Economy, Markets

Even More Signs Of A Possible Reversal In The Wealth Effect

“If you build a bridge it has to reach the other side. So I think a bridge that relies on wealth effects, you better hope that you got enough growth to justify the asset price increase which created the wealth effect in the first place. So there is some sort of virtuous cycle that gets kicked off which becomes self-fulfilling over time. The alternative is you kick off the wealth effect now, but over time people realize the wealth ain’t coming and then you have an asset price adjustment.” –Raghuram Rajan, current head of the Reserve Bank of India and former chief economist at the IMF

There is no doubt the Fed achieved its goal of boosting the prices of risk assets over the past several years. Whether the Fed was able to create a, “virtuous cycle,” of growth that validates the gains in stocks is another question entirely. From the looks of equity values relative to their earnings, I’d have to say it now appears that, just a Rajan suggested, “the wealth ain’t coming.”

This is most evident in the recent fortunes of the most wealthy. CEO pay is falling at the fastest rate since the financial crisis. This is mainly because corporate earnings and profit margins are falling and the efforts of CEO’s and CFO’s aimed at engineering better financial results just aren’t enough to overcome these headwinds.

In addition to the public executive suite, it appears startup founders and their venture capitalist backers are feeling the heat from a broad shift in risk appetites.

This doesn’t just affect Silicon Valley. Startup hotbeds in places like Seattle, Austin and others are even feeling more pain right now than the Bay Area.

Still, Silicon Valley is the single largest startup market on the planet by far and the weakness there is already apparent in their real estate market.

It’s not just the ultra-high-end of that real estate market that’s feeling pressured. Real estate prices broadly declined in San Francisco last month.

On the other side of the country, the pressure on the wealthy is coming from troubles in investment banking. Like the troubles in VC, this is mainly due to a broad shift in risk appetites (mainly in the credit market’s unwillingness to fund deals).

It appears hedge fund managers are also feeling the pinch of waning risk appetites.

In a recent piece, I noted the weakness in market for real estate in the Hamptons as a direct result of this pressure on the wealth there. But it appears they may be selling their winter homes, too.

Beyond real estate, there’s a common theme now of weakening sales across virtually every luxury retailer, as well.  I recently wrote a bit about Sotheby’s issues. LVMH had a similarly rough first quarter.

…as did Burberry.

If the Fed’s theory regarding the wealth effect is correct the weakness at the very high-end that we are now seeing could be a very good leading economic indicator. And it might not take long to see this weakness, “trickle down.” In fact, it may already be apparent in auto sales. As a direct beneficiary of zero-percent interest rates, this has been a bright spot for the economy… until now.

Car makers now have so much inventory, both new and used, they are getting desperate to offload it.

Weakness in autos is also starting to show up in credit, which has underpinned the entire boom in the sector.

All in all it seems there is reason to worry about the consequences of the Fed-engineered wealth effect in recent years. If it is now unwinding, “an asset price adjustment,” as Rajan suggested, may now be looming.

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Investing, Trading

Trader Mentality Interview

I recently did an interview with Trader Mentality in which I discuss my personal investing discipline and the major influences who helped me develop and continue to shape it. I also share some advice for those new to the markets:

Economy, Posts

Here’s The Perfect Metaphor For Recent Fed Policy

Last week I came across this quote via John Hussman:

“The spread of fire-suppression mentality can be linked to the establishment of forest management in the United States, such that by the early 1900s forests became viewed as resources that needed to be protected – in other words, burning was no longer allowed. The danger of this approach became tragically apparent in Yellowstone, which was recognized by the late 1980s as being overdue for fire; yet smaller blazes were not allowed to burn because of what were perceived to be risks that were too high given the dry conditions. And so smaller fires were put out, but in the end could not be controlled and converged into the largest conflagration in the history of Yellowstone. Not only did the fire wipe out more than 30 times the acreage of any previously recorded fire, it also destroyed summer and winter grazing grounds for elk and bison herds, further altering the ecosystem. Because of fire suppression, the trees had no opportunity or reason to ever replace each other, and the forest thus grew feeble and prone to destruction… In 1995, the Federal Wildland Fire Management policy recognized wildfire as a crucial natural process and called for it to be reintroduced into the ecosystem… Central bankers, too, could learn a thing or two from their forestry brethren.” -Mark Spitznagel, The Dao of Capital

What a brilliant metaphor for the central bank policies we have witnessed for at least the past several decades! The Fed has been desperately trying to prevent or put out fires only to make the markets and the economy that much more vulnerable to them by encouraging every greater debt accumulation and risk taking. It reminds me of this New Yorker article which also utilized an insightful fire-based metaphor and originated the term, “Minsky moment.”

“Twenty-five years ago, when most economists were extolling the virtues of financial deregulation and innovation, a maverick named Hyman P. Minsky maintained a more negative view of Wall Street; in fact, he noted that bankers, traders, and other financiers periodically played the role of arsonists, setting the entire economy ablaze. Wall Street encouraged businesses and individuals to take on too much risk, he believed, generating ruinous boom-and-bust cycles. The only way to break this pattern was for the government to step in and regulate the moneymen.” -John Cassidy, The New Yorker, Feb. 4, 2008

Rather than rein Wall Street in, the Fed, via policies aimed at stimulating a wealth effect, has only encouraged the arsonists to create more imbalances and greater instability. What will it take for them to finally take a page out of the forest management playbook and realize they can’t banish the business cycle?

For more Spitznagel insights see this video of his appearance on Bloomberg television from a couple of months ago:


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

We’ve been hearing for years now how this is supposedly, “the most hated bull market in Wall Street history.” In fact, it’s become such a popular meme that even USA Today picked it up this week and ran with it. The trouble is there is absolutely no evidence at all to support this idea.

In fact, all the sentiment studies I look at suggest this has been one of the most beloved stock markets in Wall Street history. The Investors’ Intelligence survey is just coming off its longest sustained period of extreme bullishness ever recorded. Screen Shot 2016-04-07 at 9.26.55 AMChart via Yardeni.com

Surveys are fine but I prefer to look at what investors are actually doing with their money. Confirming the extreme bullishness in the II survey is mutual fund cash levels, which recently hit an all-time low as a percent of total assets.

Mutual_Fund_Cash_LevelChart via SentimenTrader.com

Another record-breaking extreme in bullishness witnessed recently can be seen in the positioning of traders in the Rydex family of mutual funds.


Beyond this small group of mutual funds, we can also look at total household assets as reported by the Fed. There has never been a time in history when investors have allocated as much money to stocks relative to cash as they have today.

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Furthermore, investors aren’t just allocating a massive amount of money to stocks, they are borrowing money from their brokers to buy even more, and doing so in record amounts.

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Even when you adjust margin debt for the growth in the overall economy, it recently hit an all-time record high. (And, btw, this doesn’t bode well for the, “bull market.”)

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It may be hard to believe but the fact is every one of these measures shows more euphoria among investors than any other time in at least a generation or two, including the dotcom bubble. So if you could stop calling this, “the most hated bull market in history,” that’d be great.

Economy, Investing, Markets

More Signs Of A Possible Reversal In The ‘Wealth Effect’

A couple of weeks ago I proposed the idea that the Fed’s efforts to stimulate a wealth effect in recent years could now be at risk of a reversal. There are growing signs that the ultra-wealthy in both Silicon Valley and on Wall Street are beginning to feel a bit of a pinch on their massive pocketbooks.

Maybe the best sign I’ve seen recently is in a new bond issue from Spotify. The company decided to issue debt rather than equity in order to avoid a down round that would be discouraging to the company’s equity investors. However, the terms of the deal are so onerous that it’s very possible it may hurt the company’s equity investors even more than a new equity offering would have. I would be hard pressed to find a better anecdotal symbol of the shift we are now seeing in risk appetites toward both startups and corporate debt.

Certainly, Spotify is not alone in seeing pressure on its equity valuation. Most unicorns now find themselves in that unenviable position.

And their investors have to be feeling a bit less optimistic about their ability to realize their gains as prices begin to reverse and the public market begins to shun them like never before.

This is only reinforcing the cycle of risk aversion in the sector.

Even Google, it seems, is now succumbing to the broad change in sentiment.

As I wrote in the earlier piece, this weakness in Silicon Valley appears to be taking a toll already on the high-end real estate market there. It’s probably only a matter of time before this is reflected in the broader real estate numbers.

The shut down of the IPO market not only hurts Silicon Valley, it hurts Wall Street, as well. And there’s another force working against these fat cats’ bank accounts: The market for mergers and acquisitions. Between the IPO and M&A markets, investment banking fees look to be hammered recently.

In the prior piece, I highlighted the slowing market for high-end homes in the Hamptons as a reflection of this weakness on Wall Street and as a clear risk to the wealth effect. We are now seeing a very similar pattern in the city, as well.

This sort of weakness is also showing up in high-end Miami condos that recently sold for as much as $850 per square foot. No longer.

And that other financial capital across the pond is also starting to see its high-end real estate market begin to weaken in very similar fashion to the Hamptons and Manhattan.

As I wrote last time:

If the Fed’s efforts in recent years were primarily focused on creating a, “wealth effect,” to stimulate the economy, they should be increasingly concerned now to see these growing signs of a reverse, “wealth effect.” Because if the economy does operate from the top down, as this theory proposes, these could be very important leading indicators.

Is the Fed paying attention? I would guess so and this could be one reason why we recently saw one of the most dovish Fed meetings in history.