The latest proclamation by some of the foremost market observers that the bond market, but not the stock market, is in a bubble has many of the rest of us casual observers scratching our heads.
One of the first things investors learn is the importance of bond interest rates in setting the context for all investing, and most (if not all) of the experts advising us to buy into the stock market now use low bond interest rates as the primary reason, pointing to the fact that with bond rates so low, stocks are the only choice for investors seeking income. So if the main pillar holding up the stock market right now is low bond interest rates, how is it possible that the bond market is in a bubble but the stock market is not? Moreover, if the bond bubble bursts and interest rates rise, won’t bonds become relatively more attractive and cause stock investors to flee the stock market. It would seem the stock and bond markets are inextricably linked right now, and both quite frothy.
The experts contend that history since 1980 indicates that bond yields (more specifically the 10-year Treasury bond) should be higher than the stock market’s equity yield (or more specifically the reciprocal of the S&P 500 Index Price/Earnings (P/E) Multiple). Today, that relationship is reversed with the equity yield higher (at approximately 4 percent) than the bond yield (at 2.25 percent). To those experts that means that either bond yields should be higher (meaning bond prices are in a bubble and need to fall) or stock prices are too low (and should rise higher), assuming that historical relationship should remain in tact.
However, that historical relationship may not be appropriate anymore. Most observers agree that markets and economies have changed rather dramatically since the 1980’s and that perhaps that long-standing relationship no longer applies. The last twenty years of the past century was characterized by high economic growth and moderate inflation, two conditions sorely lacking since the turn of this century. Perhaps going forward equity yields should be higher than bond yields, consistent with the longer term relationship that was actually the norm for the 85 year period from 1871-1956. (Dividend yields compared with bond yields during the past 150-year period provides a similar pattern as equity yields, namely that dividend yields were actually higher than bond yields for most of that time period.) Maybe that suggests stock yields should be higher than bond yields today too, and in fact the stock market as well as the bond market is in a bubble!
More compelling evidence suggests the stock market is unquestionably in bubble territory. Stock market values are driven by earnings and P/E multiples and the foregoing analysis shows how low bond interest rates directly propped up P/E multiples. Less obvious is that low bond yields have inflated company earnings too, if indirectly, in many ways. Low rates enable leveraged companies to borrow copiously while keeping interest expense to a minimum. Those same low rates have enabled companies to borrow an unprecedented amount of capital to buy-back their own stock shares, reducing shares outstanding, and thereby inflating their earnings per share. The low interest rate environment has also enabled margin buying to reach all time highs, from investors who borrow up to 50 percent of the capital they need to buy stock shares, thus fueling demand for stock and sending prices higher. Imagine how rising interest rates will adversely affect buy-backs and margin buying. If bond rates are too low, then stock prices built upon those low rates are clearly too high!
After factoring in all of that and the fact that earnings have been increasingly finagled and “engineered” through the use of Non-Generally Accepted Accounting Principles (Non-GAAP), which tend to inflate company earnings, it is obvious that the stock market has been pushed to an unnaturally high level.
Certainly the experts know all this, so how can they possibly conclude that the bond market is in a bubble and the stock market is not? When those bubbles finally do burst, it is not hard to imagine that both markets, and in fact all financial markets, will suffer serious consequences.
Thursday, August 3, 2017
Tuesday, August 1, 2017
Can a Loss of Confidence in Digital Advertising Cause Financial Market Fallout?
What? Market observers have been sifting through the financial tea leaves for years looking for the next “black swan,” that most extraordinary and unlikely event that will cause the financial markets to tumble. Dozens of possibilities ranging in scope and scale are found all over the map, literally: Euro zone, China, Japan for their challenging economies; North Korea, Russia, Iran, Syria, Venezuela for their geopolitical implications; stock bubbles, bond bubbles, auto loan bubbles, student loan bubbles, municipal bond and pension bubbles, and so forth.
What about the bubble in digital/online internet advertising? Many recent and prospective fortunes are tied to the continued rapid rise in digital advertising, but bumps seem to be popping up along that otherwise clear path. Recent reports are that a significant share of “customer clicks” is the result of “bot traffic” (internet robots), not actual customers. Estimates are that businesses have lost more than $16 billion due to ad fraud this year alone. Even more significantly, it would appear that corporate America is beginning to question the effectiveness of digital ads as a marketing tool. Proctor and Gamble recently reported that notwithstanding its decision to reduce its online advertising budget by $100 million in the June 2017 quarter, the company saw no difference is sales. Those trends should be disturbing to stakeholders in the digital ad business.
So, what’s the big deal? The fact is that since the beginning of this century much of the robust economic growth of mature global economies in many industries has come from the growth of the internet, in one way or another. Much of the optimism about future economic growth stems from its continued expansion. The problem is that much of that activity is paid for with revenue from digital ads, and the fate of many of the fastest growing and most valuable companies on earth, like Google and Facebook, are tied to ad revenue growth.
Online advertising is here to stay, but what if the prospects of its growth are tarnished, diminished or, worse yet, more companies get the heretical idea to reduce their online advertising budgets? Digital ad spending is approximately $200 billion globally now and expected to grow more than 50 percent in the next three years. The mere hint of a slowdown in that inexorable rise in digital advertising could have severe ramifications for many companies, and by extension, economies and financial markets. Time will tell if such a heretofore unimaginable reversal of fortune and loss of optimism in that business can cause meaningful fallout in global economies and financial markets.
What about the bubble in digital/online internet advertising? Many recent and prospective fortunes are tied to the continued rapid rise in digital advertising, but bumps seem to be popping up along that otherwise clear path. Recent reports are that a significant share of “customer clicks” is the result of “bot traffic” (internet robots), not actual customers. Estimates are that businesses have lost more than $16 billion due to ad fraud this year alone. Even more significantly, it would appear that corporate America is beginning to question the effectiveness of digital ads as a marketing tool. Proctor and Gamble recently reported that notwithstanding its decision to reduce its online advertising budget by $100 million in the June 2017 quarter, the company saw no difference is sales. Those trends should be disturbing to stakeholders in the digital ad business.
So, what’s the big deal? The fact is that since the beginning of this century much of the robust economic growth of mature global economies in many industries has come from the growth of the internet, in one way or another. Much of the optimism about future economic growth stems from its continued expansion. The problem is that much of that activity is paid for with revenue from digital ads, and the fate of many of the fastest growing and most valuable companies on earth, like Google and Facebook, are tied to ad revenue growth.
Online advertising is here to stay, but what if the prospects of its growth are tarnished, diminished or, worse yet, more companies get the heretical idea to reduce their online advertising budgets? Digital ad spending is approximately $200 billion globally now and expected to grow more than 50 percent in the next three years. The mere hint of a slowdown in that inexorable rise in digital advertising could have severe ramifications for many companies, and by extension, economies and financial markets. Time will tell if such a heretofore unimaginable reversal of fortune and loss of optimism in that business can cause meaningful fallout in global economies and financial markets.
Wednesday, July 26, 2017
Three Reasons To Think Twice About Investing In The Stock Market Now
Reason #1. Global equities (stock) prices primarily reflect sustained economic growth trends over the long term, and there are few signs of sustained growth happening any time soon.
The long term stability and growth of the global economy cannot be sustained, so long as global debt is three times global gross domestic product (GDP), as it stands now. This is the result of decades of fiscal mismanagement, profligacy and just plain overspending on a global scale; it is also a problem that defies an easy or quick fix. In fact, notwithstanding the best intentions of the global economic order to grow out of and deleverage to reduce that outlandish debt/GDP ratio over the past eight years, the only discernable effect of global quantitative easing and low (even negative) interest rates has been to reduce private debt by making it public, i.e. government/sovereign, debt. That makes global governments today more vulnerable than ever to bankruptcy and many observers believe that the next financial crisis will be ignited by a sovereign debt crisis. High government debt levels and already historic low interest rates also means that if and when such a crisis should emerge, the same governments that bailed us out in 2008 will be hard pressed to repeat that effort.
In the meantime, all that debt is deflationary and weighs heavily against economic growth, and together with unfavorable demographics, continued globalization and disruptive technological change, it is likely that the USA and all the major economies of the world, including Europe, Japan and China, will face significant economic headwinds.
This predicament is so insidious and so entrenched it is unlikely that anything short of the emergence of a transformational technology, in the way that the widespread use of the internet was in the 1990s, will positively change that outlook for many years to come.
Reason #2. There has been so much deception in and manipulation of economies and the financial markets, it would appear no one really knows where reality begins and fantasy ends.
Stock prices are driven by earnings and price/earnings (P/E) multiples. Global central banks low interest rate policies have pushed P/E multiples to their upper limits causing markets to rally since 2009, but clearly interest rates can only rise from these levels, so markets will need earnings growth in order to rise to new highs.
Earnings appear to be growing again although it is difficult to assess real earnings growth from that created by the wonders of financial engineering. The low interest rate environment has allowed (even encouraged) corporations to borrow capital to buy back their own stock, which has managed to shrink their shares outstanding making shares scarce while simultaneously increasing earnings per share. Additionally, many corporations have opted to report earnings according to non-Generally Accepted Accounting Principles (non-GAAP) thereby allowing them flexibility to easily manipulate and inflate those earnings. Non-GAAP earnings have proven to be significantly higher than GAAP earnings.
Those initiatives combined with the willingness of governments and sovereign wealth funds to buy and hold equities seemingly into perpetuity has created an apparent scarcity in supply available in the open market, i.e., no sellers at any price, thereby distorting and raising prices. The widespread growth in Exchanged Traded Funds (ETFs) and other forms of passive investing is further distorting the fair market prices of individual equities.
The health of our economy is also being reported through a filter of false optimism, as government redefines macroeconomic metrics to portray more favorable results in economic growth, employment, inflation, and many other factors. By traditional measures, for example, economic growth has been negative (that is, recessionary) for the past eight years (not the 1-2% as reported)!
Just as the legacies of baseball star Barry Bonds, bicycle racing champ Lance Armstrong and others were tainted by the realization that their performances were “juiced” by the wonders of drugs, so too has the stock market’s performance in recent years been juiced by the wonders of free capital and financial engineering. But unlike their individual performances, whether legitimate or otherwise in the eyes of the public, no one can deny that Barry Bonds broke home run records or that Lance Armstrong won all those bicycle races. Only time will tell whether or not the superior market results produced by all that free money and engineering will be sustained once all that stimulation is gone.
Most disappointing is that market pundits and commentators rarely acknowledge these economic and market differences by making historical comparisons which are irrelevant if not disingenuous. In fact, with few exceptions, they comment on market movements as if they are moving freely and completely unencumbered by extreme global government intervention and manipulation.
Reason #3. The markets appear to be in the very late innings of a secular market rally in prices. By most traditional metrics markets are inflated if not approaching all time highs in many cases. (Using traditional metrics, they are at all-time highs!)
Historical analysis indicates that when market valuations are so stretched, very low returns can be expected in the following decade. That fact, combined with the fact that the US market has not sustained at least a 5% price pullback for nearly 9 months, the longest period since 1996, and longer than all but four periods occurring since the Great Depression, increases the odds that a price correction is coming. Consequently, one must assume that the downside risk from this point forward is potentially much more significant than is the upside potential.
Any one of these reasons should make investors pause, but all three taken together make a compelling case for investors to exercise extreme caution when considering making new investments in the equities market. In summary, the economic backdrop for investing is treacherous and likely to remain so for many years, market values are inflated by any measure, and with all the manipulation and misinformation it is difficult to assess exactly where investments stand at this juncture. This is not to suggest that investors sell all their holdings, as no one can know how long this charade can continue, and history has shown that markets can remain irrational longer than one might expect. However, prudent investors should consider harvesting some investment gains and trimming their current equity holdings, especially in areas that have sustained significant gains in recent years.
The long term stability and growth of the global economy cannot be sustained, so long as global debt is three times global gross domestic product (GDP), as it stands now. This is the result of decades of fiscal mismanagement, profligacy and just plain overspending on a global scale; it is also a problem that defies an easy or quick fix. In fact, notwithstanding the best intentions of the global economic order to grow out of and deleverage to reduce that outlandish debt/GDP ratio over the past eight years, the only discernable effect of global quantitative easing and low (even negative) interest rates has been to reduce private debt by making it public, i.e. government/sovereign, debt. That makes global governments today more vulnerable than ever to bankruptcy and many observers believe that the next financial crisis will be ignited by a sovereign debt crisis. High government debt levels and already historic low interest rates also means that if and when such a crisis should emerge, the same governments that bailed us out in 2008 will be hard pressed to repeat that effort.
In the meantime, all that debt is deflationary and weighs heavily against economic growth, and together with unfavorable demographics, continued globalization and disruptive technological change, it is likely that the USA and all the major economies of the world, including Europe, Japan and China, will face significant economic headwinds.
This predicament is so insidious and so entrenched it is unlikely that anything short of the emergence of a transformational technology, in the way that the widespread use of the internet was in the 1990s, will positively change that outlook for many years to come.
Reason #2. There has been so much deception in and manipulation of economies and the financial markets, it would appear no one really knows where reality begins and fantasy ends.
Stock prices are driven by earnings and price/earnings (P/E) multiples. Global central banks low interest rate policies have pushed P/E multiples to their upper limits causing markets to rally since 2009, but clearly interest rates can only rise from these levels, so markets will need earnings growth in order to rise to new highs.
Earnings appear to be growing again although it is difficult to assess real earnings growth from that created by the wonders of financial engineering. The low interest rate environment has allowed (even encouraged) corporations to borrow capital to buy back their own stock, which has managed to shrink their shares outstanding making shares scarce while simultaneously increasing earnings per share. Additionally, many corporations have opted to report earnings according to non-Generally Accepted Accounting Principles (non-GAAP) thereby allowing them flexibility to easily manipulate and inflate those earnings. Non-GAAP earnings have proven to be significantly higher than GAAP earnings.
Those initiatives combined with the willingness of governments and sovereign wealth funds to buy and hold equities seemingly into perpetuity has created an apparent scarcity in supply available in the open market, i.e., no sellers at any price, thereby distorting and raising prices. The widespread growth in Exchanged Traded Funds (ETFs) and other forms of passive investing is further distorting the fair market prices of individual equities.
The health of our economy is also being reported through a filter of false optimism, as government redefines macroeconomic metrics to portray more favorable results in economic growth, employment, inflation, and many other factors. By traditional measures, for example, economic growth has been negative (that is, recessionary) for the past eight years (not the 1-2% as reported)!
Just as the legacies of baseball star Barry Bonds, bicycle racing champ Lance Armstrong and others were tainted by the realization that their performances were “juiced” by the wonders of drugs, so too has the stock market’s performance in recent years been juiced by the wonders of free capital and financial engineering. But unlike their individual performances, whether legitimate or otherwise in the eyes of the public, no one can deny that Barry Bonds broke home run records or that Lance Armstrong won all those bicycle races. Only time will tell whether or not the superior market results produced by all that free money and engineering will be sustained once all that stimulation is gone.
Most disappointing is that market pundits and commentators rarely acknowledge these economic and market differences by making historical comparisons which are irrelevant if not disingenuous. In fact, with few exceptions, they comment on market movements as if they are moving freely and completely unencumbered by extreme global government intervention and manipulation.
Reason #3. The markets appear to be in the very late innings of a secular market rally in prices. By most traditional metrics markets are inflated if not approaching all time highs in many cases. (Using traditional metrics, they are at all-time highs!)
Historical analysis indicates that when market valuations are so stretched, very low returns can be expected in the following decade. That fact, combined with the fact that the US market has not sustained at least a 5% price pullback for nearly 9 months, the longest period since 1996, and longer than all but four periods occurring since the Great Depression, increases the odds that a price correction is coming. Consequently, one must assume that the downside risk from this point forward is potentially much more significant than is the upside potential.
Any one of these reasons should make investors pause, but all three taken together make a compelling case for investors to exercise extreme caution when considering making new investments in the equities market. In summary, the economic backdrop for investing is treacherous and likely to remain so for many years, market values are inflated by any measure, and with all the manipulation and misinformation it is difficult to assess exactly where investments stand at this juncture. This is not to suggest that investors sell all their holdings, as no one can know how long this charade can continue, and history has shown that markets can remain irrational longer than one might expect. However, prudent investors should consider harvesting some investment gains and trimming their current equity holdings, especially in areas that have sustained significant gains in recent years.
Saturday, July 15, 2017
Interest Rate Conundrum Seems Well Beyond the Fed’s Pay Grade
In recent months the Federal Reserve (the Fed) started a marketing (if not real) campaign to raise interest rate levels to more “normal” levels, ostensibly because the US and global economy has shown meaningful signs of “recovery and stability.” The real reason is more likely to bail out the global financial system, including banks, insurance companies and pension funds that need higher rates to insure their continuing solvency and stability. Another more plausible reason is to give the Fed breathing room to lower rates again when the economy starts rolling into a long-overdue recession.
The most compelling evidence for an economic recovery has been the meteoric rise of the US stock market since 2009, and that, for most realistic observers, is the direct result of a relentless campaign of historically low interest rates and unprecedented money printing by global central banks including the Fed. Going forward, many experts believe that the continued rise of the stock market will require leadership from financial sector equities, which need higher interest rates to propel their profitability. Therein lies the problem: the real economy and the broader financial markets need low interest rates for stability and improvement, but the financial sector needs higher rates.
Even the financial sector itself is caught in a love-hate relationship with low/high interest rates. Its profitability requires strong and steady loan growth, which requires strong economic growth, which requires low interest rates. Loan profitability, however, requires, greater profit margins, i.e., a greater difference between long and short interest rates (aka spreads), which require a steeper yield curve resulting from higher interest rates.
As if that situation isn’t bad enough, the Fed has been walking an interest rate tightrope for years because of their effect on the US dollar. Higher interest rates and a stronger dollar have the potential to throw us into a recession as it makes our exports less price competitive in the global market, has the potential to crash commodity prices (which are already near all time lows), and could cause a debt debacle in the emerging markets that loaded up on $9 Trillion in dollar-denominated debt after the financial crisis! A stronger dollar makes that debt more expensive to repay.
On the other hand, keeping interest rates low poses an existential threat to the Fed and global central banks (i.e., the keepers of global fiat/paper currencies) and low interest rates could cause them to lose control of the financial markets as participants begin to favor gold and other precious metals (for which they have minimal control) over paper currencies (which is their exclusive domain).
Three large banks, JP Morgan Chase, Citigroup, and Wells Fargo, recently reported decent Q2 financial results, but it would seem the market was disappointed and unimpressed and responded with a modest sell-off in financial equities.
What’s the correct next step? Does the Fed continue its charade of talking up interest rates in the hope of propelling the financial sector even at the risk of tanking the global economy? What to do? What to do? Clearly no one, least of all the Fed, seems to have a clue!
The most compelling evidence for an economic recovery has been the meteoric rise of the US stock market since 2009, and that, for most realistic observers, is the direct result of a relentless campaign of historically low interest rates and unprecedented money printing by global central banks including the Fed. Going forward, many experts believe that the continued rise of the stock market will require leadership from financial sector equities, which need higher interest rates to propel their profitability. Therein lies the problem: the real economy and the broader financial markets need low interest rates for stability and improvement, but the financial sector needs higher rates.
Even the financial sector itself is caught in a love-hate relationship with low/high interest rates. Its profitability requires strong and steady loan growth, which requires strong economic growth, which requires low interest rates. Loan profitability, however, requires, greater profit margins, i.e., a greater difference between long and short interest rates (aka spreads), which require a steeper yield curve resulting from higher interest rates.
As if that situation isn’t bad enough, the Fed has been walking an interest rate tightrope for years because of their effect on the US dollar. Higher interest rates and a stronger dollar have the potential to throw us into a recession as it makes our exports less price competitive in the global market, has the potential to crash commodity prices (which are already near all time lows), and could cause a debt debacle in the emerging markets that loaded up on $9 Trillion in dollar-denominated debt after the financial crisis! A stronger dollar makes that debt more expensive to repay.
On the other hand, keeping interest rates low poses an existential threat to the Fed and global central banks (i.e., the keepers of global fiat/paper currencies) and low interest rates could cause them to lose control of the financial markets as participants begin to favor gold and other precious metals (for which they have minimal control) over paper currencies (which is their exclusive domain).
Three large banks, JP Morgan Chase, Citigroup, and Wells Fargo, recently reported decent Q2 financial results, but it would seem the market was disappointed and unimpressed and responded with a modest sell-off in financial equities.
What’s the correct next step? Does the Fed continue its charade of talking up interest rates in the hope of propelling the financial sector even at the risk of tanking the global economy? What to do? What to do? Clearly no one, least of all the Fed, seems to have a clue!
Saturday, February 4, 2017
Silicon Valley Should Practice What It Preaches
Does anybody else see the irony in the great technologists of Silicon Valley railing against the Trump Administration for hampering the economic prosperity of our youth, restricting immigration and diversity, and fostering income inequality. Their own companies employ sophisticated technologies to ensure that they can employ as few as possible, which allows them to pay their employees outlandish sums of money. The products and services they sell allow other companies to do the same. Over the decades those companies have done their best to reduce or even eliminate the world’s “blue collar jobs” and are now with their so-called Artificial Intelligence attempting to do the same to global “white collar” jobs. In fact, it is likely that the Trump administration will be unable to keep its promise to return the millions of manufacturing jobs that have moved offshore during the past 40 years, because many of those jobs have been replaced by computer operated machines.
How does any of that help today’s youth make their economic way in the world, or help middle class incomes keep pace with inflation or help immigrants assimilate into American culture? Additionally, if Silicon Valley gets it way, all jobs paying a living wage will require employees to possess sophisticated skills in some aspect of building and/or operating computer systems. That also hampers economic diversity if not ethnic diversity in today’s workforce. That may be progress, but it is not very “progressive.”
No one is arguing that improving technology is not a boon for the global economy or humanity at large; a favorite example is how Microsoft Windows transformed tasks that took me weeks to perform down to days and sometimes mere hours. And companies like Google, Amazon and many others continue to enhance and improve our lives daily. But many of the recent additions, like the Facebooks and Twitters of the world, one can easily argue have not only made our lives less productive and less secure, but have in some ways contributed to the “dumbing down” and social ineptitude, if not delinquency, of our children and young adults. The constant preoccupation with the internet, mobile gadgets, and “virtual reality” is leading many among us to opt out of “real world” reality. This “ear bud generation” seems less interested and aware of the mounting challenges of the increasingly dangerous world in which we live.
Today’s technologists would be well advised to reflect on their own complicity with what’s wrong with our world and think about “high tech” solutions for addressing those problems before opting for “low brow” criticism and cheap shots for those currently charged with meeting and overcoming the challenges that await us.
How does any of that help today’s youth make their economic way in the world, or help middle class incomes keep pace with inflation or help immigrants assimilate into American culture? Additionally, if Silicon Valley gets it way, all jobs paying a living wage will require employees to possess sophisticated skills in some aspect of building and/or operating computer systems. That also hampers economic diversity if not ethnic diversity in today’s workforce. That may be progress, but it is not very “progressive.”
No one is arguing that improving technology is not a boon for the global economy or humanity at large; a favorite example is how Microsoft Windows transformed tasks that took me weeks to perform down to days and sometimes mere hours. And companies like Google, Amazon and many others continue to enhance and improve our lives daily. But many of the recent additions, like the Facebooks and Twitters of the world, one can easily argue have not only made our lives less productive and less secure, but have in some ways contributed to the “dumbing down” and social ineptitude, if not delinquency, of our children and young adults. The constant preoccupation with the internet, mobile gadgets, and “virtual reality” is leading many among us to opt out of “real world” reality. This “ear bud generation” seems less interested and aware of the mounting challenges of the increasingly dangerous world in which we live.
Today’s technologists would be well advised to reflect on their own complicity with what’s wrong with our world and think about “high tech” solutions for addressing those problems before opting for “low brow” criticism and cheap shots for those currently charged with meeting and overcoming the challenges that await us.
Subscribe to:
Posts (Atom)