Understanding bears, bulls and clowns

Its not the end of the world folks. Headlines regarding market carnage, ridiculous bets between economists aside, you just need to print out this chart, lay it on the floor, stand on your desk and look at it:

eotw

This is the S&P Composite stock index, taken back to 1900 and deflated by CPI, correctly displayed as a semi-log chart. Below that is the Shiller price earnings or cyclically adjusted PE ratio (CAPE), which is a much more robust version of the standard 12 month forward used by most investment houses.

The chart comes from Pring Turner via Albert Edwards latest research note at SocGen who I spoke about yesterday with his ‘new GFC’ call.

Instead of Euros, dollars and Yuan, this is about understanding the bigger cycles behind stock markets. His take:

Valuation booms are followed inevitably by busts. But the key point is that these valuation bear markets take the Shiller PE back down to 7x or below.

Valuation bear markets can occur in either a high or low inflation environment but what is true for all of them is that they take many economic cycles to play out. The three previous valuation bear markets have taken between 4 to 6 recessions to fully play out (the red part of the top line are recessions).

We also know from Japan’s lost decade (and a half) that the process takes many economic cycles and we also know that each gut-wrenching episode of additional stock market de-rating typically occurs during recessions.

I’ve long characterised market action within secular bull and bear markets, where rallies and crashes within those dominant inclines and declines is perfectly normal and nothing to get excited about.

Edward’s call for the current secular bear market, while shocking, is not out of the ballpark of history. That some latch on to these calls as “The end of the world as we know it” as great headlines and shock jock economic wagers to the contrary shows their lack of understanding of macro itself.

Here’s Edwards final say, my emphasis added:

Since valuations peaked at the most obscene level ever in 2000, we have only seen two recessions and at the nadir of the last one, in March 2009, the Shiller PE bottomed at 13.3x, way above the typical sub-7x bottom. In valuation terms the bear market was not completed in 2009 and indeed after only two recessions there was no reason to expect it to have been completed.

If I am right and we have just seen a cyclical bull market within a secular bear market, then the next recession will spell real trouble for investors ill-prepared for equity valuations to fall to new lows. To bottom on a Shiller PE of 7x would see the S&P falling to around 550.

I will repeat that: If I am right, the S&P would fall to 550, a 75% decline from the recent 2100 peak. That obviously will be a catastrophe for the economy via the wealth effect and all the Fed’s QE hard work will turn dust. That is why I believe the Fed will fight the next bear market with every weapon available including deeply negative Fed Funds rates in addition to more QE.

Indeed, negative policy rates will become ubiquitous.

Indeed. Welcome to the Ice Age, or as I like to call it The Great Volatility.

Comments

  1. We are not as financialised as the US economy yet but we will be when the banks are bailed out. In a financialised economy market drops can be the cause of a recession since so many people depend on speculation to top up their incomes.

    Those reverse repos are getting tangled up with Chinese devaluation, not enough quality collateral

    http://www.talkmarkets.com/content/us-markets/chapter-2-in-the-rrp-fairy-tale?post=82652

    Could it be that people are lying about what assets they really control ? Say it ain’t so.

  2. “…That is why I believe the Fed will fight the next bear market with every weapon available including deeply negative Fed Funds rates in addition to more QE….”

    Or perhaps we might realise that the Fed (and the other Central Banks) don’t have a clue what they are doing and we will reconsider the lunacy of outsourcing the lion share of money creation to private banks – who even when tightly regulated (is that still a thing?) still manage to pump and dump economic activity on a regular basis.

    How much more evidence do we need that the experiment over the last few hundred years has been a dismal failure and we need true chartalism that is managed by the representatives of the people or institutions supervised by them.

    And for all of those who claim that our private bank money creation model works a treat and has produced everything good in the world keep in mind that as it does involve partial chartalism and loads of money creation, it is can and has allowed economic growth and development.

    But that is not the point.

    The point is that while it was an improvement on the gold standard and commodity money relics/fables, it is still defective and has reached the end of its serviceable life.

    It time for a proper publicly run fiat/chartalist monetary system instead of the confusing public/private franken-banking beast that has been running amok for about a century.

    And with a proper public chartalist monetary system we can allow all those who wish to run and issue their own private IOU / money / credit systems to knock themselves out. Let a hundred flowers bloom.

    • The point is that while it was an improvement on the gold standard and commodity money concept, it is still defective and has reached the end of its serviceable life.
      —Pfh007
      The present system represented by the crude central bank interference of the simple Benjamin Bernanke was never going to be an improvement on the modern gold standard of Isaac Newton…humanis generis decus….
      The current system of unsound money will now take us into negative interest rate policy(NIRP) in contemptuous disregard of the virtue of saving.
      Please, no more experimenting.
      Currency redeemable in gold had its problems but we need sound money to be able to plan ahead.

      • Athalone,

        Keep in mind that the current model is not a proper fiat system. It is a franken-banking public/private hybrid. So I share all of your criticism of it and its high priests including Benanke.

        Nothing wrong with people using gold as the basis of a private money system. Let it compete with a proper public fiat system and whatever other money systems people wish to try or use – bitcoin etc or bank notes issued by banks.

        If people do not trust the Public Money they can use private gold backed money. Nothing to stop a private company buying a large stash of gold and then issuing bits of paper or “block chains” that are backed by a physical amount of gold. Providing the company is trustworthy and it keeps its stash secure it may find lots of interest.

        Public money obtains its power by law. Using gold, silver or platinum adds nothing to that other than a bunch of logistical issues.

      • “…the simple Benjamin Bernanke”

        Just out of interest, do you consider yourself intellectually superior to Ben Bernanke? Or, more precisely, a better monetary economist?

      • @Macron

        My calling was 40 years a dental surgeon.
        The calling of Sir Isaac Newton and Ben Bernanke was central banking, the former in Threadneedle Street, the latter in Constitution Avenue.
        Anyone with a gift for wisdom would see that my comment alluded to a comparison of the two.
        I’m sorry…you missed it.

    • From Uncle Max Keiser here is an interview with one of the Fed Bankers who talks about how they front loaded the banking system ( I believe world debt is at 30 Trillion) to create wealth but got it totally wrong and the only thing that has created a return is cash. start 6.13
      https://www.youtube.com/watch?v=_9IJ-VLyGcQ
      So the swings and roundabouts where the bulls create imagined wealth through the fairy effect of animal spirits in the market has not been counter balanced with the destruction of their wealth and return to those who have run real companies based on real stuff.
      As pointed out by Pickerty the only wealth effect is for the 0.01% who have direct access to 0% money and created the appearance of wealth creation through company share buy back scheme to sucker the rest of us into investing.
      Gold seems pretty good bet going forward to replace your fiat.

      • Gold may well replace our current franken-banking monetary system but that will probably happen because many seem to think that what we have now is a proper public fiat system.

        As a result they see the options as being more of the same or going back to the future and seek to re-introduce a commodity money system.

        Not sure that either option is desirable but if forced to choose between the two I would probably go for a commodity money system over the the mutant parasite model we currently have.

    • How much more evidence do we need ? When did evidence have anything to do with belief ? The incentive to ignore the evidence is passed from one vested generation to the next. I am favouring another hundred years at least of making the same mistake.

  3. Tassie TomMEMBER

    What a great article. Thanks Chris.

    This time it IS different. Firstly, we have already had a 60% decline in 11 years, so theoretically we have around 8 years of declines to go to drop not that much more. The 60% decline is a bit exaggerated though because the starting point was so high in 2000. Secondly, the P/E has held up very well in those 11 years – in every other secular bear the P/E was well into single digits by this point in time.

    It will be interesting to see how this all plays out. Hopefully my super will be buying for the next 20 years, and when I retire it will all be good news.

    • your point about the P/E holding up is so so true…thats why i lambast the analysts who suggest a 14x P/E is conservative, when they should be looking at 10-12 times as the MAX, particularly for financials.

      oh yes, there will be plenty of buying opportunities, both in real estate and shares – thats why my super is 95% cash.

      • Good strategy as long as the ‘cash’ is not a deposit in the big banks that are invested themselves in derivatives, the sharemarket and houses.
        While ever your cash is a deposit in the bank which has offered you no collateral, you are an unsecured creditor behind the bond holder.

      • Tassie TomMEMBER

        @ athalone – How does “depositor first” legislation work? I thought that depositors ranked ahead of bond holders, but not covered bonds. I might have this all wrong though.

        My understanding (which again might be all wrong) was that the main effect of the “government guarantee” was to get the depositor’s money back quickly, as the depositor would very likely get it back eventually but it would be locked up for years while the liquidators sorted the whole mess out.

        Even in the 1890s most depositors got their money back 10 or 15 years down the track.

      • @Tassie
        1)We are a member of the G-20 which in November 2014 agreed to prepare for ‘bail-ins’ for banks in the probability of future bank failures.That preparation led to the ‘bail-ins’ being used from 1 January 2016… three small Italian banks have bailed-in their depositors in recent days.
        2)The government guarantee is extended for approved depositories at $20billion per bank.The big banks have a distinct disadvantage for their depositors here as they have average deposits for the big-4 of $400billion each.(5cents in the dollar).

      • “My understanding (which again might be all wrong) was that the main effect of the “government guarantee” was to get the depositor’s money back quickly, as the depositor would very likely get it back eventually but it would be locked up for years while the liquidators sorted the whole mess out.”

        It says on APRA’s website that they intend on making payments (for at-call accounts) within seven calendar days. If there is a systemic collapse of our banking system you’d think they’d want to get the payments out as quickly as possible to ensure the economy doesn’t grind to a complete stop.

      • “The government guarantee is extended for approved depositories at $20billion per bank.”

        Do you have a reference for that? It’s not mentioned on APRA’s Financial Claims Scheme page. http://www.apra.gov.au/crossindustry/fcs/Pages/default.aspx

        “For ADIs, the scheme provides protection to depositors up to the limit of the scheme ($250,000 per account-holder per ADI) and seeks to provide depositors with timely access to their deposits in the unlikely event of the failure of their ADI.”

      • “2)The government guarantee is extended for approved depositories at $20billion per bank.The big banks have a distinct disadvantage for their depositors here as they have average deposits for the big-4 of $400billion each.”

        Wow, if that’s true then I’m glad I don’t have any cash with the big banks! Excuse the ignorance, but can anyone explain to me why the scheme covers multiple accounts? Why not just offer each citizen a guarantee of up to 250k and after that you’re on your own. I support some sort of government intervention, I mean you don’t want people losing their jobs and their cash savings at the same time, but the current scheme seems to represent a significant risk to the government.

      • “three small Italian banks have bailed-in their depositors in recent days”

        I’d like to see a link to this as well. I can find plenty links to bondholders being given haircuts but not depositors.

        And note that in Australia, unlike Italy, depositors rank ahead of unsecured creditors. It would have to be one hell of a haircut to wipe out all creditors (with the exception of the small amount of covered bond holders) so that deposits would take a hit.

        Edit: Even with the EU’s bail-in laws, “deposits of less than €100,000 will still be protected under the new regime.”

        http://www.telegraph.co.uk/finance/economics/11947986/EU-takes-member-states-to-court-over-bail-in-laws-to-protect-taxpayers.html

      • “Wow, if that’s true then I’m glad I don’t have any cash with the big banks! ”

        I’d wait until we see a reference before worrying about this. I think it’s wrong.

      • @AB
        ‘DEPOSITOR PROTECTION IN AUSTRALIA’

        http://www.rba.gov.au/publications/bulletin/2011/dec/pdf/bu-1211-5.pdf

        few lines down from top of page 9:

        Payouts of deposits covered under the FCS are initially financed by the Government through a standing appropriation of $20 billion per failed ADI (although it is possible that additional funds could be made available, if needed, subject to parliamentary approval). The amount paid out under the FCS, and expenses incurred by APRA in connection with the FCS, would then be recovered via a priority claim of the Government against the assets of the ADI in the liquidation process. If the amount realised is insufficient, the Government can recover the shortfall through a levy on the ADI industry.”

        The taxpayer cannot afford to take on the nearly $2 trillion in bank deposits on top of government debt and household debt.

      • “The taxpayer cannot afford to take on the nearly $2 trillion in bank deposits on top of government debt and household debt.”

        As much as I think there’s a chance that one of our banks may fail over the next decade, there’s no way that its assets will go to zero. Depositors rank ahead of all unsecured creditors except covered bond holders and it sounds like the government can jump in front of even those if required.

        “The amount paid out under the FCS, and expenses incurred by APRA in connection with the FCS, would then be recovered via a priority claim of the Government against the assets of the ADI in the liquidation process. If the amount realised is insufficient, the Government can recover the shortfall through a levy on the ADI industry.”

        I don’t see any outcome whereby the deposit guaranteed won’t be honoured even if it means printing AUD (which I don’t think will happen). The collapse in confidence would mean that the other banks would fail very quickly afterwards and no government is going to encourage that situation.

      • @athalone – I’m rarely accused of economic overconfidence though I guess it’s relative here on Zerohedge, sorry MB! Not too many other places where considering a Big 4 collapse a reasonable possibility would be described as anything approaching confident.

        Why would a sovereign currency issuing government ever need to be “courageous” enough to force depositors to take a haircut, especially when they rank ahead of nearly all other unsecured creditors unlike in many other countries?

        All bank assets wiped out, all shareholder funds gone, all bond-holders except for the 8% of so covered bonds destroyed, all deposits over the guaranteed amount cut, and only then would guaranteed deposits get touched assuming the government wouldn’t pay them out anyway.

        Confident in Australia’s economic future I am not, but I just cannot see that happening.

      • Hi AB
        The government (the taxpayer) doesn’t have the funds to pay anyone should the banks be insolvent as they were in October 2008.

      • On the flip side – from your own graph CB, the next BOOM will absolutely go off it’s TIT’s. The trend is UP, but the next UP will be the greatest RISE EVER (according to your graph). So from 2020 – 2023, shit a brick it will be fucking HUGE!

    • Quote: “Hopefully my super will be buying for the next 20 years,”

      Aren’t they locked in to buying (& holding) set portions of various asset classes? Won’t this mean they will have limited options and the best option now is capital preservation, then you go back to your normal(?) growth type super portfolio once you think the markets are on the up? That’s what I’m doing & why my super is in capital guaranteed, cash etc options

      • Tassie TomMEMBER

        My super’s about 40% cash, but I’m not smart enough or sophisticated enough to pick the tops and bottoms. I’ve watched other people (including my folks) up-risk their portfolio in the good times and down-risk it at the bottom – all they do is lose money. It sounds stupid but it’s human nature – the reason that the market is down is that there is pessimism, and if people are pessimistic they will down-risk.

        The best thing for me to do is just feed in the same every month, have plenty in cash, and try not to worry when it goes down. When it goes up it feels good, but I have to tell myself that it is bad because my monthly contribution doesn’t buy as much, and vice versa.

      • @athalone
        “Capital guaranteed by whom or what?”
        Very good point, one we will only truly find out when TSHTF

        @TT
        You are spot on TT most people get in & out of investments at the wrong time, and none of us chain pick the tops & bottoms consistantly. But I hope the knowledge & suggestions on this site mean we will not fall into that trap for the most part. And if we do it’s now easy & cheap to switch online with many funds. Well at least you have a good chunk in cash considering the stock markets performance this year, which means you are ahead of most Aussies this year!

      • Hope you’re not talking there about an AMP Capital Guarantee?
        If so you should be worried.
        As others have stated there is a $250K limit in S/Funds Guaranteed but that is per Fund if its a SMSF.
        That’s why I’m happy to be sitting tight with 95% in Physical Au. Even if they manipulate it down OR hold it down -it should still keep its value as the A$ sinks below .60 .

      • “Hope you’re not talking there about an AMP Capital Guarantee?”

        Yes, I’d be wary of any company capital guarantee. The company I worked for at the time of the GFC (AXA – now with its AU/NZ operations owned by AMP) had some big problems with its capital guaranteed products internationally.

      • I’ve posted this in the past, but I would be checking if you have any ‘Property’ options / allocations in your super. You could be locked in the whole way down.

        REST Property Option – Terms and Conditions
        rest.com.au

        A new Property option is opening on 1 January 2013 with new terms and conditions. This brochure sets out the terms and conditions that apply to members (including pension members) who invest in the new Property option on or after 1 January 2013. These terms and conditions have been introduced for the purpose of complying with the illiquid investment rules in Regulation 6.34 of the Superannuation Industry (Supervision) Regulations 1994.

        Terms and conditions applying to all Property option members Members (including pension members) who select the Property option as part of their investment choice must agree to the following terms and conditions:

        (a) The Property option is an illiquid investment because either or both of the following apply to the underlying investments:

        (i) the underlying investment (being either direct property or units in an unlisted property trust) cannot be converted to cash within 30 days to meet a member’s or pension member’s withdrawal, rollover, transfer or switch request (“Transaction Request”) out of the Property option;

        (ii) converting the underlying investment of the Property option into cash within 30 days would be likely to have a significant adverse impact on
        the realisable value of the investment;

        (b) The Trustee is not required to process Transaction Requests within 30 days;

        (c) The Trustee will process Transaction Requests within 30 days, unless the Trustee has frozen Transaction Requests out of the Property option;

        (d) The Trustee may, without prior notice, freeze Transaction Requests out of the Property option for up to two years and the member (including a pension member, to the extent applicable – see below) waives their right to require the Trustee to process any Transaction Request they make until the freeze is over due to the illiquid nature of the underlying investments; and

        (e) The Trustee may at any time close the Property option to new contributions (or new monies in the case of pension members).

        Additional terms and conditions apply to Pension members who invest in the new Property option on or after 1 January 2013

        (f) Pension members may only elect to have a maximum of 80% of their entire initial balance invested in the Property option;

        (g) If the Trustee determines to freeze Transaction Requests out of the Property option and a pension member has less than (or equal to) 80% of their entire balance invested in the Property option on a pension payment date during the freeze, then that pension member will still receive his or her nominated pension payment due on that pension payment date (paid firstly from and in proportion to their non-Property balance(s) on that pension payment date); and

        (h) If the Trustee determines to freeze Transaction Requests out of the Property option and a pension member has more than 80% of their entire balance invested in the Property option on a pension payment date during the freeze, then that pension member will receive his or her minimum legislated pension payment amount (but no more) on that pension payment date (paid firstly from and in proportion to their non-Property balance(s) on that pension payment date).

        Should the Property option be frozen at any point in time, the Trustee will communicate this to all members (including pension members) invested in the Property option. The Trustee will also communicate to all members (including pension members) invested in the Property option whether contributions (or monies in the case of pension members) will be accepted into the Property option during the freeze or not.

      • Tassie TomMEMBER

        Yes I know it’s not the most sophisticated and effective method, but its pitfalls are largely protected by 1) holding lots of cash too (you don’t want to suddenly find that you need liquidity right when it’s not there) and 2) having a plan to get out of it – at 10-year plan should suffice.

        Investment rule Number 1 is to honestly know your own limitations. I know that I am not equipped to reliably buy at the bottom and sell at the top – I’d likely do the opposite if I tried (and have done before). I also know that if I was faced with an investment of plummeting value AND liquidity that I would shit myself. Hence I’m not an investment property owner. However, as things are currently structured I do have the mental ability to “ride out” and continue to “buy in” during a storm – the GFC was scary but it served me well.

        Come to think of it, I wonder how many investment property owners have thought about how they would face a simultaneous large loss of value and liquidity?

      • “Yes I know it’s not the most sophisticated and effective method…”

        Sophisticated? No.
        Effective? Plenty of studies I’ve read would suggest that it’s very effective.

    • Am also 100% AUD but somehow returned 4.2 %.

      Anyway I am glad I can only have local ‘cash’ in my super (as far as I can tell that is) because the work experience dude might buy me some rubles or reals …

    • BoomToBustMEMBER

      My wife and I are 100% cash in Super also. As someone else here noted a few months ago their is also, and they plan to move to high returns once this whole crash business is done and dusted. We will probably follow suit with said plan.

  4. athalone
    January 14, 2016 at 1:53 pm
    @AB
    ‘DEPOSITOR PROTECTION IN AUSTRALIA’

    http://www.rba.gov.au/publications/bulletin/2011/dec/pdf/bu-1211-5.pdf

    few lines down from top of page 9:

    Payouts of deposits covered under the FCS are initially financed by the Government through a standing appropriation of $20 billion per failed ADI (although it is possible that additional funds could be made available, if needed, subject to parliamentary approval). The amount paid out under the FCS, and expenses incurred by APRA in connection with the FCS, would then be recovered via a priority claim of the Government against the assets of the ADI in the liquidation process. If the amount realised is insufficient, the Government can recover the shortfall through a levy on the ADI industry.”

    The taxpayer cannot afford to take on the nearly $2 trillion in bank deposits on top of government debt and household debt.