The American public thinks they are rugged individualists, who come to conclusions based upon sound reason and a rational thought process. The truth is that the vast majority of Americans act like a herd of cattle or a horde of lemmings. Throughout history there have been many instances of mass delusion. They include the South Sea Company bubble, Mississippi Company bubble, Dutch Tulip bubble, and Salem witch trials. It appears that mass delusion has replaced baseball as the national past-time in America. In the space of the last 15 years the American public have fallen for the three whopper delusions:
“Of course, we doubt if many public prescriptions are really intended to solve problems. People certainly believe they are when they propose them. But, like so much of what goes on in a public spectacle, its favorite slogans, too, are delusional – more in the nature of placebos than propositions. People repeat them like Hail Marys because it makes them feel better. Most of our beliefs about the economy – and everything else – are of this nature. They are forms of self medication, superstitious lip service we pay to the powers of the dark, like touching wood….or throwing salt over your shoulder. “Stocks for the long run,” “Globalization is good.” We repeat slogans to ourselves, because everyone else does. It is not so much bad luck we want to avoid as being on our own. Why it is that losing your life savings should be less painful if you have lost it in the company of one million other losers, we don’t know. But mankind is first of all a herd animal and fears nothing more than not being part of the herd.”
We have arrived at critical juncture in the ongoing financial crisis. Have the government actions of the last year successfully spurred the animal spirits of Americans, resulting in a self-sustaining recovery?
The Obama administration and most of the mainstream media would answer yes. GDP has been positive for the last four quarters. Consumer spending has increased in five consecutive months. Corporate profits have been relatively strong. The country has stopped losing jobs. The missing piece has been a housing recovery.
No need to worry. Famous or infamous (depending on your point of view) $15 billion man John Paulson has assured the world that house prices will rise 8% to 10% in 2011. His basis for this forecast is that California prices have rebounded 8% to 10% in the last year, and this recovery will spread to the rest of the nation.
Maybe Paulson has teamed up with his buddies at Goldman Sachs to develop a product that guarantees a housing recovery. I tend to not believe anything that comes out of the mouth of anyone associated with Wall Street, but let’s assess the facts and see if they point to an impressive housing recovery in 2011.
The man who has been right on housing for the last ten years has been Yale Professor Robert Shiller. His analysis of U.S. housing prices from 1890 until present, which he first published in 2005, unequivocally proved that we were in the midst of the greatest housing bubble in history. At the same time, David Lereah, the chief economist (shill) for the National Association of Realtors, was pronouncing it was the best time to buy. He published his masterpiece of market tops, Are You Missing the Real Estate Boom? at the 2005 housing peak. He called a bottom in January 2007, and the NAR has continued to tell Americans it is the best time to buy for the last five years as prices have dropped 36% nationally.
Dr. Shiller continues to be the voice of reason when it comes to the housing market. He is doubtful that the recent “recovery” will continue:
“Recent polls show that economic forecasters are largely bullish about the housing market for the next year or two. But one wonders about the basis for such a positive forecast. Momentum may be on the forecasts’
Some really interesting thoughts by Robert Shiller on the psychology of the markets and how negative psychology is beginning to compound, creating a snowball effect. Mr. Shiller is increasingly concerned about the economic outlook and the potential that we are talking ourselves off the edge of the cliff:
Today’s chart of the day comes to us courtesy of Robert Shiller at Yale University. The following is Shiller’s famous inflation adjusted home price index. Interestingly, despite a 30%+ decline from peak to trough, housing prices are still more expensive than at any other point in the last 120 years when you exclude the recent bubble era. Some say housing prices have bottomed. Not unless it’s truly “different this time”.
The couple bought their first home in a modest suburb in the late 1970s for an undisclosed price, then bought a home in another suburb in 1980 for $96,000. In 1987 they sold that residence for $110,000 and bought another one for $135,000. They then sold that house for $400,000 in 2002 and bought their current home for a price "in the $600,000s" (realtor-speak for about $650,000). After peaking in value at the bubble top in 2005-06 at around $1,000,000, the home is now on the market for $637,000 ($600,000 + 6% commission).
To peek under the hood of the larger trends, I’ve laid out each buy/sell along with its inflation adjusted value in current dollars. As always, I use the BLS inflation calculator; though it reflects the flaws of the CPI calculation methodology, it is consistent.
1980 purchase: $96,000
in 2010 dollars: $252,000
1987 sale: $110,000
in 2010 dollars: $210,000
1987 purchase: $135,000
in 2010 dollars: $257,000
2002 sale: $400,000
in 2010 dollars: $482,000
2002 purchase: $650,000
in 2010 dollars: $783,000
2010 sale: (projected) $637,000
These inflation-adjusted "real" numbers are insightfully different from the nominal prices.
To place the 1980 valuations in proper context, we need to recall that the U.S. was suffering from sky-high inflation in the late 70s and extremely high rates of new household formation as the 78 millon Baby Boomers went out and bought houses. Those two factors created a housing boom, both in valuations and homes built.
It took $1.36 in 1980 to buy what $1 had bought a mere three years before in 1977. As people fled the stock market for tangible assets and Boomers started families, real estate soared (as did gold). While I don’t have the numbers for that house bought for $96,000 in 1980, anecdotally I can assure you that homes…
Some of the world’s smartest and dumbest economists have gathered in Davos, Switzerland to talk about the global banking system and how they’re all hoping that 2010 doesn’t turn out like 2008. CNBC’s Becky Quick grabbed Yale economist Robert Shiller for a quick chat.
Obviously, Shiller is one of the sharper tools in the economic shed, starting this interview by noting of his duller brethren: "The problem with a lot of economic theory is that they have not recognized what drives the economy." Sad, but true.
Relying on the valuation methodology made famous by Yale professor Robert Shiller, author of the prescient bestseller Irrational Exuberance, along with some analysis of his own, Doug Short, publisher of dshort.com, raises the question that many bulls seem to be ignoring (or avoiding): "Is the Stock Market Cheap?":
For a more precise view of how today’s P/E10 relates to the past, our chart includes horizontal bands to divide the monthly valuations into quintiles — five groups, each with 20% of the total. Ratios in the top 20% suggest a highly overvalued market, the bottom 20% a highly undervalued market. What can we learn from this analysis? Over the past several months, the decline from the all-time P/E10 high dramatically accelerated toward value territory, with the ratio dropping from the 1st to the upper 4th quintile in March. The price rebound since March has now put the ratio at the top of the 2nd quintile — quite expensive!
A more cautionary observation is that every time the P/E10 has fallen from the first to the fourth quintile, it has ultimately declined to the fifth quintile and bottomed in single digits. Based on the latest 10-year earnings average, to reach a P/E10 in the high single digits would require an S&P 500 price decline below 600. Of course, a happier alternative would be for corporate earnings to make a strong and prolonged surge. When might we see the P/E10 bottom? These secular declines have ranged in length from over 19 years to as few as three. The current decline is now nearing its tenth year.
I would add that the equity market’s low-valuation extremes were hit during what might be described as "turbulent times," including World War I, the Great Depression, World War II, and the stagflation of the late-1970s. Except for the most delusional of permabulls, it would be hard for anyone to argue that the unraveling that began more than two years ago doesn’t also fit that bill.
The owners of capital fared no better, with the nominal S&P500 stock price index down 20% for the decade. The dividends stockholders collected made up for some of that, but inflation took away even more.
Blue line: Nominal value of S&P500 stock index, January 1980 to December 2009. Red line: value as of January 2000. Data source: Robert Shiller.
One of the reasons stocks did so badly was that real earnings ended the decade 80% lower than they began. Even when you smooth out cyclical variations by taking a decade-long average as in the dashed blue line below, the downturn in earnings at the end of the decade is still pretty significant.
Green line: Real value (in 2009 dollars) of earnings on the S&P500, January 1980 to December 2009. Dashed blue line: arithmetic average of green line for the preceding 10 years. Data source: Robert Shiller.
But a bigger reason why stocks did so badly was the changed valuation of those earnings. Yale Professor Robert Shiller likes to summarize this by using decade-long averages of real earnings to calculate a price-earnings ratio. In January 2000, this cyclically adjusted P/E ratio was profoundly out of line with the average values we’d seen over the previous century. If you trust the tendency of this series to revert to its long-run average, it means that whenever the blue line is above the red, you should expect stock prices to grow at a slower rate than earnings. If you bought when the blue was as far above the red as it was in January 2000, then I hope there was something else you found to enjoy about the naughty aughts.
Cyclically adjusted P/E over the last century. Blue line: Ratio of real value (in 2009 dollars) of S&P composite index to the arithmetic average value of real earnings over
Always and everywhere the market timing argument resurfaces in multifarious forms. The idea is simple: sell high and buy low: what could be more obvious? Well, there’s a problem. It’s not necessarily insurmountable but it’s definitely a bit tricky.
You may need a time machine to implement the concept successfully.
The idea behind market timing is easy to state. Sell stocks when they’re high and buy them when they’re low. It’s the basic idea the lies behind all investment in stocks so it’s hard to see why anyone should object. The difficulty lies in the impossibility of implementing the technique accurately in the timescales generally envisaged. Which, to be precise, tends to mean any timescale you can envisage at all. Mostly we have no idea ahead of time whether any given stock has peaked or troughed. Most guesses – let’s not dignify these with the term “forecast” – turn out to be wrong.
Unfortunately the idea is seductive and apparently easy to implement, in hindsight. Looking back everything seems so obvious that the untrained human brain finds it almost impossible to believe that the future isn’t equally predictable.
Buy and Hold
A recent study from the CFA shows that markets go up twice as much as they go down. Their recommendation, if you have cash to invest, is to invest everything now: the research shows that this will maximise your returns over an investment lifetime.
However, this is a pretty unnerving suggestion: had you thrown your money into the market back in the middle of 2006 you’d be sitting on a very nasty loss. Of course, you’d have been appallingly unlucky to get your timing that wrong, but inevitably some people did and the fact that the odds were against them doing so will be no consolation. The alternative suggested by the authors is to feed your money into the markets gradually – averaging your costs. This is a form of insurance, ensuring that you don’t put all your cash in at the market top or, of course, the market bottom.
However, the research also shows that there’s a limit to the value of averaging. After eighteen months there’s no discernable benefit to spreading the timescale of your investments. The vast majority of the benefit comes
Robert Shiller of the infamous Case-Shiller index has a particularly interesting piece in the NYT. Instead of hammering on numbers he takes a look at the psychology of home buyers and sellers and why that might affect home prices for some time to come.
Shiller examines the behavioral biases that lead people to “irrationally” hold onto houses during a period or declining values. The concluding paragraphs are thought provoking:
For this reason, not all economists agree that home price declines are really predictable. Ray Fair, my colleague at Yale, for one, warns that any trend up or down may suddenly be reversed if there is an economic “regime change” — a shift big enough to make people change their thinking.
But market changes that big don’t occur every day. And when they do, there is a coordination problem: people won’t all change their views about homeownership at once. Some will focus on recent price declines, which may seem to belie any improvement in the economy, reinforcing negative attitudes about the housing market.
Even if there is a quick end to the recession, the housing market’s poor performance may linger. After the last home price boom, which ended about the time of the 1990-91 recession, home prices did not start moving upward, even incrementally, until 1997.
I say it’s thought provoking because when you look at the recent frenzy in the lower priced end of the housing markets it’s hard to come up with a theory that squares with Shiller’s ideas. Unless you are of the opinion that the drastic decline in prices constitutes an economic “regime change.” Certainly, there hasn’t been any fundamental shift at all in the general economy that has prevailed in this sudden shift from a buyers to sellers market. So what might be driving it?
The only plausible theory I can come up with is that the buyers perceived an exceptional opportunity to purchase housing at favorable prices. Did they do so on the assumption that prices were about to begin a march back? Is the meme that you can’t lose money long term buying real estate so firmly ingrained that no amount of empirical evidence to the contrary will diminish it or are they simply grabbing an opportunity to buy shelter?
There wasn't a whole lot of action during the cash market session as indices held on to most of their premarket gains. The only index to come up short was the semiconductor index. It confirmed a wedge breakdown, and it's looking increasingly likely a double top is in play. A retest of the 200-day MA would appear to be the favored outcome going forward. The S&P hasn't quite negated the 'bull trap' and the risk is a triple top if this weakness in the Semiconductor Index spreads to the Nasdaq, Large and Small Caps. The technical picture remains okay plus it looks to be enjoying the start of a relative advantage against the Russell 2000. ...
This is discouraging. There seems to be a prevailing attitude, even among very intelligent people (personal observation), that science is just another subject of equivalence to religion, or apparently astrology, in explaining life in the big universe. Or, subjects that are not within the realm of science are imagined to be a science based on a misunderstanding of what science is.
This misunderstanding of science may reflect a failed education system, and unfortunately, we may be traveling backwards. The highest percent of non-skeptics were in the youngest age group where a majority of people think astrology is at least "sort of" scientific.
In China, in contrast, 92% of people polled said they do not believe "in horoscopes." The exact question the researchers asked may in part explain the discrepant results. And I wonder, did some Americans get Astrology confused with Astronomy? Also not good.
King Dollar has been on a role since last summer, up over 20% in less than a year. When looking back on the US$, the rally has been rare and nearly historic. Majority of the rally took place inside the steep rising channel above. Over the past month the US$ might have put in a double top. Over the past few days, the US$ has slipped a little below rising support at red arrow above.
Here's an interesting argument by Felix Salmon, although I think he is taking two correct observations and mistakenly attributing a cause-and-effect relationship to them: Bitcoin is going nowhere because women are not involved.
More likely, in my opinion, women are not involved in bitcoin because bitcoin is going nowhere (and they know it). Or maybe, simply, bitcoin is going nowhere and women are not involved.
Nathaniel Popper’s new book, Digital Gold, is as close as you can get to being the definitive account of the history of Bitcoin. As its subtitle proclaims, the book tells the story of the “misfits” (the first generation of hacker-l...
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As we get into the heart of earnings season and anticipate the GDP report for Q1, the investor spotlight has been taken off the Federal Reserve and timing of its first interest rate hike, at least temporarily. Even though Q1 economic growth will undoubtedly look weak, the future remains bright for the U.S economy – even though many multinationals will struggle with top-line growth due to the strong dollar – and any near-term selloff resulting from weak economic or earnings news should be bought yet again in expectation of better results for the balance of the year. High sector correlations remain a concern, reflectin...
Kim Parlee interviews Phil on Money Talk. Be sure to watch the replays if you missed the show live on Wednesday night (it was recorded on Monday). As usual, Phil provides an excellent program packed with macro analysis, important lessons and trading ideas. ~ Ilene
The replay is now available on BNN's website. For the three part series, click on the links below.
Part 1 is here (discussing the macro outlook for the markets)
Part 2 is here. (discussing our main trading strategies)
Part 3 is here. (reviewing our pick of th...
In my last post (Part 1 of this article), I looked at alternative ETFs that could be used as hedges against the corrections that we have seen during that long 2 year bull run. Looking at the results, it seems that for short (less than a month) corrections, a VIX ETF like VXX could actually be a viable candidate to hedge or speculate on the way down. Another alternative ETF was TMF, a long Treasuries ETF which banks on the fact that when markets go down, money tends to pack into treasuries viewed as safe instruments. In some cases, TMF even outperformed the usual hedging instruments like leveraged ETFs. There could of course be other factors at play since some of 2014 corrections were related to geopolitical events which are certain...
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PSW Members - well, what a year for biotechs! The Biotech Index (IBB) is up a whopping 40%, beating the S&P hands down! The healthcare sector has had a number of high flying IPOs, and beat the Tech Sector in total nubmer of IPOs in the past 12 months. What could go wrong?
Phil has given his Secret Santa Inflation Hedges for 2015, and since I have been trying to keep my head above water between work, PSW, and baseball with my boys...it is time that something is put together for PSW on biotechs in 2015.
Cancer and fibrosis remain two of the hottest areas for VC backed biotechs to invest their monies. A number of companies have gone IPO which have drugs/technologies that fight cancer, includin...
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Last fall there was some discussion on the PSW board regarding setting up a YouCaring donation page for a PSW member, Shadowfax. Since then, we have been looking into ways to help get him additional medical services and to pay down his medical debts. After following those leads, we are ready to move ahead with the YouCaring site. (Link is posted below.) Any help you can give will be greatly appreciated; not only to help aid in his medical bill debt, but to also show what a great community this group is.
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