But we found this chart to be especially meaningful:
Historically, the typical bull-bear market cycle has produced a range of 10-year prospective returns in a band between about 7.5% and 13%. That band presently corresponds to a range for the S&P 500 index between 600 and 1000. A 10% prospective return is right in the middle, at about 800 on the S&P. Once you recognize that profit margins are in fact cyclical, that range is about right, as uncomfortable as it may be to contemplate. Jeremy Grantham of GMO estimates that fair value is "no higher than 950." A tighter norm for prospective return between 9-11% maps to an S&P 500 between 750 and 850.
Finally, while I certainly would not expect it in the absence of extreme macroeconomic upheaval, major secular undervaluation as we observed in 1950, 1974 and 1982 would presently map to about 400 on the S&P 500. When you think of "once in a generation" valuations and "secular bear market lows" - that number, not anything near present levels, should be what crosses your mind. I am well aware that even discussing numbers like these, given the present mindset of investors, is likely to be dismissed as utterly ridiculous. Frankly, I would rather risk the ridicule of those who pay lip-service to research, cash flows, fundamentals, and value than to pretend these outcomes are impossible, when the historical record (and even the experience of the past decade) strongly indicates otherwise.
As Howard Marks of Oaktree Capital has noted, "We hear a lot about 'worst-case' projections, but they often turn out to be not negative enough.. most people view risk taking primarily as a way to make money. Bearing higher risk generally produces higher returns. The market has to set things up to look like that'll be the case; if it didn't, people wouldn't make risky investments. But it can't always work that way, or else risky investments wouldn't be risky. And when risk bearing doesn't work, it really doesn't work, and people are reminded what risk's all about."
The favourable stock market reaction to the latest report of growth in orders for durable goods in America misses an essential point. At around $200 billion an month, it is still around 20% below its peak in 2007 and only at 2000 levels.
Germany and emerging market economies, like China and India, which have contributed the bulk of global growth since 2008, are showing signs of slowing. The effects of the excessive credit expansion in China and India are showing up in bank bad debts.
Then there are pernicious feedback loops. Tighter money market conditions feed into lower growth, increasing the problems of government finances. Falling tax revenues and rising expenditures push up budget deficits, requiring greater borrowing. Lower growth feeds into greater business failures that increase bank bad debts, feeding further tightening in lending conditions and the cost of finance.
The rapid and marked deterioration in economic and financial conditions means that the risk of a serious disruption is now significant.
If market seize up again, then “this time it will be different“. There might just not be enough money to bail out everyone and every country that may need rescuing.
Government policy options are severely restricted. Government support is restricted because of excessive debt levels and the reluctance of investors to finance indebted sovereigns. Interest rates in most developed countries are low or zero, restricting the ability to stimulate the economy by cutting borrowing cost. Unconventional monetary strategies – namely printing money or quantitative easing – have been tried with limited success. Further doses, while eagerly anticipated by market participants, may not be effective.
The global economy may muddle through, but a second credit crash is now distinctly possible. But the trigger and timing is unknown. As John Maynard Keynes remarked: “The expected never happens; it is the unexpected always.”
Figure 1 displays the P/E and M/O ratios from 1954 to 2010. The two series appear to be highly correlated. For example, between 1981 and 2000, as baby boomers reached their peak working and saving ages, the M/O ratio increased from about 0.18 to about 0.74. During the same period, the P/E ratio tripled from about 8 to 24. In the 2000s, as the baby boom generation started aging and the baby bust generation started to reach prime working and saving ages, the M/O and P/E ratios both declined substantially. Statistical analysis confirms this correlation. In our model, we obtain a statistically and economically significant estimate of the relationship between the P/E and M/O ratios. We estimate that the M/O ratio explains about 61% of the movements in the P/E ratio during the sample period. In other words, the M/O ratio predicts long-run trends in the P/E ratio well.
Despite theoretical ambiguities, U.S. equity values have been closely related to demographic trends in the past half century. There has been a tight correlation between population dependency ratios, such as the M/O ratio, and the P/E ratio of the U.S. stock market. In the context of the impending retirement of baby boomers over the next two decades, this correlation portends poorly for equity values. Moreover, the demographic changes related to the retirement of the baby boom generation are well known. This suggests that market participants may anticipate that equities will perform poorly in the future, an expectation that can potentially depress current stock prices. In that sense, these demographic shifts may present headwinds today for the stock market’s recovery from the financial crisis.
When we take a position that isn't willing to embrace evolution, when we take a position that basically runs counter to what 98 of 100 climate scientists have said, what the National Academy of Science - Sciences has said about what is causing climate change and man's contribution to it, I think we find ourselves on the wrong side of science, and, therefore, in a losing position....I can't remember a time in our history where we actually were willing to shun science and become a - a party that - that was antithetical to science. I'm not sure that's good for our future and it's not a winning formula.
Here he is on the GOP's recent economic brinkmanship:
Well, I wouldn't necessarily trust any of my opponents right now, who were on a recent debate stage with me, when every single one of them would have allowed this country to default. You can imagine, even given the uncertainty of the marketplace the last several days and even the last couple of weeks, if we had defaulted the first time in the history of the greatest country that ever was, being 25 percent of the world's GDP and having the largest financial services sector in this world by a long shot, if we had defaulted, Jake, this marketplace would be in absolute turmoil. And people who are already losing enough as it is on their 401(k)s and retirement programs and home valuations, it would have been catastrophic.
Roger McNamee Roger McNamee is a founding partner of the venture capital firm Elevation Partners. Prior to co-founding the firm McNamee co-founded private equity firm Silver Lake Partners and headed the T. Rowe Price Science and Technology Fund. McNamee is also a touring musician, first as a founding member of the Flying Other Brothers, and more recently in that group's follow-on band, Moonalice.
So firstly, he says, it’s important to realise we are in a debt deflation crisis (one of Ben Bernanke’s specalist subjects). Second, that there’s always been a major difference in the Fed’s thinking when it comes to QE1 and QE2.
QE1 was ultimately a defensive move designed to put a floor on a major output collapse. QE2 was, however, was always designed as an offensive manoeuvre.
Under QE1, the Fed expanded its balance sheet by taking in Treasuries, as well as a whole bunch of “other” assets, including a major slice of non-performing mortgage debt.
The balance sheet expansion allowed the Fed to achieve one of two critical support functions to the banking industry. It provided banks with much needed liquidity via an expansion of base money.
Measures like Tarp, meanwhile, helped to recapitalise the banks. And both capitalisation and liquidity were essential to keep banks in the business of lending — and with that the floor on the crisis stable.
The problem was, that despite the recapitalisation and liquidity, banks were still not lending due to a general lack of creditworthy customers. No matter how hard the Fed tried to get the money into the spending stream via the banks, it quickly realised it couldn’t.
A transfer union of the type described here is clearly not a desirable perspective. And the massive volume of transfers is also unlikely to be economically or politically viable. Although such a transfer union could be the logical endpoint of the path which European policy makers are currently pursuing, we consider a transfer union of this type as unlikely. A more likely outcome is a breakdown of the eurozone prior reaching this endpoint. One possible reason for this breakdown is a raise in political tensions among member countries. A second, more likely reason is the bond market’s possible loss of confidence in the sustainability of the whole eurozone.
Even as the firms asserted in news releases or earnings calls that they had ample cash, they drew Fed funding in secret, avoiding the stigma of weakness