Investing, Markets

Stan Druckenmiller: ‘What Part of “Get Out of The Stock Market” Don’t You Understand?’

The big news out of the Sohn Conference yesterday was Stan Druckenmiller’s appearance. Some of revelations were new and some not so new but all were unequivocal.

Let’s start with the not so new:

Here’s what is new:

  • Druck says the Fed has “no endgame” and is now “raising the odds of the tail risk its trying to avoid.” (via Jenn Ablan)
  • The stock market has now “exhausted itself” and it’s time to “get out.” (via Josh Brown)

Could he make it any plainer than that?

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Investing, Markets

Why ‘Tobin’s Q’ Should Make You More Cautious Towards The Stock Market Today

After writing “Here’s The Perfect Metaphor For Recent Fed Policy,” I had to pick up a copy of The Dao of Capital. Mark Spitznagel just has a unique way of looking at the markets that really resonates with me.

One thing that really jumped out at me while reading it was Spitznagel’s research regarding Tobin’s Q, (though he calls it, “The Misesian Stationarity Index”). It struck me for two reasons. First, I haven’t seen much research like this elsewhere and second, the opinions I have seen regarding it are all of a dismissive nature.

Just Google “Tobin’s Q” and you’ll find all sorts of pieces proclaiming, ‘Don’t worry about Tobin’s Q,’ and, ‘Tobin’s Q is not an effective way to time the market,’ etc. Actually, both of these sentiments are incorrect.

Spitznagel’s research published in the book shows investors should be worried about the extreme level of Tobin’s Q today for the simple fact that is a very good way to time the market.

But before I get into that I should probably explain what the ratio is. It’s pretty simple, really; the Q-Ratio is just the total value of the stock market (numerator) relative to the total net worth of the companies that comprise it (denominator). The data is provided quarterly by the Fed.

When the Q-Ratio is very low, stocks, as a group, are inexpensive relative to their replacement cost. Conversely, when the ratio is very high, stocks are relatively expensive in this regard.

Critics have suggested this way of thinking about the stock market is outdated. In other words, “this time is different.” And even if they admit that comparing equity valuations to net worth has some value they insist that value does not include timing the market.

However, Spitznagel shows that when you separate the historical record of the ratio into quartiles and compare forward returns to the risk-free rate, stocks have performed very poorly after very high q-ratio readings. They also performed very well after very low q-ratio readings. Once again, it turns out that, “the price you pay determines your rate of return,” is validated by the data.


Additionally, when the Q-Ratio has been very high, as it is today, the size of the subsequent drawdowns were much larger than those following low readings in the ratio. In other words, when stocks become largely very expensive, as they are today (see the chart at the top of this post) we should come to expect large losses.


So if you care about forward returns relative to potential drawdowns, the Q-Ratio is something you probably want to pay very close attention to. Clearly, it has great value in determining this reward-to-risk ratio that is critical to the investment process. And, like other measures, the Q-Ratio is currently suggesting investors are taking a great deal of risk for very little in the way of potential reward.

How the Q-Ratio comes to be so skewed is different topic altogether and something you’ll learn in reading the book. But here’s a hint. And if you need further incentive to pick up a copy, Spitznagel also includes a couple of simple strategies built around the Q-Ratio that handily beat a buy-and-hold approach.

Economy, Investing, Markets

No — This Chart Doesn’t Prove This Is The Most Hated Bull Market

All it proves is that the wealth gap is, indeed, growing ever wider. Gallup recently released the results of a poll many are using to claim, “See! I told you this was the most hated bull market of all time!” It shows that only 52% of Americans currently own stocks, tied for the fewest on record (chart above).

Let’s set aside the fact that this is poll and many Americans don’t realize how much they currently have invested in the stock market via retirement plans. Let’s just focus instead on the actual data from the Fed which shows equity ownership as a percent of household financial assets near all-time highs. If they do, in fact, hate stocks, they certainly aren’t putting their money where their mouths are.

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Now this still doesn’t address what percent of Americans actually own stocks. It just aggregates all of their financial assets and tells us what share is allocated to the stock market. But it certainly suggests that Americans don’t hate the stock market. In fact, as a group they have never preferred stocks to cash more than they do today.

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And if you’re looking to understand why Americans as a group might not feel as wealthy or optimistic about their personal finances as they have in the past, despite the Fed’s apparent success in boosting the prices of risk assets, you might want to take a look at another poll. The Atlantic reports:

The Fed asked respondents how they would pay for a $400 emergency. The answer: 47 percent of respondents said that either they would cover the expense by borrowing or selling something, or they would not be able to come up with the $400 at all. Four hundred dollars! Who knew?

If 47% of Americans don’t even have $400 in savings is it any wonder they aren’t buying stocks? But if they actually had $400 to their names, that Fed data referenced above suggests it would most likely be invested in the stock market, not in cash, that latter asset class truly being the most hated in history.


It’s Time To Put An End To The “Most Hated Bull Market” Meme

Investing, Markets

This Indicator Is Still Flashing A Bear Market Warning

The NYSE just released the margin debt numbers for March and, considering the rally in stocks we’ve seen, it wasn’t much of an uptick. In fact, the nominal level of margin debt remains well below its 12-month average.


The 12-month rate of change, which is pretty tightly correlated with stocks’ same rate of change, is also still negative.


Now this sort of a downtrend in margin debt doesn’t always lead to a bear market but let’s put it into some context. Not only is margin debt now in a downtrend, it’s coming off of the highest absolute (top chart) and relative (chart below) highs ever seen.


And if you think if margin debt as a simple indicator of potential supply and demand for stocks (when borrowing is low there is great potential demand and vice versa), this should have you worried about another bear market. And the statistics bear this out.

When margin debt has reached relative extremes it has been a very good indicator of, in the words of Warren Buffett, broad investor, “fear and greed.” To demonstrate, when financial speculation relative to the overall size of the economy has been very low, forward 3-year returns have been very good and vice versa.


What’s important to note today is that margin debt is now in a downtrend and its massive relative size suggests returns over the next 3 years will be very poor. In other words, based solely on this one measure, buying stocks today presents investors with a great deal of risk for very little potential reward.


Fighting Bullish Spin With Data And Analysis

I came across a blog post today over at Dash of Insight. Normally, I enjoy checking in with Jeff’s thoughts here and there but today I have to take issue with something.

In “expensive misconceptions,” he likens a chart of John Hussman’s with things like the Baltic Dry Index and the Hindenburg Omen ultimately concluding these are all nothing more than opportunities for investors to indulge in confirmation bias.


Specifically, he takes issue with the chart in question (above) by writing:

“I have a simple question for you: Could you step up in front of a group of people and explain this chart? If not, why do you believe it? A smart and influential guy presents something that you cannot really evaluate. Why is this a sound basis for your decisions?”

In other words, because “you” (read “he”?) can’t explain the chart, it is simply not valid. To be clear, Jeff makes no attempt to even understand the chart or the concept behind it let alone pose any counterargument to it at all, at least not anywhere in this post.

So let me help him out here by explaining it. This chart is a visual representation of Warren Buffett’s famous words: “The price you pay determines your rate of return.” In fact, this chart is a very close cousin to what Buffett has called, “the best single measure of where valuations stand at any given moment.” That is, the total value of the equity market in relation to GNP, essentially a price-to-sales ratio for the broad stock market.

It’s very simple, actually. When investors have paid high prices in the past, as indicated by the total value of the country’s equities relative to the country’s economic output (including foreign sales generated by domestic companies – one popular critique of the Buffett Yardstick is that it doesn’t account for this), they have received meager and even negative returns over long periods of time, as indicated by the forward 12-year returns on the chart. Conversely, when investors have been able to buy stocks at relatively low valuations, their returns have been very good over the following decade or more.

Furthermore, this negative correlation between valuations and forward returns is statistically very high (greater than -90%) and backed by 65 years worth of data. The Buffett Yardstick, as Hussman demonstrates, has been nearly as good as his own version at forecasting forward returns and is backed by roughly 90 years worth of data. Both charts, and the data and reasoning behind them, clearly demonstrate and validate the concept that, “the price you pay determines your rate of return.”


The only “expensive misconception” here is failing to understand this iron “law of valuation,” as Hussman calls it. Investors who are willing to believe they should reasonably expect wonderful returns regardless of the price they pay will inevitably be introduced to this law over the course of their investing lifetime, as countless others have been in the past. Just ask anyone who bought stocks in 1929, 1937 or 2000, the last three times stocks reached current valuation extremes, according to the Buffett Yardstick.

Finally, I find it terrifically ironic, and perhaps enlightening from a sentiment standpoint, to see Jeff end the piece with this:

“The insightful investor fights spin with data and analysis.”

Because, at least in this instance, it appears he’s fighting robust data and analysis with nothing but spin. In fact, Jeff may be indulging in a bit of confirmation bias of his own:

Confirmation bias, also called confirmatory bias or myside bias, is the tendency to search for, interpret, favor, and recall information in a way that confirms one’s preexisting beliefs or hypotheses, while giving disproportionately less consideration to alternative possibilities. -Wikipedia

“Less consideration to alternative possibilities”? How about none at all?