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Evergreen - GaveKal - November 30, 2018,
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This is the weekly GaveKal report from
Friday, Nov. 30, 2018 and one of a series of such reports focused on the
'Bubble 3.0'. The others in this series are listed below. The GaveKal reports
are available by subscription from Evergreen and are provided in PDF as well as
email format. In my summary I will insert my own comments about the text.
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Introduction
The series began in February 2017 and is focused on the author's contention
that the investments markets are currently experiencing a massive 'bubble' that
is, unsustainable high levels of asset prices. Mr. Hay intends these reports to
comprise major parts of a consolidated examination of the phenomena in a
forthcoming book form. He notes that the current week (in November) was
dominated by the comments of the FED Chairman, Jerome Powell which caused the
S&P to rise by 2.3% in one day. The market participants inferred from the
Chairman that the FED might soon end its series of interest rate increases, but
that is by no means assured. Mr. Hay does consider that the previous decline in
the market 'values' was a result of the previous FED policy over the long term
of increasing market asset prices - inflation. His analysis is that such a
rally is best sold into temporarily as the longer term remains a continued
sell-off.
And sure enough the decline accelerated in December.
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The pain before the gain
Our author excites us readers with the comment that from his lengthy experience
bull markets are "much more fun that bear markets". Whod'a guessed?
The youngsters here have never seen a real bear market.
(Being 85, I can assure David that I have seen many of these 'non - fun
episodes.)
He turns to GMO for statistics about the general market trend from
'undervalued' in 2009 to fair value in 2012 to overvalue in 2014 to
extraordinary hypervalue now.
Then he inserts a chart that depicts the GMO expectation for market performance
over the coming years. In two words - Not good - Even with a presumed 50/50
allocation to stocks and bonds the forecast is for negative returns.
His thought about this situation is that the prudent investor ought currently
to have a pile of cash on hand. But that those who have continued to chase the
markets up likely do not have that reserve. But at that point he waxes
optimistic, considering that in the remaining month the market still might
achieve an historical record of '10 consecutive up years.'
Sorry about that - December dispelled that unprecedented opportunity.
A few well chosen thoughts follow: "Bull markets ... make investors
'afraid to sell'. And, 'Late stage bull markets become like an elaborate con
job.' after a few more punches - "most of the foregoing has fallen on deaf
ears".
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Flash crash flashback
Now for the meat of the report. He assesses the nature of today's market
structure. Computers anyone? The 'algorithms have taken over. 'Passive'
investing is the current fad. Statistics again - NYSE trading volume is
estimated to be 80 - 90 % the result of algo's. Another insight, "My only
insight is that it simply shows that perhaps the only force driving the stock
market these days that is more powerful than the 'algos' and computers is the
FED." Bingo - enter the FED.
Our author is too polite to mention that all this is the result of the
financial industry trying to reduce THEIR costs and attempt to retrieve profits
despite enforced regulations. He produces several graphs which depict an
interesting 'coincidence' between computer driven exchange volume and the dates
of FED pronouncements. (Really? can't be!)
But the situation is worse. Active real research on fundamentals is expensive,
of course, but that was the basis for the vaunted 'efficient market theory'.
Now we have ETF's created by the industry to entice 'investors' into passive
index investing.
But now Mr. Hay brings up the bacon - the FED and the result of its QE in
providing a 'pretend' unending increase in asset prices into which the buy-side
computer programs are delighted (if computers can have emotions) well anyway
their authors - to buy and buy. And all that buying has been financed by the
FED purchasing the Treasury debt generated by Fed government paying (exchanging
)credit for assets. It is called 'deficit financing'. And many corporations
have been happy to emulate the FED. Don't forget that if a single individual
were to pay $10 more for a share of stock today than its price yesterday each
and every one of those other millions of shares are automatically increased
also by $10. But wait, what happens when someone's computer detects some
anomaly and SELLS a share for $10 less.
Mr. Hay again. He notes that for several months already (Nov, remember) there
has been a 'tide shift', "A key flow reversal is that interest rates have
staged a comeback in many countries." The result, he notes, is that
computers are no longer 'churning' out buy orders but their programers have
considered it is time to sell. He calls this a 'radical departure'. Investors
have been 'duped' into 'believing that the stock market is no longer a volatile
beast, capable of destroying vast amounts of wealth in breathtaking short
order." Including, I confess, your reporter here who lost over 12% between
1 Sept and 31 Dec. At a return of 3% annually it will take over 4 years just to
regain the same.
But our intrepid author tries to remain optimistic by hoping in Nov. for a
Santa Claus Rally' come December.
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What about that upside stuff?
Mr. Hay tells it clearly. "If my belief that Bubble 3.0 is rapidly
deflating is correct, this is actually great news for prudent investors - like
those who systematically reduced risk late in a bull market".
Well, I did get a few hundred thousand into cash in time but no where near
enough. He mentions Jim Grant who has been urging this action for a long time.
By coincidence, I happened to see Grant being interviewed on CSPAN on Sunday -
excellent - check the interview out in the CSPAN archive.
From this he turns to the bond market and references several previous GaveKal
reports and adds graphs depicting the shifting credit spreads between BBB and
High-Yield instruments.
He has news "The great news for risk-averse and income needy investors is
that these days you can lock in 3% per annum for several years with the safest
of bond vehicles." Yes, if you were smart and moved your stash into cash
in time to buy bonds now. But he again cites GMO to the effect that the stock
market is not going to generate even 3% per year over the next 7 years. So he
tells us that a 12 month Treasury now could be a great performer over that 7
years, due not only to the interest but also from the CG by annual roll overs.
Furthermore, he adds, credit spreads are already widening - with more graphics
to depict that. He believes that the up-move in spreads is going to increase.
And such increases are bad news for stocks and on long term corporate bonds.
He repeats, "To be clear, in our view the credit spread eruption is in its
early stages so it's best to stay short-term and ultra-high quality for
now."
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The potential sequential plan
Here comes the climax of this report. "our best guess on what the sequence
of events is likely to be as the Fed continues to raise rates AND - very
critically but mostly ignored - rapidly contracts it massive balance sheet. As
this tightening cycle nears a crescendo, it's probable it will set off a
powerful chain reaction that may rival what we saw 10 years ago".
He repeats that the FED reduction of its balance sheet is little appreciated in
the media, but that is something I have been harping on for a long time.
He does note Randall Forsyth's column in the Nov 26 Barron's which I also have
cited. The point is that the QE program of buying Treasury debt (credit)
resulted as expected in the great increase in asset prices (which was the
purpose) then the QT program of selling Treasury debt will result in a great
decrease in asset prices. Mr. Hay devotes much more space to describing this
phenomena.
His bottom line expectation. "as conditions become increasingly precarious
(and recessionary), stocks will crater and the Fed will panic. It will begin
cutting rates first and then soon, perhaps simultaneously, halt its QT process.
at that point long treasury yields will plunge."
So timing is everything for us. And the 2020 election figures in to that.
And Mr. Hay is well aware of this and lays out a complex schedule of what kind
of bonds to buy and when, which requires a full page of description folks here
should study.
My question about this is not that it will happen but about the timing. The FED
is in a dilemma. The anti-Trump establishment economist staff wants to hit
Trump with the described here results of continuing the 600 billion a year
contraction of the balance sheet (generating much more than 600 billion in
contraction of the money supply) But the Democrat (and even Republican
establishment) expects the Treasury to expand its credit based purchasing
(asset confiscation) program with deficit spending generating over 1 trillion a
year increase in the debt - that same balance sheet. Question then is - can the
FED hold off on reversing QT for a new QE as long as Mr. Hay believes?
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All of this is my inadequate effort to alert
you to the seriousness of the current financial situation by trying to
summarize one of the best analyses of that situation that I have found and urge
you to study the full report and the others in the series. It is an example of
a whole being much greater than the sum of its parts.
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The other Gave Kal EVA weekly reports in this
series: They are all available at the Evergreen on line archive
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Bubble Watch: A New Series Dedicated to
Investors Interested in Preserving Their Wealth: December 22, 2017
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Biggest Bubble Ever: - Feb. 9, 2018
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Bubble 3.0 How Central Banks Created the Next
Financial Crisis: - April 27, 2018
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Bubble 3.0 How Did We Get Here Part I: - June
1, 2018
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Bubble 3.0 How did We Get Here Part II: -
June 8, 2018
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Bubble 3.0 A Fast and Furious Challenge: -
July 6, 2018
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Bubble 3.0 Up From the Ashes: - August 24,
2018
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Bubble 3.0 The Biggest Bubble Inside the
Biggest Bubble Ever (September 21, 2018)
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Bubble 3.0 What Could Go Right: - Oct 12,
2018
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Bubble 3.0 The Upside of Downside: - Nov, 30,
2018
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Special Edition EVA, The Stealth Bear Market:
- Dec 14, 2018
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What Price Prosperity? Part I: January 11,
2019
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What Price Prosperity? Part II: January 18,
2019
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Bubble 3.0 No Way Out: February 22, 2019
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Bubble 3.0 Can an Acronym Save the World?
(Part I): April 5, 2019
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Bubble 3.0 Can an Acronym Save the World ?
(Part II): April 12, 2019
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Bubble 3.0 The Intersection of Bubble and
Bubble: May 17, 2019
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Bubble 3.0 A Blast From A Bubble Past: June
14, 2019
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Bubble 3.0 The Post-Retirement Society: July
12, 2019
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Bubble 3.0 Debt-End: August 8, 2019
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Bubble 3.0 Deja Vu 2000 or Flashback 2007?
(Part I): September 6, 2019
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Bubble 3.0 Deja Vu 2000 or Flashback 2007?
(Part II): September 13, 2019
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Bubble 3.0 Back to the 2015 Future: November
15, 2019
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