John Mauldin (CBS Marketwatch, Dec 6,2017):
Bonfires are fun to watch, but they eventually burn out.
Human folly apparently doesn’t, so we just keep adding to the absurdities. The volume of daily economic lunacy that lights up my various devices is truly stunning, and it seems to be increasing. (You can find a previous series of charts in my free newsletter, Thoughts from the Frontline.)
Let’s take a look at a series of charts I received from my “kitchen cabinet” of friends.
First up is Grant Williams, who sent me a monumental slide deck. Here’s an example of craziness:
This chart is straightforward: It shows outstanding credit as a percentage of GDP. Broadly speaking, this is a measure of how leveraged the U.S. economy is.
It was in a sedate 130%-170% range as the economy industrialized in the late-19th and early-20th centuries. It popped higher in the 1920s and 1930s before settling down again. Then came the 1980s. Credit jumped above 200% of GDP and has never looked back.
It climbed steadily until 2009 and now hovers over 350%.
Absurd doesn’t do this situation justice. We are mind-boggingly leveraged. And consider what the chart doesn’t show: Many individuals and businesses carry no debt at all, or certainly less than the 350% leverage. That means many others must be leveraged far higher.
While lending has been a very lucrative business in recent decades, it’s hard to believe it can last. At some point we must experience a great deleveraging. When that happens, it won’t be fun.
“Contrarian” investors believe success lies in going against the crowd, because the crowd is usually wrong. My own experience suggests one small adjustment: Pay attention not to what the crowd says but to what it does. Words are cheap.
This next chart is a prime example:
We see here the amount of cash held by Merrill Lynch clients from 2005 to the present, as a percentage of their assets. The average is about 13%.
The pattern is uncanny. In 2007, as stock indexes reached their peak, cash holdings were well below average. They rose quickly as the crisis unfolded, peaking almost exactly with the market low in early 2009.
In other words, at the very time when it would have been best to reduce cash and buy equities, Merrill Lynch clients did the opposite. And when they should have been raising cash, they kept their holdings low. I don’t think this pattern is unique to Merrill Lynch’s clients; market timing is hard for everyone.
The disturbing part is where the chart ends. Merrill Lynch client cash allocations are now even lower than they were at that 2007 trough. Interest rates are much lower, too, so maybe that’s not surprising.
Central banks spent the past decade all but forcing investors to buy risk assets and shun cash. This data suggest it worked. But whatever the reason, investor cash levels suggest that caution is unpopular right now.
So if you consider yourself a contrarian, maybe it’s time to raise some cash.
Michael Lewitt’s latest letter contributed a list of absurdities. Anyone questioning whether financial markets are in a bubble should consider what we have witnessed in 2017:
• A painting (which may be fake) sold for $450 million.
• Bitcoin BTCUSD, +7.87% (which may be worthless) soared from $952 to over $11,000.
• The Bank of Japan and the European Central Bank bought $2 trillion of assets.
• Global debt rose above $225 trillion to more than 324% of global GDP.
• U.S. corporations sold a record $1.75 trillion in bonds.
• European high-yield bonds traded at a yield under 2%.
• Argentina, a serial defaulter, sold 100-year bonds in an oversubscribed offer.
• Illinois, hopelessly insolvent, sold 3.75% bonds to bondholders fighting for allocations.
• Global stock market capitalization skyrocketed by $15 trillion to over $85 trillion and a record 113% of global GDP.
• The market cap of the FANGs increased by more than $1 trillion.
• S&P 500 SPX, -0.37% volatility dropped to 50-year lows and Treasury volatility to 30-year lows.
• Money-losing Tesla Inc. TSLA, -0.46% sold 5% bonds with no covenants as it burned $4 billion-plus in cash and produced few cars.
This is a joyless bubble, however. It is accompanied by political divisiveness and social turmoil. Immoral behavior that was tolerated for years is finally called to account, while a few brave journalists fight against establishment forces to reveal deep corruption at the core of our government. (Yes, I am speaking of Uranium One and the Obama Justice Department).
In 2018, a lot of chickens are going to come home to roost in Washington, on Wall Street, and in the media centers of New York City and Los Angeles. Icons will be blasted into dust as the tides of cheap money, cronyism, complicity and stupidity recede. Beware entities with too much debt, too much secrecy, too much hype. Beware false idols. Every bubble destroys its idols, and so shall this one.
The next absurdity is absurd because it is so obvious, yet many don’t want to see it. Too bad, because I’m going to make you look.
This comes from Michael Lebowitz of 720 Global. It’s the S&P 500 overlaid with the Federal Reserve’s balance sheet and the forecast of where the Fed intends to take its balance sheet.