Charts, Economy, Investing, Markets

Stocks And Bonds Are Saying Totally Different Things About The Economy Right Now

They say the markets are forward-looking, discounting what will happen in the near future rather than what has already happened in the recent past. I believe this is true. However, some markets are better at this than others.

And right now two major markets appear to be discounting totally different outcomes. The stock market has rallied hard off of its recent lows, suggesting fears of recession and a concomitant bear market were overblown.

At the same time, long-term interest rates, after falling along with stocks earlier in the year, have failed to match the recent equity rally. In fact, they’ve reversed right back to their lows. This suggests the bond market is as worried about low growth and inflation as ever.

So who’s right?

Personally, I’m leaning toward believing the bond market. The stock market might not care about the current earnings recession but history shows it leads to an economic one 81% of the time:

Charts, Investing, Markets

This Is STILL The Worst Possible Environment For Stock Market Investors

The latest Z.1 data was released yesterday showing that, as of the end of the year, the stock market was still very overvalued, investors were still overly bullish and the S&P 500 was still very overbought relative to its long-term regression trend. In other words, this is still the worst possible environment for equity investors.

Let’s start with Buffett’s favorite valuation yardstick, total equity market cap relative to GDP. It still shows the broad stock market to be more highly valued currently than any other period during the past 60 years outside the peak of the dotcom bubble.

Screen Shot 2016-03-11 at 9.42.47 AM

The percent of household assets allocated to stocks is also hovering near record highs, suggesting investors have rarely been more bullish than they are today.

Screen Shot 2016-03-11 at 9.42.37 AM

Even more interesting from a sentiment standpoint, however, may be the ratio of household equity holdings to money market funds assets. This ratio is just off its all-time high set during the second quarter of 2015. Yes, this is likely due to seven years of ZIRP but it’s hard to argue that investors haven’t completely bought into the TINA argument over that time.

Screen Shot 2016-03-11 at 10.47.03 AM

Finally, the S&P 500 finished the month of December 82% higher than its exponential regression trend line. This is roughly where it stood in the Fall of 2007 just prior to the financial crisis. (It is also roughly the level attained just prior to the crash of 1929, as well, though this is not pictured in the chart below.) The only time it’s been higher than this is, you guessed it, during the height of the dotcom bubble.

Screen Shot 2016-03-11 at 10.37.08 AM

When you combine these three signals (not including the money market fund ratio) we get a blended forecast of 1.33% for the broad stock market annually over the next decade. Since 1951 this model has an 89% correlation with forward 10-year returns so it’s something worth paying close attention to. Compare that prospective return to the 2% offered by the 10-year treasury note and it’s hard to argue that stocks currently offer adequate reward to offset their much greater risk.

Screen Shot 2016-03-11 at 10.30.28 AM

What’s more, the S&P 500 in December closed beneath its 10-month moving average signaling a long-term trend reversal.

Screen Shot 2016-03-11 at 11.08.03 AM

At the end of 2015, stocks remained very overvalued, over-bullish and over-bought and the trend had reversed to the downside. None of this has changed in the 70 days since. And in the past, this setup has led to some of the worst bear markets we have ever seen.

Ultimately, equity investors currently face the very real prospect of another massive potential drawdown in hopes of achieving an annual return less than the “risk-free” rate. That’s not a risk/reward equation that should get anyone excited about owning stocks right now.

RAMALLAH, WEST BANK - JANUARY 10: US President George W. Bush holds a news conference with Palestinian President Mahmoud Abbas (not pictured) at Abbas's Muqata headquarters on January 10, 2008 in Ramallah, West Bank. Bush is on his second day of his first visit to the Middle East aimed at advancing peace negotiations. After talks with Israeli Prime Minister Ehud Olmert yesterday, he vowed to apply pressure if it is needed in finding a lasting peace  (Photo by Uriel Sinai/Getty Images) *** Local Caption *** George W. Bush
Charts, Economy, Investing, Markets, Posts

Don’t Dismiss The Systemic Risk Of A Corporate Credit Bust

After the worst start to a new stock market year in history, some have begun to wonder if the unusual weakness is a sign of larger problems in the economy or financial system. Certainly, the growing strains in the credit market suggest it’s more than, “just an energy thing.”

These worries have been met with a popular response. I’ve seen a variety of headlines conclude, “why this market meltdown isn’t a repeat of 2008,” or something along those lines. But this rush to judge may be premature.

The incredible boom we have seen in corporate credit in recent years is actually very similar to the boom in the mortgage market which led to the financial crisis. As Jeff Snider noted yesterday, just the past few years issuance of lower-rated corporate debt dwarfs the size of the entire subprime mortgage market in 2007.

ABOOK-Feb-2016-DB-Corporate-Bubble-JunkAt the same time, lenders’ underwriting standards have never been more lenient. Covenant-lite lending, as a percent of total leveraged loans, has absolutely exploded in recent years. In effect, corporations have had access to their own version of NINJA (no income, no job, no assets) loans.

Screen Shot 2016-02-02 at 11.07.16 AM

Finally, sub-prime mortgages were highly-levered (in terms of loan-to-value) and built upon inflated home prices compounding the problem. Similarly, corporate leverage is now off the chart.

Screen Shot 2016-02-02 at 11.16.00 AM

At the same time, these soaring leverage ratios are built upon similarly inflated profit margins.


So it’s probably far too early to say that the current weakness in risk assets, especially in the credit markets, is in any way, “contained,” as of yet. In fact, there are many similarities between today’s corporate credit boom and the mortgage boom that led to the financial crisis nearly a decade ago. And to dismiss the systemic risk once again? Shame on you.


The Only Guy On The FOMC With Any Experience Actually Managing Risk Is Sounding The Alarm

Charts, Markets, Posts

If History Rhymes This Indicator Suggests Stocks Still Have A Long Way To Fall

The latest NYSE margin debt figures came out this week showing another drop during the month of December. Moreover, the level of margin debt has now spent a few months below its 12-month moving average, which has been a decent bear market signal in the past (first proposed by Norman Fosback).

Screen Shot 2016-01-29 at 9.48.21 AM

Even when adjusted for the size of the overall economy, margin debt recently hit record high levels, greater even than what we saw at the peaks just prior to the dotcom bust and the financial crisis.

Screen Shot 2016-01-29 at 9.48.09 AM

The reason I like to look at margin debt relative to GDP is that is it fairly negatively correlated with forward 3-year returns in the stock market. When levered financial speculation has been rampant, as indicated by a high level of margin debt-to-gdp, stocks have regularly suffered severe losses over the next several years and vice versa.

Screen Shot 2016-01-29 at 9.47.54 AM

Unless you believe, “this time is different,” you should probably expect some rough sledding for the stock market going forward. How rough? Well, after both of the prior occurrences in which margin debt became as substantial as it is today, stocks suffered a 50% drawdown (and 3-year returns of roughly -40% at the lows). If history indeed rhymes, another such decline is not out of the question.

Charts, Economy, Investing, Markets, Posts

Corporate Bonds Pass An Ominous Milestone

The spread between the yield on corporate bonds and that on treasuries passed the 2% mark yesterday for the first time in over three years yesterday.

In the chart above I’ve annotated with red vertical lines the prior two occasions when spreads widened to this degree for the first time in at least two years. Notice that each of the two prior occurrences led to painful bear markets and recessions.

Now this indicator alone isn’t sufficient evidence that another painful bear market and concomitant recession are on their way. However, when you pair it with the all the other data out there, it’s confirmation of the growing probability of both.


Why Recession Is More Likely Than You Think

This Chart Suggests A Bear Market Could Be Lurking