From GMO’s Edward Chancellor

The Typical Characteristics of a Stock Market Mania

1. This-time-is-different mentality. Throughout history, successive market manias have been rationalized with the argument that history is no longer a reliable guide to the future. Both the “new era” of the 1920s and “new paradigm” of the 1990s were marked by a “this-time-is-different” mentality. The same mode of thinking is evident again today. U.S. profit margins are currently at peak levels and the profit share of GDP in the United States is more than two standard deviations above its long-term mean (based on data going back to the 1920s). The U.S. profits dataset is the most reliably mean-reverting financial series available, claims Andrew Smithers of Smithers & Co. Most commentary, however, assumes that U.S. profits have reached, in Irving Fisher’s immortal phrase, a “permanently high plateau.” As John Hussman of Hussman Funds comments, “Believing that historical tendencies have evolved into a new paradigm will likely have the same results as playing leapfrog with a unicorn.” Painful.

2. Moral hazard. Speculative bubbles tend to form when market participants believe that financial risk has been underwritten by the authorities. The “Greenspan Put” appeared in the late 1990s after it became clear that the Fed was prepared to support falling markets but wasn’t going to act against the bubble in  technology stocks. Fed policy hasn’t significantly changed since then. Monetary policy in the aftermath of the financial crisis has aimed to put a floor under asset prices, encouraging investors to take on more risk. As a consequence, U.S. household wealth – comprising largely of home equity and stocks – has rebounded to a near-record level of 472% of GDP, nearly 100% above its long-term mean. Whenever a cloud appears over Wall Street, market participants have come to expect more quantitative easing and guarantees of perpetually low interest rates. The personnel may change at the Fed, but the Greenspan Put remains in place.

3. Easy money. Great speculative bubbles have generally been accompanied by periods of low interest rates. Greenspan’s easy money policies in the last decade inflated the U.S. housing bubble, along with numerous other bubbles around the world. Bernanke’s cure for the economy in the wake of the financial crisis has been more of the same. For more than five years, U.S. real interest rates have been maintained at negative levels. An avowed aim of the Fed’s quantitative easing has been to push down long-term interest rates in order to boost both the stock market and home prices. In particular, lowering the long-term discount rate has boosted the valuation of growth stocks.

4. Overblown growth stories. Another common feature of a bubble is the overblown growth story. We witnessed this during the Dotcom bubble, ad nauseam. In the late 1990s we were told that tech stocks were experiencing “S-curve” growth (which posits very rapid growth in the near term); investors were also encouraged to value the “real options” of Internet stocks from future income streams yet to be conceived. Many of today’s high profile growth stocks – operating in fields such as social networking, electric cars, biotechnology, and, of course, the Internet – have been boosted by similar wishful thinking. Just as there were serial railway bubbles over the course of the 19th century, Internet stocks in the age of Dotcom 2.0 appear to be experiencing what my colleague James Montier has termed a “bubble echo.”

5. No valuation anchor. The most speculative markets – from the 17th century Dutch tulip mania onwards – have been marked by the absence of any valuation anchor; when there’s no income to tether the speculator’s imagination, asset prices can become unbounded. Our electronic age has even come up with a digital version of the Semper Augustus tulip. The fact that Bitcoin – the best known among the dozens of competing crypto-currencies – soared by 5,500% during the course of 2013 is testimony to the strength of the recent speculative tempo.

Needless to say, most of the recent stock market darlings – Netflix, Facebook, Tesla, and Twitter – have little or nothing in the way of profits. Internet retailer Amazon.com, whose margins have deteriorated in recent years yet whose stock soared nearly 60% in 2013, is the poster child for a market that is more obsessed with growth than profitability.

6. Conspicuous consumption. Asset price bubbles are associated with quick fortunes, rising inequality, and luxury spending booms. Since the spring of 2009, not only has the Fed engineered a strong rebound in the level of household wealth, but the richest part of the population has enjoyed the greatest share of the gains. Luxury spending has surged globally since the crisis.

The art market provides an excellent barometer of the speculative mood, given art prices depend entirely upon what other people are prepared to pay. A bubble in modern and contemporary art, which was evident before the financial crisis, has returned. Last November, a sculpture by Jeff Koons – Balloon Dog (Orange) – fetched $58 million at auction, a record sum for a work by a living artist. The contemporary collector apparently isn’t fazed by the fact that this dog was one of five “unique” versions or that Koons himself didn’t produce the work by his own hand but had it made in a factory. The same month, a painting by Francis Bacon sold for $142 million, the highest price ever paid for any work at auction.

7. Ponzi finance. Manic markets are often marked by a decline in credit standards. In the last decade, subprime debt inflated the U.S. real estate bubble. The financial crisis may have had many unpleasant after-effects, but it hasn’t diminished the appetite for low quality U.S. credit. In fact, we have recently witnessed the lowest yields for junk bonds in history. The quality of debt issuance has been deteriorating. Last year, nearly two out of three corporate bond issues carried a junk rating. Last year, total issuance of high yield and leveraged loans exceeded $1 trillion. More than half of the 2013 vintage leveraged loans came without the traditional covenants to protect investors. The decline in the quality of credit has attracted the attention of Jeremy Stein, one of the more market-savvy Fed governors. Stein’s boss, Janet Yellen, has also expressed concern about the manic leveraged loan market.

8. Irrational exuberance. Valuation is the truest measure of speculative mood. There are other ways to take the market’s pulse, however. Most conventional measures of market sentiment have become very elevated over the past year. The IPO market in 2013 and into the first quarter of 2014 has become particularly speculative. New IPOs in 2013 rose on average by 20% on their first day’s trading (Twitter rose 74% on the day it came to the market last November). Nearly three-quarters of the IPOs, which were launched in the six months to March, produced no profits. A good portion of these profitless IPOs, in particular those of the biotech variety, hadn’t even got around to generating anything by way of revenue. They are story stocks, pure and simple.

Other sentiment measures have been telling the same story. The trading activity of corporate insiders is a reasonably good indicator of managements’ view on the intrinsic value of their companies. Recently, the ratio of insider sales to purchases has climbed to near record levels. Equity mutual fund flows – another commonly cited sentiment indicator – have also picked up lately, while household cash balances (as a share of total assets) have declined. Margin debt as a share of GDP is close to its peak level. Market volatility has been trending downwards, while the daily correlation of stocks – another useful gauge of the market’s fear level – has also come down.

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And yes: we have all of the above right now, most of which in record amounts. So… buy, buy, buy.

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Original source at: zero hedge - on a long enough timeline, the survival rate for everyone drops to zero | http://www.zerohedge.com/news/2014-05-05/eight-characteristics-stock-market-mania

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We’ve all done it, haven’t we? Chucked something in the wash and turned it on too high, only to see it pop out at the end of the cycle and it ends up the size of your hamster. Well, Obama has been doing the same. Except this time it’s not your winter woollies that he’s shrinking, it’s the greenback.

The US currency is shrinking as a percentage of world currency today according to the International Monetary Fund. It’s still in pole position for the moment, but business transactions are showing that companies around the world are today ready and willing to make the move to do business in other currencies.

The US Dollar has long been the world’s number one denomination in world currency supply. It represents 62% of total holdings in foreign exchange in central banks around the world. But, it is in for a tough race from up-and-coming strong currencies. The Japanese Yen and the Chinese Yuan are both giving the Americans a good run for their money. The Swiss franc is too (surprisingly). There is $6 trillion in foreign exchange holdings around the world at any given time, on average and the US Dollar represents almost two-thirds of that.

The fact that Brazil and China have also just signed a currency-swap deal worth something to the tune of $30 billion stands as living proof that the dollar may be further on the wane. China will exceed all expectations in the future as the world’s largest economy. The US will be overtaken. The Chinese currency will one day overtake the Dollar too. Has to be!

Although, it’s not quite there for the moment. China is not near being the world’s reserve currency yet. In order to be the world’s reserve currency there would be the need to produce enormous quantities of what the world wants. China has got that one off pat already. Then, countries holding the reserve currency would need to be able to spend that currency elsewhere in other countries or find a place to put it while waiting to do so. World capital markets are currently in dollars (40%), which means that there would be no possibility of using the Chinese currency. But, that’s only a matter of time. Some are predicting this will happen pretty soon.

The Federal Reserve has come in for some strong criticism over the unconventional Quantitative Easing methods that have resulted in 3 trillion spanking new dollars rolling off the printing presses. This has certainly brought about some degree of worry around the world that the dollar is not quite as safe as it might have been thought to be in the past. Is the world worrying that the dollar is not as safe a bet as it used to be in world domination. Are central banks worried that it will shrink in the wash and the colors will run?

Some are predicting that the dollar will shrink rapidly over the next two years and it will lose its top place as the world’s reserve currency by 2015. In the 1950s the dollar was 90% of total foreign currency holdings around the world. The dollar has definitely lost out to other currencies that are stronger. If there is a continued move and the dollar shrinks, then the resulting catastrophe that will ensue will have a spiral effect on the already enormous US budget deficit (over $1 trillion a year on average).

The only reason the Federal Reserve has been in a position to print more money recently is simply because they are in the strong position to be able to do so as the world’s leading reserve currency. If that changes, then the Americans won’t have the possibility of just hitting the button and setting the printing presses rolling. That means the US will be in no other position than to end up having to pay their debt back.

The US economy and the market are starting to show signs of recovery. Signs. It’s not sustained, hope as they might. If the dollar loses its attraction, then it won’t be used as the international reserve currency. Businesses will start using another currency and the dollar will lose out further still.

Some experts are saying that the problems of the dollar are like a time-bomb ready to explode. Ultimately, it will bring about the death of the dollar. As we stand on and watch, huddled around the coffin as it is lowered into the ground, we know it’s all too late. The flowers have been sent and the Stars and Stripes has been played in recognition of loyal service for the nation.

The QE methods are nothing more than aiding and abetting the already problematic situation of the greenback. We might look back in years to come and reminisce over whether it was the right (long-term) solution to use QE, whether printing bucks sent the greenback to an early grave, or whether it just reached the end of its life and croaked peacefully without making too much noise.

But, criticism of and worry over the dollar and its longevity have been hot topics for years now. The US dollar is a fiat currency that can easily lose status, deriving its value from government regulation and law. But, then again, so is the Euro. So, people living in Europe shouldn’t start throwing stones…they live in glass houses too…and that’s before they start.

Originally posted: Death of the Dollar

You might also enjoy: You’re Miserable USA! | Emerging Markets: Lock, Stock and Barrel | End of the Financial World 2014 |  Kristallnacht on Wall Street? Bull! | China’s Credit Crunch | Working for the Few | USA:The Land of the Not-So-Free  

 

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Original source at: zero hedge - on a long enough timeline, the survival rate for everyone drops to zero | http://www.zerohedge.com/contributed/2014-02-05/death-dollar

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Just a week ago, Ben Bernanke stumbled when he almost admitted that "forward guidance worked in theory, but not in practice," and while the Fed is sticking to its guns with lower for longer "forward guidance" to replace "as much money as you can eat" quantitative easing; and the ECB promising moar for longer; the Bank of England's Mark Carney just threw them all under the bus by u-turning on his employment-based forward guidance strategy. Having previously established thresholds for his monetray policy guidance, as the FT reports, he has now ditched those plans (as we warned he might "lose his credibility" here) as the British economy is "in a different place" now. And still, we are supposed to trust these bankers to run the world? Perhaps most interesting is the FT changed its title on the story very quickly!

 

Via The FT,

 

Mr Carney signalled the policy U-turn in a series of TV interviews while attending the World Economic Forum in Davos. However, he added that he had no plans to raise interest rates “immediately”.

 

 

Speaking to the BBC’s Newsnight in response to the news this week that UK unemployment had fallen to 7.1 per cent, almost to the point the BoE said it would consider a rate rise, the bank has decided not to revise its 7 per cent unemployment threshold but drop the idea completely.

 

 

The BoE followed the Federal Reserve in announcing forward guidance last August in a bid to make monetary policy “more effective”. It said it would not consider a rate rise in the UK at least until unemployment fell to 7 per cent from the rate last summer of 7.9 per cent.

 

The BoE forecast that it was most likely that unemployment would fall to the 7 per cent threshold only in 2016. Recognising a serious forecasting error has caused red faces at the BoE and created confusion over the policy, Mr Carney will address the subject again on Friday and Saturday.

 

 

Commenting on the huge errors in the bank’s forecasts, Mr Carney said: “If our forecast is going to be wrong, it’s better to be wrong in that direction”.

 

What is perhaps more interesting is the fact that the FT changed the title of the story very quickly…

 

Before…

 

After…

 

It seems someone at the BoE did not like it…

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Original source at: zero hedge - on a long enough timeline, the survival rate for everyone drops to zero | http://www.zerohedge.com/news/2014-01-23/bank-england-folds-forward-guidance

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