Yes, Virginia, There Is A "Santa Rally"

Authord by Lance Roberts via RealInvestmentAdvice.com,

Yes, Virgina, There Is A Santa Claus

Every year, at this time, I republish the story of 8-year Virginia O’Hanlon who asked the most important of questions. I encourage you to read it as it reminds us of the importance, meaning and the “Spirit” of the Christmas season. 

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Eight-year-old Virginia O’Hanlon wrote a letter to the editor of New York’s Sun, and the quick response was printed as an unsigned editorial Sept. 21, 1897. The work of veteran newsman Francis Pharcellus Church has since become history’s most reprinted newspaper editorial, appearing in part or whole in dozens of languages in books, movies, and other editorials, and on posters and stamps

THE EDITORIAL

DEAR EDITOR:

I am 8 years old.
Some of my little friends say there is no Santa Claus.
Papa says, ‘If you see it in THE SUN it’s so.’
Please tell me the truth; is there a Santa Claus?

VIRGINIA O’HANLON.
115 WEST NINETY-FIFTH STREET.

“VIRGINIA, your little friends are wrong. They have been affected by the skepticism of a skeptical age. They do not believe except they see. They think that nothing can be which is not comprehensible to their little minds. All minds, Virginia, whether they be men’s or children’s, are little. In this great universe of ours, man is a mere insect, an ant, in his intellect, as compared with the boundless world about him, as measured by the intelligence capable of grasping the whole of truth and knowledge.

 

Yes, VIRGINIA, there is a Santa Claus. He exists as certainly as love and generosity and devotion exist, and you know that they abound and give to your life its highest beauty and joy. Alas! how dreary would be the world if there were no Santa Claus? It would be as dreary as if there were no VIRGINIAS. There would be no childlike faith then, no poetry, no romance to make tolerable this existence. We should have no enjoyment, except in sense and sight. The eternal light with which childhood fills the world would be extinguished.

 

Not believe in Santa Claus! You might as well not believe in fairies! You might get your papa to hire men to watch in all the chimneys on Christmas Eve to catch Santa Claus, but even if they did not see Santa Claus coming down, what would that prove? Nobody sees Santa Claus, but that is no sign that there is no Santa Claus. The most real things in the world are those that neither children nor men can see. Did you ever see fairies dancing on the lawn? Of course not, but that’s no proof that they are not there. Nobody can conceive or imagine all the wonders there are unseen and unseeable in the world.

 

You may tear apart the baby’s rattle and see what makes the noise inside, but there is a veil covering the unseen world which not the strongest man, nor even the united strength of all the strongest men that ever lived, could tear apart. Only faith, fancy, poetry, love, romance, can push aside that curtain and view and picture the supernal beauty and glory beyond. Is it all real? Ah, VIRGINIA, in all this world there is nothing else real and abiding.

No Santa Claus! Thank God he lives, and he lives forever. A thousand years from now, Virginia, nay, ten times ten thousand years from now, he will continue to make glad the heart of childhood.”

Merry Christmas, and may this new year bring you joy, laughter, and prosperity.

From all of us at Real Investment Advice, Real Investment News, and Clarity Financial.

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Santa Rally?

With the market now back to overbought conditions, it is now or never for the traditional “Santa Rally” between Christmas and New Year’s Day.

If we go back to 1990, the month of December has had average returns of 2.02% with positive returns 81% of the time. Over the past 100 years, those numbers fall slightly to a 1.39% average return with positive returns 73% of the time.

For the month of December, so far, the market has risen 1.33% which is in-line with the historical norm.

As discussed over the last couple of weeks, this is not to be unexpected as portfolio managers and hedge funds “Stuff Their Stockings” of highly visible positions to have them reflected in year-end statements. 

However, come January, it is potentially a different story. As I have been laying out over the last several weeks, the “tax cut” rally may well come to an end as portfolio managers, being reluctant to sell before year-end which would put them under the 2017 tax code, will likely sell in January to lock in gains under the new tax code when they pay taxes in 2019.

While “this time” is never exactly like the “last time,” there is a reasonable precedent that a sell-off in January is a likelihood. With the outside gains this past year, and now extreme overbought conditions as discussed last week, the odds of a correction are high.

This next week, as close to the end of the year as possible, we will likely be adding two positions to portfolios to hedge against a potential “tax gain” related sell off.  The first position will be a short-S&P 500 index combined with an intermediate-duration bond position.

Given that IF a sell-off occurs money will rotate from “risk” to “safety.” In this case, the S&P 500 should fall while bond prices rise as rates head lower. As shown below, with the stock-bond ratio at extremes, this trade is fairly low risk.

(The current stock/bond ratio is at the highest level in history. Also, note that the correlation “broke” in 2013 with QE 3. That gap will likely be filled at some point.)

If I am wrong, and the markets continue to rise, our existing long-positions, which outweigh the hedges by a large percentage, will continue to advance with the hedge only slightly inhibiting performance. If a sell-off does occur, the hedges will mitigate some of the downside risk while we evaluate our next potential moves.

We will keep you apprised of our actions next week.

Dot Com 2.0

by Michael Lebowitz, CFA

On May 20, 1999, eToys.com became a publically traded stock, offering shares to the public at a price of $20 per share. Lurching to $76 per share on the first day of trading and then over $80 a share by mid-August of that same year, investors were blindly optimistic about the prospects for this internet retailer. In early January 2001, after a weaker than expected holiday season, the company laid off half of its staff. By late February, eToys.com stock traded at meager 0.09 cents per share and filed for bankruptcy in March. The bubble had burst on eToys.com and hundreds of other tech companies selling investors on the promise of a new economic paradigm and internet fantasies.

By late 1999, when eToys.com was flourishing, the NASDAQ stock market was in the midst of a ten-year run in which it gained over 2,700%. Valuations, especially those in the tech sector but also in the broader-based markets, rose well above every prior instance. Caution and conservatism were thrown out the window in place of greed and rampant speculation. A decade of impressive market gains resulted in a high level of complacency.

We are now 18 years beyond the tech bubble, and we find ourselves in similar shoes. Most measures of equity valuation are currently higher than just about every other equity market peak including even some from 1999. The market has produced a constant stream of winners seemingly coming in waves over the last few years. Among the more popular is the FANG stocks and their valuations that assume perfection in perpetuity.

Further reminding us of the late 90’s tech bubble and the eToys.com era are Bitcoin and blockchain related stocks. Longfin Corp. (LFIN) for instance, just completed an initial public offering (IPO) at $5 per share on December 13th. On December 18th LFIN announced the purchase of Ziddu Coin a business lender dealing in crypto-currency loans. Following the announcement, the stock rose as high as $136 a share producing a 2620% gain for those investors that sold at the highs. As we pen this note, the stock trades at $41.

Instead of using “dot com,” companies like LFIN, Overstock, Riot Blockchain and other companies are seizing on investor greed by telling a grand story of Bitcoin and blockchain riches. It is, to be sure, the new-new paradigm.

Another recent example is Long Island Iced Tea Corp. which was a purveyor of bottled drinks with a stock price languishing around the $2 range. Well, that is until the company changed its name to Long “Blockchain” Corp. which sent investors into a buying frenzy running the stock price up nearly 500% in one day.

The instances where anything related to Bitcoin and blockchain is instantly deserving of massive valuations is a mirage; here today and gone tomorrow. The current era serves as a gentle reminder of the greed and wild speculation of the latest bubble. In early 2000, the markets topped with no-name (and no-profit) companies capturing the wild hopes of investors. The NASDAQ took over 16 years to re-capture the prior high water mark representing precious years that investors lost.

Whether LFIN and the like are signaling that we are in the bottom of the ninth of the latest bubble or still have a few innings to go is up for debate. What is important, however, is to retell yourself the story of the tech bubble and how investors ignored the glaring signals. Does today’s price action sound familiar? If so we recommend that you continue to remain cognizant of the patterns of prior market bubble episodes and proceed accordingly.

Rules For The Road

If you are long equities in the current market, we continue to recommend following some basic rules of portfolio management.

“It is through following these basic rules that, with the markets overbought, underlying fundamentals stretched, we continue to suggest some portfolio actions be taken to reduce, not eliminate, overall risk.

1. Tighten up stop-loss levels to current support levels for each position.


2. Hedge portfolios against major market declines.


3. Take profits in positions that have been big winners


4. Sell laggards and losers


5. Raise cash and rebalance portfolios to target weightings.

Notice, nothing in there says “sell everything and go to cash.”

As I noted in last week’s missive on the current bubble, our job as investors is pretty simple – protect our investment capital from short-term destruction so we can play the long-term investment game.

In case you missed it, let me repeat for you the most important lines:

Our job as investors is actually quite simple. We must focus on:

• Capital preservation


• A rate of return sufficient to keep pace with the rate of inflation.


• Expectations based on realistic objectives.  (The market does not compound at 8%, 6% or 4%)


• Higher rates of return require an exponential increase in the underlying risk profile.  This tends to not work out well.


• You can replace lost capital – but you can’t replace lost time.  Time is a precious commodity that you cannot afford to waste.


• Portfolios are time-frame specific. If you have a 5-years to retirement but build a portfolio with a 20-year time horizon (taking on more risk) the results will likely be disastrous.

With forward returns likely to be lower and more volatile than what was witnessed in the 80-90’s, the need for a more conservative approach is rising. Controlling risk, reducing emotional investment mistakes and limiting the destruction of investment capital will likely be the real formula for investment success in the decade ahead.

This brings up some very important investment guidelines that I have learned over the last 30 years.

• Investing is not a competition. There are no prizes for winning but there are severe penalties for losing.


• Emotions have no place in investing.You are generally better off doing the opposite of what you “feel” you should be doing.


• The ONLY investments that you can “buy and hold” are those that provide an income stream with a return of principal function.


• Market valuations (except at extremes) are very poor market timing devices.


• Fundamentals and Economics drive long-term investment decisions – “Greed and Fear” drive short-term trading. Knowing what type of investor you are determines the basis of your strategy.


• “Market timing” is impossible– managing exposure to risk is both logical and possible.


• Investment is about discipline and patience. Lacking either one can be destructive to your investment goals.


• There is no value in daily media commentary– turn off the television and save yourself the mental capital.


• Investing is no different than gambling– both are “guesses” about future outcomes based on probabilities.  The winner is the one who knows when to “fold” and when to go “all in”.


• No investment strategy works all the time. The trick is knowing the difference between a bad investment strategy and one that is temporarily out of favor.

As an investment manager, I am neither bullish or bearish. I simply view the world through the lens of statistics and probabilities. My job is to manage the inherent risk to investment capital. If I protect the investment capital in the short term – the long-term capital appreciation will take of itself.

One Of Bank of America"s "Guaranteed Bear Market" Indicators Was Just Triggered

It is undisputed that the last 2 quarters have demonstrated an impressive jump in corporate earnings growth, if mostly due to a beneficial base effect from plunging 2016 earnings which pushed them below levels reached in 2014. And naturally, this rebound has been more than priced into a market which has seen substantial multiple expansion since the Trump election to boot. But what is much more important for the market is what corporate earnings look like in the future, and it is here that Bank of America has just raised a very troubling red flag.

According to BofA"s Savita Subramanian, in November the S&P 500"s three-month earnings estimate revision ratio (ERR) fell for the fourth consecutive month to 0.99 (from 1.03), indicating that for the first time in seven months, there were more negative than positive earnings revisions, needless to say a major negative inflection point in the recent surge in profits. The bank"s more volatile one-month ERR also weakened to 0.94 (from 1.16).

A breakdown of EER by sector showed a sudden and broad-based deterioration, as the three-month ERR weakened across eight of the 11 sectors, with Materials, Health Care, and Financials seeing the biggest declines while, not surprisingly, Tech and Energy have the highest three-month ERRs, with Energy"s ERR expanding the most on the back of rallying oil prices. Meanwhile, Telecom, Real Estate, and Discretionary have the weakest ratios, and November saw a drop in the Health Care and Industrials" EER ratio below 1.0 (meaning more cuts than raises to earnings forecasts) for the first time since March. Furthermore, while two sectors have been "improving" in recent months: namely Energy and Tech whose ERRs have been rising; all other sectors have seen their ERRs roll over.

Why is this significant?

As BofA explains, the three-month S&P 500 ERR is used by the bank as one of its 19 key "bear market signposts", and with the one-month ERR falling below 1.0 for the second time in six months, this marks the trigger for the 11th bear market signpost. BofA"s ERR rule is triggered when, over a six-month window, all of the following criteria are met: 1) the one-month ERR falls from above 1.0 to below 1.0; 2) the one-month ERR is below 1.0 for two or more months; and 3) the three-month ERR falls below 1.1 for at least one month.

Incidentaqlly, the hit rate of the "ERR" bear market indicator, meaning its historical accuracy in predicting a bear market is 100%, the only question is how long it takes. The last time this trigger was set was mid-2003, and here is the punchline from Bank of America:

Since 1986, a bear market has followed each time that the ERR rule has been triggered. While individual signposts may not be useful for market timing (this one was triggered several years too early in the last two cycles), prior bear markets were preceded by a broader array of signals having been triggered.

This is shown in the chart below:

Ok so one indicator out of 19 now is flashing "bear market" dead ahead. That"s hardly bad if the rest are all green, right? Well, they aren"t.

As discussed two weeks ago, Bank of America recently compiled a list of bear market signposts that have always occurred ahead of bear markets. No single indicator is perfect, and as Subramanian wrote, "in this cycle, several will undoubtedly lag or not occur at all." And while single indicators may not be useful for market timing, they can be viewed as conservative preconditions for a bear market. In this context, the suddenly "triggered" ERR indicator is one of the bank"s 19 bear market signposts.

Here a caveat is warranted: in the last two cycles, the ERR rule was triggered several years too early (Chart 3 above), although a bear market followed each time that the ERR rule has been triggered. As for timing, the more signposts triggered, the greater the risk of an imminent bear market, in BofA"s view. And in November, the one-month ERR falling below 1.0 for the second time in six month marked the 11th trigger (out of 19). This is shown in the table below.

It also means that nearly two-thirds of Bank of America"s bear market indicators have now been triggered. As Subramanian concludes "every cycle is different, but we expect to see more signposts triggered before the eventual market peak."

Then again, this remains a "market" where even if 12 out of the 11 indicators are triggered, it may just send the S&P limit up as there is no point in selling if all that does is guarantee another central bank bailout.

The Stock Market Is Like Yellowstone: "It's Beautiful, But It Has A Volcano Underneath It"

Authored by Mac Slavo via SHTFplan.com,

Anyone putting money in the stock market at this point should have their head examined. The fact that the stock market had reached a record high for the ninth day in a row should be enough for any rational person to see that we’re in a bubble of massive proportions. But there’s also the fact that all of the big players in the investment community are backing out of stocks like there’s no tomorrow.

Sovereign wealth funds are pulling their money out of stock markets in developed countries, corporate insiders are selling stocks in their own companies, and infamous investment companies like Goldman Sachs are admitting that there’s a 99% chance that the stock market won’t keep rising like this in the near future. Berkshire Hathaway, the 7th largest company in the S&P 500, is sitting on a $100 billion dollar pile of cash that grows year after year, because as the stock market climbs to new heights, there aren’t many attractive investments left. You can’t buy low and sell high when there are no lows, and that should say a lot about current state of the economy.

The latest damning report on the stock market comes from Barry James, the president of James Advantage Fund. In a recent interview with CNBC he compared the global market to Yellowstone National Park.

“It’s beautiful, but it has a volcano underneath it.”

“Even though [the market] looks beautiful - setting new highs, good momentum, and earnings have been coming in strong, [there are] things to worry about,” explained the portfolio manager recently on CNBC’s “Futures Now.”

Aside from the rise of passive investing, which James says is creating a “herd mentality” among investors, he also believed that the earnings picture isn’t telling the whole story.

“In the 18 months ending in June, we saw companies that had no earnings, they were losing money, outperform those that were making money,” said James. He highlighted many stocks’ performances this year may not be reflective of their revenues.

And when you look at the data behind these stocks, you’ll find that we’ve been down this road before, and it’s not pretty. Much like Goldman Sachs’ prediction that the market simply cannot sustain itself at this rate, James sees evidence that we’re in for a crash sometime in the next year.

But the biggest threat to the market rally, according to James, is the current valuation levels of stocks.

“We went back to 1994 and researched team data that said [that if we look at cyclically adjusted P/E, one out of two times] the market was down in the next 12 months, and about one out of three times it was down more than 10 percent,” he said.

The stock market has defied all expectations for years. We’re in the one of the longest bull markets in history, which has also coincided with some of the worst economic growth numbers ever recorded, and that obviously isn’t sustainable. Every day that passes, the odds of our economy crashing go up a little more, and the investors who know this are getting out while they still can.

Breaking Down The Bull Market Thesis

Authored by Lance Roberts via RealInvestmentAdvice.com,

Stocks Rise Following Breakout

In last week’s missive “Bulls Run On Yellen’s Easy Money,” I addressed the breakout and why we increased equity exposure modestly in portfolios.

“However, this changed this past week as Yellen uttered the two magic words: ‘EASY MONEY.’

Okay, it wasn’t exactly two words. It was actually:

‘Because the neutral rate is currently quite low by historical standards, the federal funds rate would not have to rise all that much further to get to a neutral policy stance.’

In other words, by saying that interest rates would not have to rise much further, the markets translated that to ‘lower interest rates for longer,’ confirming the Federal Reserve will remain “highly accommodative” to the markets so, therefore, ‘buy stocks.’

And with that, the robots leaped into action pushing markets OUT of the month-and-a-half long trading range of just 1.5%. This push to new highs, as noted above, also triggered a short-term ‘buy signal,’ at the bottom of the chart, which suggests this rally should continue higher over the next week, or so, heading into the month of August.” 

“With the break above 2452 on Friday, assuming it will hold above that level into next week, it will provide an opportunity to increase short-term equity allocations in portfolios. However, be mindful, this is VERY short-term in nature and could be quickly reversed – so manage your risk accordingly.”

As stated, this analysis is VERY short-term in nature. Price trends are currently positive which keeps portfolios long-biased for the time being. However, while our portfolios are “bullishly” positioned for the short-term, we remain much more pessimistic about the longer-term return dynamics.

I want to spend the rest of this weekend’s missive analyzing the ongoing bull thesis that has been pushed out by the media recently.

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Analyzing The Bull Thesis

Michael Santoli via CNBC

“Exactly a decade ago, it was time for investors to start worrying, even as stocks sat at record highs and the signs of onrushing danger were far from obvious.”

I am not so sure that warning signs weren’t obvious. Starting in mid-2007, the market began to struggle to make gains and initial “sell signals” were given as internal measures began to deteriorate.

Furthermore, as shown in the chart below, the “financial crisis” was not a sudden event. Had investors been paying attention to the market, rather than listening to the advice of “buying the dips” or Fed Chairmen declaring “subprime is contained” and “it’s a Goldilocks economy,” there were three separate opportunities to step aside BEFORE the Lehman event ever occurred.  

Yet, in 2007, much like today, individuals were being told to disregard much of the same evidence that existed then as they are today. Let’s take a look at a few of the arguments being made currently.

Earnings Growth Is Driving The Markets

The bulls currently have the “wind at their backs” as the continued “hope” the Trump administration will foster an age of deregulation, infrastructure spending and tax cuts which will boost corporate earnings in the future. Shortly after the election in 2016, Jack Bouroudjian via CNBC wrote:

“Let’s be clear, this market run up to the 20K level has a much more solid foundation for valuation. We are not looking at a P/E which has been stretched beyond historical norms as was the case in 1999, nor are we looking at a dot com bubble ready to implode. On the contrary, between digestible valuations and the prospects of real pro-growth policies, we have the foundation for a run up in equities over the course of the next few years which could leave 20K in the dust.”

The problem is 9-months later there has been no advancement on that legislative agenda while the markets have surged more than 18% since the election. As I discussed previously, the market has already priced in the expected earnings growth from the “promised” Trump agenda which puts the market in danger of disappointment.

“Given that stocks have surged based on ‘hopes’ of deeper tax cuts, a tax cut only roughly half of previous estimates certainly puts valuations at risk. Once again, the market has already priced in earnings growth through 2018, making disappointment a much higher probability.”

“Considering that forward estimates are generally overstated by 33% on average, the risk is high of disappointment.  As shown below, there was a $10 difference between what earnings were expected to be in 2017 at the beginning of 2016 and today. Furthermore, forward earnings have only risen by $4.15/share for the end of 2018. Yet, as shown, above prices have more than priced in that future growth.“

However, as Dr. Lacy Hunt recently discussed, this may not be the case.

“Considering the current public and private debt overhang, tax reductions are not likely to be as successful as the much larger tax cuts were for Presidents Ronald Reagan and George W. Bush. Gross federal debt now stands at 105.5% of GDP, compared with 31.7% and 57.0%, respectively, when the 1981 and 2002 tax laws were implemented. Additionally, tax reductions work slowly, with only 50% of the impact registering within a year and a half after the tax changes are enacted. Thus, while the economy is waiting for increased revenues from faster growth from the tax cuts, surging federal debt is likely to continue to drive U.S. aggregate indebtedness higher, further restraining economic growth.

However, if the household and corporate tax reductions and infrastructure tax credits proposed are not financed by other budget offsets, history suggests they will be met with little or no success. The test case is Japan. In implementing tax cuts and massive infrastructure spending, Japanese government debt exploded from 68.9% of GDP in 1997 to 198.0% in the third quarter of 2016. Over that period nominal GDP in Japan has remained roughly unchanged. Additionally, when Japan began these debt experiments, the global economy was far stronger than it is currently, thus Japan was supported by external conditions to a far greater degree than the U.S. would be in present circumstances.”

With analysts once again hoping for a “hockey stick” recovery in earnings in the months ahead, it is worth noting this has always been the case. Currently, there are few, if any, Wall Street analysts expecting a recession at any point the future. Unfortunately, it is just a function of time until the recession occurs and earnings fall in tandem.

Valuations

Another argument often used to support the “bullish” meme is that valuations aren’t as high as they were in 2000. While that is true, there is a vase fundamental difference between now and then. In 2000, as valuations surged toward 42x CAPE earnings, there were MANY technology companies with negative earnings which skewed the valuation measure. Most of the companies are now gone, or the ones that survived finally begin generating earnings.

While valuations are NOT a good market timing indicator, and are not predictive of the end of a bull market advance, by all historical measures, they are expensive. Most importantly, while high valuations certainly aren’t predictive of bear market onsets, they are HIGHLY predictive of very low returns in the future. 

One of the other arguments to justify higher valuations has been that interest rates are so low. Okay, let’s take the smoothed P/E ratio (CAPE-10 above) and compare it to the 10-year average of interest rates going back to 1900.

Importantly, the statement of “lower future returns” is very misunderstood. Based on current valuations the future return of the market over the next decade will be in the neighborhood of 2%. This DOES NOT mean the average return of the market each year will be 2% but rather a volatile series of returns (such as 5%, 6%, 8%, -20%, 15%, 10%, 8%,6%,-20%) which equate to an average of 2%.

Sentiment Is Bullish

Of course, as discussed previously, investor behavior makes forward long-term returns even worse.

The bulls have continually argued the “retail” investor is going to jump into the markets at any moment which, with all the “cash on the sidelines,” will keep the bull market alive. The chart below suggests they are already in. At 30% of total assets, households are committed to the markets at levels only seen near peaks of markets in 1968, 2000, and 2007.  I don’t really need to tell you what happened next.

Furthermore, as I have discussed repeatedly in the past, there is NO “cash on the sidelines” to begin with. To wit:

“Every transaction in the market requires both a buyer and a seller with the only differentiating factor being at what PRICE the transaction occurs. Since this must be the case for there to be equilibrium to the markets there can be no ‘sidelines.’

Furthermore, despite this very salient point, a look at the stock-to-cash ratios also suggest there is very little available buying power for investors current.”

There is no cash on the sidelines.

Furthermore, the dearth of “bears” is a significant problem. With virtually everyone on the “buy” side of the market, there will be few people to eventually “sell to.” The hidden danger is with much of the daily trading volume run by computerized trading, a surge in selling could exacerbate price declines as computers “run wild” looking for vacant buyers.

This thought dovetails into the “hyperextension” of the market currently. Since price is a reflection of investor sentiment, it is not surprising the recent surge in confidence is reflected by a symbiotic surge in asset prices.

The chart below shows the deviation above the 3-year moving average. Importantly, at the peak of the previous two bull markets, the deviation never pushed into the 3-standard deviation range as it is currently. This suggests there is VERY little room left to the upside before some corrective action occurs.

The problem, as always, is sharp deviations from the long-term moving average always “reverts to the mean” at some point. The only questions are “when” and “by how much?”

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Managing Past The Noise

There are obviously many more arguments for both camps depending on your personal bias. But there is the rub. YOUR personal bias may be leading you astray as “cognitive biases” impair investor returns over time.

“Confirmation bias, also called my side bias, is the tendency to search for, interpret, and remember information in a way that confirms one’s preconceptions or working hypotheses. It is a systematic error of inductive reasoning.”

Therefore, it is important to consider both sides of the current debate in order to make logical, rather than emotional, decisions about current portfolio allocations and risk management.

Currently, the “bulls” are still well in control of the markets which means keeping portfolios tilted towards equity exposure.  However, as David Rosenberg recently penned, the markets may be set up for disappointment. To wit:

“So we have a sluggish U.S. economy on our hands with growth revisions to the downside. We have a situation where some investors see the softness enduring long enough that Fed funds futures are now pricing in less than 50-50 odds that Yellen et al make another rate move by year-end. Yet the Fed is signaling that it will begin to shrink the balance sheet by the fourth quarter, with no economic liftoff.

The political backdrop is rife with gridlock — unbelievably, there is still hope among investors that tax reform is coming by 2018. At the same time, evidence is mounting that the Dems have a serious shot of taking the House next year. We have a White House that, with the help of inside leaks and the media, continues to find itself embroiled in controversies. And health care reform, which was always pledged to be the first item to be done, is looking more and more like a pipe dream. When hasn’t governing been complicated? It took the Gipper five years and endless bottles of scotch with Tip to get tax reform legislated in 1986!

We have heightened geopolitical risks from North Korea and China has instructed the U.S. that it will not be pressured to invoke sanctions against its unstable satellite.

We have a central bank chief who looks to be a lame duck…a recent WSJ survey found that economists only peg her odds of staying on past February 2018 at 20.8%. Just more uncertainty to deal with.”

Currently, there is much “hope” things will “change” for the better. The problem facing President Trump, is an aging economic cycle, $20+ trillion in debt, an almost $700 billion deficit, unemployment below 5%, jobless claims at historical lows, and a tightening of monetary policy and 80% of households heavily leveraged with little free cash flow. Combined, these issues alone will likely offset most of the positive effects of tax cuts and deregulations.

Furthermore, while “bearish” concerns are often dismissed when markets are rising, it does not mean they aren’t valid. Unfortunately, by the time the “herd” is alerted to a shift in overall sentiment, the stampede for the exits will already be well underway. 

Importantly, when discussing the “bull/bear” case it is worth remembering that the financial markets only make “record new highs” roughly 5% of the time. In other words, most investors spend a bulk of their time making up lost ground.

The process of “getting back to even” is not an investment strategy that will work over the long term. This is why there are basic investment rules all great investors follow:

1. Sell positions that simply are not working. If they are not working in a strongly rising market, they will hurt you more when the market falls. Investment Rule: Cut losers short.


2. Trim winning positions back to original portfolio weightings. This allows you to harvest profits but remain invested in positions that are working. Investment Rule: Let winners run.


3. Retain cash raised from sales for opportunities to purchase investments later at a better price. Investment Rule: Sell High, Buy Low

These rules are hard to follow because:

1. The bulk of financial advice only tells you to “buy”


2. The vast majority of analysts ratings are “buy”


3. And Wall Street needs you to “buy” so they have someone to sell their products to.

With everyone telling you to “buy” it is easy to understand why individuals have a such a difficult and poor track record of managing their money.

Trying to predict the markets is quite pointless. The risk for investors is “willful blindness” that builds when complacency reaches extremes. It is worth remembering that the bullish mantra we hear today is much the same as it was in both 1999 and 2007.

Again, I don’t need to remind you what happened next.

Bitcoin Buyer Beware

Entrepreneurs have a new trick to raise money quickly, and it all takes place online, free from the constraints of banks and regulators. As Axios reports, since the beginning of 2017, 65 startups have raised $522 million using initial coin offerings — trading a digital coin (essentially an investment in their company) for a digital currency, like Bitcoin or Ether.

One recent example, as NYT reports, saw Bay Area coders earn $35 million in less than 30 seconds during an online fund-raising event. They sold Basic Attention Tokens (BAT coin) which will grant buyers access to an innovative ad-free web browser the coders are intending to create, but have yet to launch.

And that"s the catch: these investors are buying promises in the form of coins for a product or service that doesn"t exist.

Similar to the Bay Area example, a group of entrepreneurs in Switzerland secured $100 million last week by selling a coin that will one day be used on Status, an online chat program that"s still being developed.

Proponents argue that these initial coin offerings are "a financial innovation that empowers developers and gives early investors a chance to share in the profits of a successful new enterprise," NYT notes.

However, many say it potentially violates securities law and that this trading of digital currencies is ripe for hackers, from NYT: "Last year, the first blockbuster coin offering, the Decentralized Autonomous Organization, quickly raised more than $150 million. But the project blew up after a hacker manipulated the code and stole more than $50 million worth of digital currency."

By selling these coins for Bitcoin or Ether, "conventional banks and financial institutions are essentially shut out, allowing initial coin offerings to take place beyond the control of regulators," and that could lead to a whole host of issues for the entrepreneurs and investors alike.

So, it is no wonder that Fred Wilson"s advice with regard ICOs is simple "buyer beware, do your homework, don"t be greedy."

Yes, buyer beware. Do your homework. Don"t be greedy.

— Fred Wilson (@fredwilson) June 14, 2017

AVC.com"s Fred Wilson has a lot more to say...

Whether you are buying in a private placement of securities as a venture capitalist or buying in an ICO as a crypto enthusiast, there are certain things that you need to be careful about. And right now, with all of the enthusiasm for crypto assets out there, I am very concerned that nobody is being careful about anything.

So here are some things to think about before placing your order on that next ICO:

1. The amount raised matters, a lot. More money is not generally a good thing. I wrote a blog post about this a while back. In my experience, the startups that are careful and raise modest amounts of capital outperform the startups that raise crazy amounts of capital and are overly aggressive. I would look for capped ICOs and modest amounts of capital. Teams should raise enough money to do what they want to do but you can do a lot with $10mm and a tremendous amount with $50mm. Ethereum raised $18.5mm USD (in BTC) in their token offering and lost some of that due to a decline in BTC value. And look at what they have been able to accomplish with that funding.


2. You should understand what the token that is being offered does and have some feel for how large of an opportunity that is. I remember friends buying hot Internet IPOs in the late 90s and I’d ask them why they were investing and they would say to me “I heard its a hot deal” and I would say “But what does the company do?” and they would say to me “I don’t know, but I know I’m going to make a lot of money.” That kind of investing is dumb. Be smart and understand what you are buying and why. And if you can’t hold the investment through to the point at which the token will have real utility and real value, you might want to think twice about buying it in the first place.


3. Valuation matters. I know that many in startup land don’t really agree with this. There are VCs who want to be in the best deals and don’t really care what they have to pay to get into them. That might work as an investment strategy but it requires a lot of luck and market timing. If, instead, you focus on valuation when you make your investments and buy into investments at prices that make sense to you and have a model for why and how the investment will be worth 10x your entry price in 5+ years, you stand a much better chance at making solid returns. There are people in the crypto space who are building valuation models. You should follow them and understand their work. And you should try to apply that kind of thinking to your crypto investing.


4. Avoid scams and things that feel like scams. Scams are not limited to the crypto sector. They exist in all forms of investing (and many other sectors too). As VCs we often get pitched an opportunity that has red flags all over it. You learn quickly to delete those emails and not return those calls. But an emerging sector, like crypto, where there is less regulation, scrutiny, due diligence, and knowledge, scams are going to be more common. There have already been a bunch of well publicized scams in the crypto sector and I would bet that one or more successfully funded ICOs that have already been done will turn out to have been a scam in some measure. There is a difference between a intentional scam and an accidental scam, but if you are the investor, you were scammed in both instances. Be on the lookout for scams and avoid them. The best red flag for a scam is lack of detail on the technology, how it will work, and a lack of credibility of the people behind the project. Do you homework on these investments and make sure the technology and the people are credible before you part with your money.


5. Look for projects where the technology is well specified and is working in the wild. It is much easier as a VC to invest in companies where the product has been shipped and you can use it. I would venture to guess that more than 80% of USV’s investments over the years have been into companies where that was the case. You can use Bitcoin, you can use Ethereum, you can use Steem, you can use Zcash. These are fully functioning crypto assets that have been “shipped” and are widely used. That does not mean they will be successful, but it sure gives you more confidence that they might be successful. Investing on a white paper is way more risky than investing in a working technology that you can use yourself.


6. Don’t be greedy. This goes for both buyers and sellers in the market. You might be able to make a killing right now. But I would suggest you resist that urge. Those who play this market right over the long term will do extremely well. But trying to make a killing overnight is always a bad idea. So for sellers that means raising reasonable amounts, not all you can get. And selling more into the market over time, as Vitalik suggests in this blog post:
   If we want to strike at the heart of this problem, how would we solve it? I would say the answer is simple: start moving to mechanisms other than single round sales. For the buyers, this means not putting all of your assets to work in one ICO, or even all of your assets into crypto. Markets can crash. You need diversification to manage risk, particularly in highly volatile markets.

I have been a big booster of Bitcoin, blockchain, crypto tokens, and the like on this blog for the past six years. I am a big long term believer in this sector. USV is investing in this sector. We are investors in token funds and I believe we will start directly buying tokens soon. So we are bullish on crypto.

However, there are many things going on in the sector right now that are head shakers to us. We have been investing in startups and emerging tech sectors for over thirty years. We have seen this movie before . We know how it plays out and we know that all is not up and to the right forever.

When people are afraid, be greedy. And when people are greedy, be afraid. We are much closer to the latter scenario in crypto right now and while I am not afraid for my investments and USV’s investments in this sector, I am afraid for the sector and those who are being the most greedy right now. I am cautioning our portfolio companies to tread carefully and we are treading carefully. And I would advise all of you to do the same.

The World's Worst Market-Timer

Authored by Kevin Muir via The Macro Tourist blog,

Today’s post is about the recent Canadian government measures to cool the scorching Toronto housing bubble, but the lesson about government ineptitude will be universal, and I am confident, shared by everyone.

By now, most non-Canadians have heard of Toronto’s out of control housing market, but probably won’t know too much about the specifics. I tried to think up a good way to show the magnitude of the rise, so I made up a chart comparing Toronto’s house index to another housing market widely known to be insane. Fueled by the latest tech boom, San Francisco has experienced a breathtakingly stupid price rise over the past few years.

Well, here are the two cities side by side:

Yup, Toronto housing price appreciation has even outpaced San Francisco! It’s a gong show here in Toronto, no doubt about it.

Last year when Vancouver was facing the same sort of runaway price rise, their government instituted a 15% foreign buyers tax. Like true bureaucrats, they did not think about grandfathering in existing sales that had not yet settled, and instead slapped an out of the blue tax on foreign capital. Not surprisingly, foreigners decided there might be better places to invest than Vancouver.

Many of them came to Toronto.

I am not claiming foreigners are the culprit for Toronto’s out of control rising housing market. I actually think absurdly low interest rates, combined with unscrupulous dealings from companies like Home Capital Group, are more to blame. But Vancouver’s decision definitely sent more money scuttling to Toronto, at a time when supply was already tight. This extra demand sent prices soaring.

Yet this price increase happened in a vacuum. There was so little supply in the winter season that bidders took prices to absurd levels. It’s like when a stock bursts out to new highs and all the stops run in a sickening whoosh.

Real estate moves a lot slower than stock trading, but markets are markets. They all operate on the same basic principles. And what is the best cure for high prices? High prices!

The market would have taken care of this on its own. We were already seeing tons of new supply coming on the market this spring. It just doesn’t happen overnight.

Instead of letting high prices be the incentive for market forces to fix the problem, the government chose to get involved. I can’t say all their initiatives were terrible, but a few of them were beyond brain dead (even for the Wynne government - and that’s saying a lot!). Here’s prominent outspoken critic Garth Turner’s assessment of the situation:

At first blush, it looks like the condo market was the big loser in Thursday’s political assault on the free market. Rent controls on new units will virtually guarantee consistent long-term negative cash-flow for investor-owned apartments. Ouch. And since half of recent condo sales have gone to investors, you can imagine the impact.

The condo trade also relies heavily on assignment clauses – allowing buyers to sell their interest in a unit prior to closing. Given the fact it can be three or four years between making a deposit on an unbuilt unit and actually seeing it registered, assignments make sense. There are whole brokerages dealing in nothing but. So now with intense scrutiny and the CRA involved, any gains are likely to end up being taxed as income. Double ouch.

In case you missed it, Ontario did about what was forecast here. A non-resident (foreign buyer) tax of 15% – or $240,000 on the average detached house. Rent controls on every unit, ensuring landlords cannot stay ahead of inflation. Letting cities tax under-used properties – about $1,400 a month on a 416 SFH.

I am sympathetic to renters who were being priced out of the market, and I understand the frustration of having prices run away from you. But I know that when government gets involved in such a heavy handed manner, it will end badly. The law of unintended consequences will bite them in the ass.

They sat around watching this problem develop for years, and then when it finally spiraled out of control, they rushed in to “fix it.”

It reminds me of the late 90’s when Nortel (and Bell which owned piles of Nortel) comprised more than half of the TSX 60 index and more than 40% of the broader TSX 300 index. Nortel kept exploding higher, and the Canadian stock indexes became an uninvestable farce. Fund managers were getting their ass kicked by the index because most of them could not invest more than 10% in any one stock, yet Nortel kept pushing the TSX indexes to the moon. After the screams from the investing community finally became deafening, TSX index officials acted and created a cap limited index. By the time they got around to implementing it, what do you think happened? You guessed it. Nortel topped and soon that cap weighted index was the last concern on the minds of fund managers.

I suspect the same will happen with the Ontario government’s real estate measures. Prices were already set to slow, and now that the government has intervened, the top is virtually assured. Like your pal that has terrible market timing but you are afraid to tell him because it might ruin your best contrarian signal, governments are the ultimate fade.

Don’t believe me? Have a look at the chart for Home Capital Group. The canary in the coal mine of Canadian real estate has been struggling for air at the bottom of the cage for some time now.

It is ironic that the day the Wynne government announced their measures to cool the housing market, Home Capital Group, one of Canada’s largest alternative real estate lenders, was being taken out back and unceremoniously shot on news they were under investigation by the Ontario Securities Commission for misleading investors. Now here’s a thought - instead of putting in all sorts of new rules to curb housing speculation, how about enforcing the existing ones?

I am straying dangerously into the territory of ranting about what should be instead of focusing on trading what will be. In fact, I am pretty sure I have crossed the line.

So in the hopes of redeeming myself, let’s examine whether there is a trade in here. Assuming I am correct in that the Ontario government has just rung the bell at the top of the Canadian housing bubble, then how do we profit from it? As you can see, the market has already sniffed out the highly leveraged stocks like Home Capital Group. Now some will argue that this is Canada’s Bear Stearns hedge fund moment. Remember back to 2007 when two highly levered Bear Stearns hedge funds ran into trouble with their mortgage backed portfolio? Although many argued the problem was contained to Bear, it quickly spread and soon enough become a nationwide contagion.

Many U.S. hedge funds and other speculators who have heard stories of the vast fortunes made by those betting against American real estate are convinced Canada will replay exactly the same way. These hedge funds are shorting Canadian banks assuming the rot will spread throughout the whole economy. Heck, I even heard of one prominent newsletter writer who thinks he will be covering his CIBC short in the single digits.

Although I have learned to never say never, I doubt Canada will repeat the U.S. playbook. There are so many reasons, but at the crux of the matter is that Canadians are boring. We just don’t run from one side of the boat to the other with the same determination as our American neighbours. Real estate cycles are long drawn out affairs. The American boom/bust was the exception, not the rule.

The bursting of Canada’s real estate bubble will be much less of a pop than most expect. Instead of playing for the big dramatic win, I think a safer way to capitalize on these new developments is by shorting the Canadian currency.

Now that the government has released these targeted measures to curb real estate appreciation, it takes a lot of heat off the Bank of Canada to raise rates. At the margin, this allows the BoC to be much more dovish.

There is a lot more to currency speculation than forecasting interest rate differentials, but for a long time, Canada’s economy has been kept aloft through real estate strength. We have come to think our shit doesn’t stink, and that somehow our economy will be magically able to continue to outperform.

As real estate softens, I doubt this will be the case.

I am a little bit of a US dollar bear, but I am becoming even more bearish on the Loonie. Maybe buying British Pounds, or even Euros, against CAD is the way to play it.

Whatever you do, make sure you keep in mind that the world’s worst market timer (the government) just cried “Uncle.” The proper trade is to assume they will make a mess. A big one.

You know, I thought the Ontario government’s actions were bad news. But now that I reflect on it, maybe it’s not that terrible. When the decline in Toronto real estate comes, the Ontario Liberals will own it. And the public will be furious with them. See, it’s not all bad…

Doug Casey Warns, The EU's Collapse Is Now "Imminent"

Authored by Nick Giambruno via InternationalMan.com,

On April 23, French voters could drive the entire European Union into its grave.

Doug Casey and I recently discussed this historic election—and why it matters to US investors.

Nick Giambruno: Doug, you predicted the fall of the European Union a few years ago. What has changed since then?

Doug Casey: Well, what"s changed is that the entire situation has gotten much worse. The inevitable has now become the imminent.

The European Union evolved, devolved actually, from basically a free trade pact among a few countries to a giant, dysfunctional, overreaching bureaucracy. Free trade is an excellent idea. However, you don"t need to legislate free trade; that’s almost a contradiction in terms. A free trade pact between different governments is unnecessary for free trade. An individual country interested in prosperity and freedom only needs to eliminate all import and export duties, and all import and export quotas. When a country has duties or quotas, it’s essentially putting itself under embargo, shooting its economy in the foot. Businesses should trade with whomever they want for their own advantage.

But that wasn"t the way the Europeans did it. The Eurocrats, instead, created a treaty the size of a New York telephone book, regulating everything. This is the problem with the European Union. They say it is about free trade, but really it’s about somebody’s arbitrary idea of “fair trade,” which amounts to regulating everything. In addition to its disastrous economic consequences, it creates misunderstandings and confusion in the mind of the average person. Brussels has become another layer of bureaucracy on top of all the national layers and local layers for the average European to deal with.

The European Union in Brussels is composed of a class of bureaucrats that are extremely well paid, have tremendous benefits, and have their own self-referencing little culture. They’re exactly the same kind of people that live within the Washington, D.C. beltway.

The EU was built upon a foundation of sand, doomed to failure from the very start. The idea was ill-fated because the Swedes and the Sicilians are as different from each other as the Poles and the Irish. There are linguistic, religious, and cultural differences, and big differences in the standard of living. Artificial political constructs never last. The EU is great for the “elites” in Brussels; not so much for the average citizen.

Meanwhile, there’s a centrifugal force even within these European countries. In Spain, the Basques and the Catalans want to split off, and in the UK, the Scots want to make the United Kingdom quite a bit less united. You"ve got to remember that before Garibaldi, Italy was scores of little dukedoms and principalities that all spoke their own variations of the Italian language. And the same was true in what’s now Germany before Bismarck in 1871.

In Italy 89% of the Venetians voted to separate a couple of years ago. The Italian South Tyrol region, where 70% of the people speak German, has a strong independence movement. There are movements in Corsica and a half dozen other departments in France. Even in Belgium, the home of the EU, the chances are excellent that Flanders will separate at some point.

The chances are better in the future that the remaining countries in Europe are going to fall apart as opposed to being compressed together artificially.

And from strictly a philosophical point of view, the ideal should not be one world government, which the “elite” would prefer, but about seven billion small individual governments. That would be much better from the point of view of freedom and prosperity.

Nick Giambruno: How does Brexit affect the future of the European Union?

Doug Casey: Well, it"s the beginning of the end. The inevitable has now become the imminent. Britain has always been perhaps the most different culture of all of those in the European Union. They entered reluctantly and late, and never seriously considered losing the pound for the euro.

You"re going to see other countries leaving the EU. The next one might be Italy. All of the Italian banks are truly and totally bankrupt at this point. Who"s going to kiss that and make it better? Is the rest of the European Union going to contribute hundreds of billions of dollars to make the average Italian depositor well again? I don"t think so. There"s an excellent chance that Italy is going to get rid of the euro and leave the EU.

If Marine Le Pen wins the elections, France will leave as well. That would be a smart move. She would also want to deport the migrants from Africa that are living in tent camps and cardboard boxes everywhere. Another good move. These people aren’t self-supporting, and are acting to destroy what’s left of French culture. Then again, Le Pen herself is no prize. She wants to continue the welfare state, and increase regulations and taxes. The French have zero good alternatives, at least if you care about either free minds or free markets. But that’s true everywhere in Europe. The very concept of liberty is dead in Europe.

Nick Giambruno: Why should Americans care about this?

Doug Casey: Well, just as the breakup of the Soviet Union had a good effect for both the world at large and for Americans, the breakup of the EU should be viewed in the same light. Freeing an economy anywhere increases prosperity and opportunity everywhere. And it sets a good example. So Americans ought to look forward to the breakup of the EU almost as much as the Europeans themselves. Unfortunately, most Americans are quite insular. And Europeans are so used to socialism that they have even less grasp of economics than Americans. But it’s going to happen anyway.

Nick Giambruno: What are the investment implications?

Doug Casey: Initially there"s going to be some chaos, and some inconvenience. Conventional investors don’t like wild markets, but turbulence is actually a good thing from the point of view of a speculator. It’s a question of your psychological attitude. Understanding psychology is as important as economics. They’re the two things that make the markets what they are. Volatility is actually your friend in the investment world.

People are naturally afraid of upsets. They"re afraid of any kind of crisis. This is natural. But it"s only during a crisis that you can get a real bargain. You have to look at the bright side and take a different attitude than most people have.

Nick Giambruno: If you position yourself on the right side of this thing, do you think you can profit from the collapse of the EU?

Doug Casey: Yes. Once the EU falls apart, there are going to be huge investment opportunities. People forget how cheap markets can become. I remember in the mid-1980s, there were three markets in the world in particular I was very interested in: Hong Kong, Belgium, and Spain. All three of those markets had similar characteristics. You could buy stocks in those markets for about half of book value, about three or four times earnings, and average dividend yields of their indices were 12–15%—individual stocks were sometimes much more—and of course since then, those dividends have gone way up. The stock prices have soared.

So I expect that that"s going to happen in the future. In one, several, many, or most of the world’s approximately 40 investable markets. Right now, however, we"re involved in a worldwide bubble in equities. It can go the opposite direction. People forget how cheap stocks can get.

I think we"re headed into very bad times. Chances are excellent you"re going to see tremendous bargains. People are chasing after stocks right now with 1% dividend yields and 30 times earnings, and they want to buy them. At some point in the future these stocks are going to be selling for three times earnings and they’re going to be yielding 5, maybe 10% in dividends. But at that point most people will be afraid to buy them. In fact, they won"t even want to know they exist at that point.

I’m not a believer in market timing. But, that said, I think it makes sense to hold fire when the market is anomalously high.

The chaos that’s building up right now in Europe can be a good thing—if you"re well positioned. You don"t want to go down with the sinking Titanic. You want to survive so you can get on the next boat taking you to a tropical paradise. But right now you"re entering the stormy North Atlantic.

*  *  *

There’s more turmoil ahead as French voters decide the EU’s fate on April 23—and it could be catastrophic for global currency and stock markets. We expect the fallout to be far worse than 2008. Most investors can’t handle that sort of chaos. But Doug Casey and his team know how to turn it into huge profits. They’re sharing need-to-know information about the coming global economic meltdown in this time-sensitive video. Click here to watch it now.

Paul Brodsky's Advice To Investors: "Get Angry"

Submitted by Paul Brodsky of Macro Allocation Inc.

Get Angry

Wall Street looks a lot like Lake Wobegone, where the women are strong, the men good looking, and all children are above average. We have always been happy warriors, but it is difficult not to resent the passive nature of investing foisted upon the markets by economic policies that backstop and boost asset prices beyond reason, which in turn diminishes the value of investment intelligence and experience. Passivity implies the markets will always produce positive real returns and real economic growth over all time horizons. It is an illogical and preposterous notion, and yet it is the zeitgeist – all above average.

Fertility rates among wealthy and educated cohorts in advanced economies – from which the investor class is comprised – have already begun to decline, as has the demand for manufacturing output among the working class in most advanced economies. Not a good situation. This reality begs fundamental questions: “are increasingly digital, indebted societies being served well by analog economies” (no) and “why is growth the unquestioned objective of policy makers and political economists” (because growth is necessary to sustain nominal asset and liability prices, which in turn is necessary to avoid credit deflation, goods and service price deflation, and bank and portfolio insolvency)?

The counterfactual to this practical yet insidious economic framework would be an economy that actually economizes, that works naturally to drive prices lower and the purchasing power value of savings higher. Since savings are ostensibly obtained through production, the incentive of workers would be to produce at a competitive global wage scale. Economic right sizing would not be feared and economies would shrink to profitability. Deflation would not be feared either; in fact it would be welcomed. Workers would actually benefit from increasing productivity, innovation and automation. They would be more productive, have more stable income and more leisure time, and be able to save for the future at a positive risk-free real rate of return. Alternatively, rentiers would not be able to reduce the value of production and increase the value of assets by issuing unreserved credit. Alas, such an economy no longer exists.

Our idealism is not entirely bitter or impractical because the counterfactual is supported by math, history and, now, current trends. Baby boomers across developed economies have begun to downsize and spend less. No amount of real growth ever sustained in the past can lift them out of debt or transfer it smoothly.

Something has to give. Central banks and governments have had to fill the void to generate growth that helps reconcile nominal asset and liability prices. While they have unlimited balance sheets with which to synthesize nominal output growth and assume others’ liabilities in perpetuity, the process of transferring the burden of growth from the factors of production to non-productive financial statements creates very wide wealth and income gaps and social unrest. Such theory closely resembles current reality.

We are angered by the elite conceit still on offer from parties benefitting from this unsustainable state of affairs and the collective passivity of public intellectuals and investors unwilling to think for themselves, identify obvious problems, and take action. Their benign neglect or, worse, near unanimous intention to exacerbate the problem through fiscal profligacy, actually evokes excitement among economists and investors. Lost in the frenzy is recognition of a dangerous financial and social setup. The preponderance of “free market” investors and allocators are betting their performance, compensation, careers and sense of self-worth on the hope that Trump Keynesianism and reforms will get them one or two more bonuses, and, failing that, that central banks will monetize financial assets at full value in real terms.

This discussion should offend blithe extrapolators posing as fiduciaries, those that leverage popular opinion without considering the potential devastation from necessary structural change. Institutionalized trend-following investors, proud of themselves for abandoning original thought and reducing the costs they pay to have their assets managed to nine basis points, are being penny wise and oh so pound foolish.

Warren Buffet’s recent attack on high fees is well-founded, but his always stay long mantra is not. Of course high fees detract from returns, and of course investors not always balls-to-the-wall long will reliably under-perform a market that only rises. Given the current setup, however, US real growth and equity values can only be perpetually strong relative to other markets; not real wealth creating on their own.

Corporate equity and property markets are confidence games that rely on promotion and debt assumption. They need a willing conspirator in the form of financial media. Bull markets and ad rates have historically been correlated, and so we should always expect financial media to promote hope in the face of a market trading 22-times earnings, 3-times book and 13-times cash flow.

A dignified spokesperson will reliably extrapolate five cases where investors would have been foolish to worry, and so thoughtful active managers are in the process of being disintermediated by passive vehicles. New heights of consensus-ness have made idiots of thoughtful analysts, investors and allocators. The meaning of “fiduciary care” has shifted from understanding the future needs and risk tolerances of one’s charges to the process of locking in negative real returns while retaining plausible deniability through compliance with regulatory best-practices.

Being content and un-prepared is unconscionable, dear fiduciary. Markets are always risky and they are getting riskier. They are not to be trusted as homes for risk-free saving. Investors at all levels are being deceived on an epic scale and most of the investor class will suffer. It never pays to bet against nature for too long, which presents a wonderful opportunity for free thinkers. The efficient investor today that methodically sets market traps to capture foolish bulls (and bears) will be the dignified investor tomorrow.

Recommendation: Uncross your fingers. Turn off the TV and find your calculator. Remind yourself why you initially got into the investment business. Change your investment objective to “seek positive real returns regardless of economic conditions”. Show your spouse why she fell in love with you. Show your kids – actually demonstrate to them – what it takes to be an adult. Be human. Think. Get angry.

Stock Valuations Enter “Crash” Territory

Hold your real assets outside of the banking system in one of many private international facilities  -->    https://www.sprottmoney.com/intlstorage 

Posted with permission and written by John Rubino (CLICK HERE FOR ORIGINAL)

The Trump Christmas stock market rally has taken valuations beyond a point that in the past has signaled trouble, which in turn has generated a lot of cautionary press like the following:

(CNBC) – While the S&P 500 is reaching all-time highs on optimism over Donald Trump’s economic agenda, some Wall Street strategists are increasingly worried about a widely followed valuation measure that’s reached levels that preceded most of the major market crashes of the last 100 years.

“The cyclically adjusted P/E (CAPE), a valuation measure created by economist Robert Shiller now stands over 27 and has been exceeded only in the 1929 mania, the 2000 tech mania and the 2007 housing and stock bubble,” Alan Newman wrote in his Stock Market Crosscurrents letter at the end of November.

Newman said even if the market’s earnings increase by 10 percent under Trump’s policies “we’re still dealing with the same picture, overvaluation on a very grand scale.”

The Shiller “cyclically adjusted price-to-earnings ratio” (CAPE) is calculated using price divided by the index’s average historical 10-year earnings, adjusted for inflation. Yale economics professor Robert Shiller’s research found future 10-year stock market returns were negatively correlated to high CAPE ratio readings on a relative basis. He won the Nobel Prize in economics in 2013 for his work on stock market inefficiency and valuations.

Other academics agreed the current extreme CAPE ratio of 27.7 is a worrying sign for future returns versus bonds.

“Only when CAPE is very high, say, CAPE is in the upper half of the tenth decile (CAPE higher than 27.6), future 10-year stock returns, on average, are lower than those on 10-year U.S. Treasurys,” Valentin Dimitrov and Prem C. Jain wrote in paper titled “Shiller’s CAPE: Market Timing and Risk” on Nov. 17.

Even based on the more common price-earnings ratio, the market looks rich. The S&P 500’s P/E based on earnings of the last 12 months is 18.9, the highest in more than 12 years, according to FactSet.

“U.S. valuations start off as being high both on a historical basis and also on a peer group. Certainly based on the Shiller PE, the equity market seems expensive,” Jefferies chief global equity strategist Sean Darby wrote on Nov. 29.

The above chart requires a bit of interpretation, mainly because of that spike in 1999 which seems to imply a much higher ceiling for stock valuations. It probably doesn’t, because of the uniquely delusional nature of the tech stock bubble. That market was driven by newly-minted dot-coms and related companies that in many cases had minimal or no earnings, so prices weren’t related to profits. In other words, you can’t calculate a price/earnings ratio if there are no earnings.

“Eyeballs” – that is, the number of people visiting at a dot-coms’ website – had temporarily replaced traditional valuation measures in the hearts of speculators. With disastrous results.

Today’s market, in contrast, is made up of companies with actual earnings, so it might be safe to discount 1999 and use the rest of the chart for comparison. In which case current equity prices look extremely dangerous.

On the other hand, today’s world has departed from past business-as-usual in other ways that might be relevant. Debt no longer seems to matter – witness the US, after doubling the federal debt in a single presidential administration, installing a new president whose platform calls for massive increases in borrowing and spending.

And while monetary policy in past eras operated in an at least partially-constrained environment, today there are apparently no limits on how low interest rates can go or how many and what kinds of assets central banks can buy with newly-created currency.

The Japanese and Swiss national banks, for instance, are already huge buyers of equities. If the Fed decides to join that party – something that Chairwoman Janet Yellen has already publicly considered – then it’s not clear whether P/E ratios will continue to matter. The unlimited printing press is definitely an argument for “this time is different.”

So is it no longer possible to make predictions based on pre-QE history? Or are there financial and economic laws that apply no matter what crazy new tools the world’s governments decide to employ?

Almost certainly the latter. Manipulating one part of the system – by, for instance, buying equities with newly-created currency – just shifts the pressure of financial imbalances to a different, harder-to-control place.

Lately the bond market has begun to show signs of stress – because who wants to own zero-coupon long-term bonds in a world where governments need higher inflation and are willing to do pretty much anything to get it?

What happens if governments respond to bond market turmoil by creating even more currency and buying up all the long-term bonds, as Japan is currently doing in its own market? The pressure will shift to the foreign exchange markets, because who will want to own fiat currencies that are being created at rates far exceeding the growth of the real economy?

Fiat currencies are the one thing governments can’t buy up with newly-created money. All are at the moment falling in relation to artificially-inflated stock and real estate prices, though we don’t notice because currencies are valued against each other. But let a soaring money supply translate into rising general prices (something the bond market is now signaling) and it’s game over. Governments will face rising instability without tools capable of managing it.

At which point will we return to the above chart and wonder why we didn’t trust history?

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Posted with permission and written by John Rubino (CLICK HERE FOR ORIGINAL)