have a clean and distinct ownership base.  Dividend-seeking investors are put off by the company’s share buyback program since it drains cash for purposes they don’t value, and capital appreciation-focused investors would prefer that GM just use all their cash generation to repurchase shares.  Split the stock and the conflict goes away, or so the idea goes.

Regardless of the merits of the idea for GM, Greenlight’s proposal raises a provocative macro question: “Is a one-size-fits-all equity structure really the best approach to both maximizing corporate value and giving shareholders the types of investments they desire?”  Once you pose the question that way, a raft of other capital market trends pop up:

• Voting rights. The vast majority of public stocks feature a “One share, one vote” structure of corporate governance. Shareholders can elect Boards, vote on major corporate actions like takeovers and mergers, and lobby for changes in management if they feel the business is being mismanaged.


• The recent high-profile SNAP IPO had an unusual feature, however: no voting rights at all.  While novel, this is the continuation of a trend among technology companies, which in many prominent cases have dual classes of stock with different voting rights.  The intention here is to limit public shareholders’ traditional rights in favor of management’s/core shareholders’ long term business plans and judgment.

• Dearth of IPOs. Look at a long term chart of the number of Initial Public Offerings in US markets, and you’ll see a significant decline in the number of new issues from the 1990s to now.  The good times were in the late 1990s, of course, when it was customary to see 30-80 IPOs per month.  Now, that number is more like 10-20.


• Venture capital’s reluctance to list “Unicorns”.   You might argue that capital markets are simply more selective now and the 1990s IPO cycle was an outlier.  But then why are so many truly revolutionary companies like Airbnb, Uber, Lyft, Palantir, and other “Unicorns” all still private?  These are transformational businesses, but the venture capitalists that fund them see no need to take them public. 
  

  Now, I am sure that Uber’s shareholders are happy just now that the company isn’t subject to the daily vagaries of the stock market, but on balance the absence of “UBER” as a symbol on the NYSE or the NASDAQ  is troublesome.

  
  

At its core, the social compact between public equity markets and society is simple: over time, any investor should have access to the equity of important enterprises created by that society.  If that isn’t happening by virtue of some misalignment of incentives, then those need to be fixed.  The alternative – that the winners stay private but the losers are public – is untenable.  Investors will choose to hoard cash and capital will slowly stop circulating to its best possible use.

Given the pace of innovation that seems to be on its way, this problem may only get worse.  If the futurists are correct, there are several societal sea changes just over the horizon, from artificial intelligence to workplace automation to driverless cars, all in various stages of development.  The home for that capital right now too often has a Sand Hill Road address rather than 11 Wall Street.

We’ve come a long way from what now seems like a pretty humble proposal regarding one car company, so let’s put on bow on all this.  A few summary points:

• For all the innovation on offer in American industry, the concept of public equity is perhaps overly reliant on an outdated concept where one equity security with proportional voting rights is the only flavor available. It is, at least, a topic worth discussing.


• Investors, in their role as consumers, are used to custom solutions in every facet of their life – so why not think about how to apportion the value of a company to fit their needs? Yes, equity and debt are the traditional solutions.  But why do you think Exchange Traded Funds are so popular?  In part it is because they target investor needs in creative ways.  Corporate boards and investment bankers might take a page from that book.


• Demographics and technology may force the issue. An aging US population might embrace novel approaches to accessing the corporate cash flows of public companies.  And if there is a new wave of innovation ready to drop on us, the only nature hedge might be to have access to the equity of those businesses.  Even if they don’t carry voting shares or other traditional features.

Now, one caveat: all of this needs sufficient regulation to curtail abuse.  The mortgage market of the early 2000s is the cautionary tale here, of course.  Changes to the notion of public equity need careful scrutiny to make sure disclosures are complete and structures are sound.

But in the end, “Equity” will need to evolve in the same way everything else does in a capitalist society – in a way that serves both investors and users of capital.

Mass Deception

Submitted by 720Global"s Michael Lebowitz via RealInvestmentAdvice.com,

Janet Yellen

At the December 14, 2016 FOMC press conference, Federal Reserve Chairwoman Janet Yellen responded to a reporter’s question about equity valuations and the possibility that equities are in a bubble by stating the following: “I believe it’s fair to say that they (valuations) remain within normal ranges”. She further justified her statement, by comparing equity valuations to historically low interest rates.

On May 5, 2015, Janet Yellen stated the following: “I would highlight that equity-market valuations at this point generally are quite high,” Ms. Yellen said. “Not so high when you compare returns on equity to returns on safe assets like bonds, which are also very low, but there are potential dangers there.”

In both instances, she hedged her comments on equity valuations by comparing them with the interest rate environment. In May of 2015, Yellen said equity-market valuations “are quite high” and today she claims they are “within normal ranges”? The data shown in the table below clearly argues otherwise.

Interestingly, not only are equity valuations currently higher than in May of 2015 but so too are interest rates.

Further concerning, how does one define “normal”? Does a price-to-earnings ratio that has only been experienced twice in over hundred years represent normal? Do interest rates near historical lows with the unemployment rate approaching 40-year lows represent normal? Is there anything normal about a zero-interest rate monetary policy and quadrupling of the Fed’s balance sheet?

Does the Federal Reserve, more so than the collective wisdom of millions of market participants, now think that it not only knows where interest rates should be but also what equity valuations are “normal”?

One should expect that the person in the seat of Chair of the Federal Reserve would have the decency to present facts in an honest, consistent and coherent manner. It is not only her job but her duty and obligation.

Homebuilders

On December 15, 2016, CNBC reported the following: “The National Association of Home Builders/Wells Fargo Housing Market Index (HMI) rose to 70, the highest level since July 2005. Fifty is the line between positive and negative sentiment. The index has not jumped by this much in one month in 20 years.”

The graph below shows how much house one can afford at various interest rates assuming a $3,000 mortgage payment.

Over the past two months U.S. mortgage rates increased almost a full percent from 3.50% to 4.375%. Given such an increase, a prospective homeowner determined to limit their mortgage payment to $3,000 a month would need to seek a 10% reduction in the price of a house. In the current interest rate environment, this equates to drop from $668,000 to $601,000 in order to achieve a $3,000 a month mortgage payment. One would expect that homebuilders temper their optimism, given that a key determinant of housing demand and ultimately their companies’ bottom lines is facing a sturdy headwind.

Advice/Summary

The point in highlighting these examples is to remind you that people’s opinions, especially those with a vested interest in a certain outcome, may not always be trustworthy. We simply urge you to examine the facts and data before blindly relying on others.

We leave you with historical insight from a few so-called experts:

• “We will not have any more crashes in our time.”: John Maynard Keynes 1927


• “There is no cause to worry. The high tide of prosperity will continue” : Andrew Mellon 1929


• “Stock prices are likely to moderate in the coming year but that doesn’t mean the party is coming to an end.” : Phil Dow 1999


• “The Federal Reserve is not currently forecasting a recession.” : Ben Bernanke 2008