A "bubble of all bubbles"?

[babyjake1961]

Here's a great piece of market analytics a friend of mine wrote. I'd be curious to hear your feedback.


What is so great about the US or global economy these days that we have such a record high value of S&P 500?

We are still on variations of QE worldwide (the US, the Eurozone, the UK) with no clear end dates set. We hear reports of unsustainable sovereign debts piling up, far in excess of countries' GDPs. We observe record large central banks' balance sheets. We feel dreadful fear of the taper tantrum, proven by the Fed's 2013 summer attempt to pull the plug. We have no easy access to consumer credit at the retail level. We experience an ever growing major geopolitical instability in many parts of the world (Lybia, Syria, Iraq, Israel, Ukraine, and more keep popping up). We have a major standoff between Russia and the West, unseen since the Cold War era. We have extremely thin stock trading volumes worldwide. We know the central banks cannot continue injecting liquidity into markets at the current pace forever for risk of hyperinflation due to a natural limit of sovereign credit worldwide.

Yet the major stock indices like S&P 500 are not only growing rapidly but even breaking their all-time highs. Is it something I am totally missing here or are we witnessing a "bubble of all bubbles" in the making?

All of my economics professors taught me prices in a free-market economy reflect the correlation between supply and demand. That covers the stock prices, too. At stock exchanges, they are largely detached from the corporate inventory assessment but rather rest on that correlation. Indices grow because cash is being pumped into them, and cash is pumped not just because the indices grow but because that very cash is available to financial institutions for pumping.

Hyman Minsky defined his famous "Minsky moment" as the time there's no more of that cash available for pumping into indices further at the previous pace. Market psychologists complement his theory by saying his moment can occur long before that when the market participants simply look back and say "Wait, this just can't be worth that much!", then promptly mass-sell. They often use the early 2000s dot-com bubble as an example: there was still more than enough cash available for pumping, yet the players suddenly came to realize the dot-coms simply couldn't be worth that much sanely.

Thin volumes are a further indication of overpricing. Basically, it means we don't only have all-time high indices readings, we also have them with relation to rather few stocks comprising these readings, being overvalued at an even higher pace.

Lastly, we have suppressed volatility. While mainly the Wall Street firms would suffer from lack thereof, volatility has historically been used for spotting imbalances. Now this once vital indication is pretty much muted by the virtually unlimited liquidity supplied by central banks, creating a false sense of involatile environment and deceitful complacency. Meanwhile, trading leverages keep growing as investment firms struggle to compete with each other on non-fluctuating markets.

Now, here's my million dollar question that bothers many: how long before the burst this time?

 

[postman]

Here's a great piece of market analytics a friend of mine wrote. I'd be curious to hear your feedback.
What is so great about the US or global economy these days that we have such a record high value of S&P 500?

...

Some interesting questions!
I'd like to address them one by one if I may.

1. Q: What is so great about the US or global economy these days that we have such a record high value of S&P 500?
A: Who cares, were here to make money, just Buy The F*cking Dip.

2. Q: ... Yet the major stock indices like S&P 500 are not only growing rapidly but even breaking their all-time highs. Is it something I am totally missing here or are we witnessing a "bubble of all bubbles" in the making?
A: Who cares, were here to make money, just Buy The F*cking Dip.

3. Q: Now, here's my million dollar question that bothers many: how long before the burst this time?
A: I refer the right honourable gentleman to the reply I gave earlier.

It p1sses me off as much as most people, but I'm long past caring what the 'Grand plan' is or even if there is one. I guess it just keeps going until your getting more than 0% on deposit, and as the FED is in control of that I wouldn't hold your breath. There are a lot of blue / purple faced Japanese people who tried that.

 

[babyjake1961]

I guess it just keeps going until your getting more than 0% on deposit, and as the FED is in control of that I wouldn't hold your breath. There are a lot of blue / purple faced Japanese people who tried that.

I don't expect any interest rate hikes until mid-2015 at best. It's logical at the first glance that money is being pumped into indices for a lack of profit with central banks.

Yet what if indices collapse for whatever reason before the interest rates are raised? Stocks comprising them are already crazily overpriced, probably, far more than the corporate inventories of those companies are worth.

 

[Martinghoul]

There are a lot of downright factual errors in your friend's analysis... And no, IMHO, the Spooz aren't a bubble. I am happy to buy some here and maybe more on a dip.

 

[12WBT]

You want current Yield to going to have to pay top dollar

I work on one week, one day and one hour.

Think most fund managers are sitting on a lot of cash.
And would love a good correction let alone a bubble being burst.
Even when the US raises rate it's only going to be a 1/4% at a time and hard to see it going over 2% any time fast after the first raise.
So global stocks are still going to yield more than bonds or bank accounts.

When bubbles burst/markets crash it's normally on unforseen events.
Maybe it's natural disaster, peoples global uprising or another bubble ticking away under the current surface.

As an investor I would like to see some pull back so I can buy some longer term plays. But I been waiting a while and maybe have to wait a bit/lot longer. Just have to sit on 3/4% bank yield.

As a trader ref rule one week, one day and one hour.

 

[babyjake1961]

There are a lot of downright factual errors in your friend's analysis...

What are they?

 

[babyjake1961]

Even when the US raises rate it's only going to be a 1/4% at a time and hard to see it going over 2% any time fast after the first raise.
So global stocks are still going to yield more than bonds or bank accounts.

Yet even this insignificant hike will return volatility to FX trading, taking away some cash from stocks to there and thereby sharply lowering the indices' readings, with a subsequent further sell-off by the stock buy-and-hold'ers.

I take it you disagree with stocks being currently dramatically and rampantly overpriced. What is it exactly that justifies their rapid price grwoth in your view? Has the business of the stock issuers been improving at the same pace their stock prices are growing?

 

[12WBT]

Yet even this insignificant hike will return volatility to FX trading, taking away some cash from stocks to there and thereby sharply lowering the indices' readings, with a subsequent further sell-off by the stock buy-and-hold'ers.

I take it you disagree with stocks being currently dramatically and rampantly overpriced. What is it exactly that justifies their rapid price grwoth in your view? Has the business of the stock issuers been improving at the same pace their stock prices are growing?

All I know is that if I want to buy stock's I want they are higher in price this year than last.

Current market conditions, central banks at unprecedented levels.

Stock issuers - no idea

 

[babyjake1961]

All I know is that if I want to buy stock's I want they are higher in price this year than last.

Current market conditions, central banks at unprecedented levels.

Stock issuers - no idea

Has there been any research done on a ratio limit until which a stock can remain overpriced relative to the company's corporate inventory through mere demand without its price collapsing? In simple words, by how much can the stock price exceed the company's actual assets price before the players figure the stock has been overpriced way too much?

 

[babyjake1961]

Forbes published a great article answering my questions just some hours ago: http://www.forbes.com/sites/investor/2014/07/24/why-are-stocks-still-rising-is-this-a-bubble/

 

[12WBT]

Has there been any research done on a ratio limit until which a stock can remain overpriced relative to the company's corporate inventory through mere demand without its price collapsing? In simple words, by how much can the stock price exceed the company's actual assets price before the players figure the stock has been overpriced way too much?

Done no research on the above.

 

[babyjake1961]

Done no research on the above.

It's right in today's Forbes article:

"Some investors worry and ask, is the stock market in a bubble? Wall Street analysts always talk about the P/E ratio of the S&P 500 index being at 17, which they say is “fair value.” But it’s only fair value if the earnings don’t decline. Once the financial engineering stops, and a recession threatens, the 17 P/E is no longer “fair value.”

Furthermore, if we look away from the S&P 500, and look at the Russell 2000 small cap index, we see a P/E ratio of 84. That’s astonishing. You never hear analysts saying that in the media. It seems to be prohibited because it could scare investors away. This overvaluation caused the sharp decline in small cap stocks from March to May. In my opinion, that was the first warning shot."

http://www.forbes.com/sites/investor/2014/07/24/why-are-stocks-still-rising-is-this-a-bubble/

 

[postman]

It's right in today's Forbes article:

Quote:
"Some investors worry and ask, is the stock market in a bubble? Wall Street analysts always talk about the P/E ratio of the S&P 500 index being at 17, which they say is “fair value.” But it’s only fair value if the earnings don’t decline. Once the financial engineering stops, and a recession threatens, the 17 P/E is no longer “fair value.”

Furthermore, if we look away from the S&P 500, and look at the Russell 2000 small cap index, we see a P/E ratio of 84. That’s astonishing. You never hear analysts saying that in the media. It seems to be prohibited because it could scare investors away. This overvaluation caused the sharp decline in small cap stocks from March to May. In my opinion, that was the first warning shot."

http://www.forbes.com/sites/investor/2014/07/24/why-are-stocks-still-rising-is-this-a-bubble/

Hey thats great news, if the Russell can operate at an average p/e ratio of 84 before it tracks sideways (not going down yet) and the S&P is only on a p/e ratio of 17, there' a huge amount of 'value' to be had in the S&P !
Obviously no bubble there!

 

[babyjake1961]

Hey thats great news, if the Russell can operate at an average p/e ratio of 84 before it tracks sideways (not going down yet) and the S&P is only on a p/e ratio of 17, there' a huge amount of 'value' to be had in the S&P !
Obviously no bubble there!

At least some indication as to how much the bubble can possibly still grow. The current record-high stock indexes at extremely low trading volumes are due to massive stock buybacks made possible through the availability of cheap debt.

A tough dilemma for the Fed, indeed: raise the interest rates and face a dramatic stock market crash or keep the rates record-low for even longer and face the build-up of a stock "bubble of all bubbles".

 

[Martinghoul]

What are they?

Well, there is currently QE ongoing only in the US and it has a reasonably clear end date (October 2014). The sovereign debt situation has been on the mend pretty consistently arnd the world since 2011. This is especially true in places where the economic recovery is reasonably strong, such as the UK and the US. The Fed did "pull the plug" and continues to taper. The data on consumer credit and lending, both business and household (e.g. the Fed SLO survey), suggests that the availability of credit is the best it has been since the crisis. The household balance sheet adjustment (deleveraging) appears to be over; delinquencies, incl in mtges, are the lowest they've been in years; household debt service ratios are at the lowest level in 30+ years. If you need data for all of these things, it's available from a variety of public sources.

All this isn't supposed to suggest that everything is all hunky-dory and there are weaknesses elsewhere. However, US households and businesses are doing relatively well. Moreover, US firms, especially the large ones that constitute the Spooz, are sitting on unprecedented amounts of cash.

 

[babyjake1961]

Well, there is currently QE ongoing only in the US and it has a reasonably clear end date (October 2014). The sovereign debt situation has been on the mend pretty consistently arnd the world since 2011. This is especially true in places where the economic recovery is reasonably strong, such as the UK and the US. The Fed did "pull the plug" and continues to taper. The data on consumer credit and lending, both business and household (e.g. the Fed SLO survey), suggests that the availability of credit is the best it has been since the crisis. The household balance sheet adjustment (deleveraging) appears to be over; delinquencies, incl in mtges, are the lowest they've been in years; household debt service ratios are at the lowest level in 30+ years. If you need data for all of these things, it's available from a variety of public sources.

All this isn't supposed to suggest that everything is all hunky-dory and there are weaknesses elsewhere. However, US households and businesses are doing relatively well. Moreover, US firms, especially the large ones that constitute the Spooz, are sitting on unprecedented amounts of cash.

What do you think will happen after interest rates rise making unavailable the cheap cash currently used for massive stock buybacks which currently propels indices to their all-time highs?

 

[postman]

What do you think will happen after interest rates rise making unavailable the cheap cash currently used for massive stock buybacks which currently propels indices to their all-time highs?

Your asking us what will happen in 6 to 9 months time?
Are you mad?
Anyone tells you they know whats going to happen to the stock market in that timeframe is crazy.

 

[babyjake1961]

Your asking us what will happen in 6 to 9 months time?
Are you mad?
Anyone tells you they know whats going to happen to the stock market in that timeframe is crazy.

Over that time, the stock buybacks will only increase and the indices will only get higher. With nothing to propel them further after the interest rate rise and cash promptly feeling out of there to the again volatile FX markets, the stock market crash will be unlike any previous one due to the peak being unprecedented.

The rate rise will sure be gradual. Nonetheless, irrespective of how small the anticipated increase, the back-buyers will try to take maximal advantage of the current lower rate, with the buybacks peaking before this very first rate hike instead of being left by corporate CFOs to continue thereafter with more expensive debt.

That's how I see it. Yet I don't claim to be the smartest one out there and would like to hear the opinions of others too. That's what discussion boards are for, after all.

 

[Martinghoul]

What do you think will happen after interest rates rise making unavailable the cheap cash currently used for massive stock buybacks which currently propels indices to their all-time highs?

I don't know, but, again, keep in mind that the cheap cash doesn't go away when rates rise. Specifically, in the first half of 2014, US investment grade corporate issuance hit the highest level ever ($642bn). That's cash that large companies have borrowed long-term at extremely low rates. Currently, US non-financial corporates hold arnd $1.64trln in cash and this number isn't going to go be affected by rising rates. Obviously, what is unclear is how companies will be using this cash. Currently, they're mostly choosing to boost earnings (through buybacks and dividends), rather than invest.

 

[babyjake1961]

I don't know, but, again, keep in mind that the cheap cash doesn't go away when rates rise. Specifically, in the first half of 2014, US investment grade corporate issuance hit the highest level ever ($642bn). That's cash that large companies have borrowed long-term at extremely low rates. Currently, US non-financial corporates hold arnd $1.64trln in cash and this number isn't going to go be affected by rising rates. Obviously, what is unclear is how companies will be using this cash. Currently, they're mostly choosing to boost earnings (through buybacks and dividends), rather than invest.

I believe this pattern will continue. If they had more sustainable ideas for investing such amounts of capital, they would already be putting that money there which we don't see happening.

It is not only the buybacks cash which propels the indices but also the cash of those who trail the indices and ride the wave. Once the buybacks decline and indices stop growing, these investors will be the first to mass-sell.

The current buybacks pace is already record-high. I think for the indices to stop growing, it might not have to take a complete halt of the buybacks but even their substantial descrease as either the debt gets more expensive, or the larger portion of the stocks has already been bought back, or both. With nothing else left to propel the indices, that will be the time the non-buybackers will pull out all at once.

Do you think the Fed will just let this situation run and the bubble inflate till it bursts all on its own or will intervene somehow for fears of an imminent unprecedented stock market crash?