More Words of Wisdom

Just because a market is over stretched doesn’t mean that it can’t become even MORE over stretched. And that’s exactly what’s happening in the US risk asset markets, where for example, the S&P500 rose another 2% last week. Of course this happened on diminishing volume, as fewer and fewer real investors choose to participate in clearly growing bubble. This leaves the hot money, fueled by the Federal Reserve and channeled by Wall Street banks, hedge funds, and computer algorithms to pump the prices ever higher.

Sadly, many scared investors are sitting out of the stock markets and sheltering in corporate bonds, both investment grade and high yield. What’s sad is that even these relatively safe asset categories are also priced at bubble levels. This means that while these safer asset groups should fare better when the inevitable risk asset bubble bursts, they will not be immune to severe losses too. Whereas in the late 1990’s, the Fed engineered a tech bubble, and in the mid-2000’s it engineered a housing and stock market bubble, this time the Fed has managed to create the ultimate monster—a bubble in virtually every risk asset bucket. When the bubble bursts, there will be very few places to hide to avoid damage.

And while asset bubbles grow, the US economy continues to miss hopes and expectations for long-lasting and organic growth. Last week, personal income growth missed consensus forecasts. The Dallas Fed manufacturing survey BADLY missed expectations—-recording its biggest drop on record. The Chicago PMI also missed badly, falling below the critical 50 level for the first time since 2009. ISM manufacturing and ISM services BOTH missed their targets. Construction spending missed. Productivity growth missed, meaning that unit labor costs will be greater than expected (this will hurt corporate profits). Factory orders also missed badly. The one positive report of the week was a jobs report that was only slightly stronger than expected. Several ‘buts’ should be noted however. First, the better rise in payrolls was driven by low paying leisure and hospitality jobs; this is hardly an equal replacement to the manufacturing and managerial jobs lost in the 2008-2009 recession. Second, the payrolls report is a LAGGING indicator, not a leading indicator. Ominously, the ISM, the PMI, and the regional Fed surveys are leading indicators, and they’re all pointed down. So while the slight jobs beat was good news, it hardly matters when what’s around the corner looks like an economic hurricane.

Technically, the S&P is still extremely over bought and over bullish. Using virtually any type of technical analysis strategy, an investor must conclude that putting new money to work at this point would be the equivalent of ‘buying high’, the opposite of what a prudent investor OUGHT to be doing.

Over a year ago, we shared some words of wisdom from one of the most successful value-oriented hedge fund managers in the world, Seth Klarman of Baupost Group. Back then, Mr. Klarman warned an audience in Boston about the false and unstable foundation upon which the risk asset markets were rising.

Since then, obviously, risk asset markets have risen markedly, despite the risks highlighted by Mr. Klarman.

Recently, in a note in his investors, he highlighted several more kernels of truth. Among them:

“Most people seem to viscerally recognize that the absence of an immediate crisis does not mean we will not eventually face one. They are wary of believing promises by those who failed to predict previous crises in housing and highly leveraged financial institutions.”


“When an economist tells them that growing the nation’s debt over the past 12 years from $6 trillion to $16 trillion is not a problem, and that doubling it again will still not be a problem,  this simply does not compute.”


“They know that a society’s wealth is not unlimited, and that if the economy is so fragile that the government cannot allow failure, then we are indeed close to collapse.”

Clearly another collapse since the last meltdown in 2008-2009 has not happened in the US. But some Wall Street pundits are now trying to convince the public that this means that it may never happen again, so buy stocks now and forever enjoy the benefits.

But it’s equally clear that these same pundits spewed the same advice in the late 1990’s and in the mid 2000’s. In both times, the S&P500 DID end up collapsing by over 50%.

This time will be no different.

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