“Macro” Musings II

[LanceSanity]

Macro musings from Robert Reich:

Good economic news: Commodity prices (oil, copper, iron ore, coal) have plummeted 15% since June because buyers aren’t buying -- China’s economy is slowing, Japan is still comatose, and Europe is near recession. Which is good for us in the short term (the typical U.S. household is saving $400 this year on lower gas prices alone).

Bad economic news: Because of the global slowdown, America can’t rely on exports to stoke demand. And other than the extra $400, the typical American has less buying power this year than last because paychecks haven’t kept up with inflation. The top 1 percent is getting 95% of all the gains, but nothing is trickling down. Trickle-down economics is a proven fraud.

Bottom line: Buckle your seat belts. The economy remains very fragile.

[wisdom]

https://finance.yahoo.com/video/markets-39-living-borrowed-time-070000553.html

Wilbur Ross

[Liberty]

http://www.philosophicaleconomics.com/2014/11/not-everyone-sucks-at-investing/

[stahleyp]

http://www.philosophicaleconomics.com/2014/11/not-everyone-sucks-at-investing/

 

haha. This guy sounds a little like Eric here. ;)

[jb85]

I've been going through a 2001 Buffett speech and he talks about the market. He goes discuss interest rates and after tax profit margins as a percent of GDP affect prices.

 

Buffett wrote:

 

"Tow years ago I believed the favorable fundamental trends had largely run their course. For the markets to go dramatically up from where it was then would have required long0term interest rates to drop much further (which is always possible) or for there to be a major improvement in corporate profitability (which seemed, at the time, considerably less possible). If you take a look at a 50-year chart of after-tax profits as a percent of gross domestic product, you find that the rate normally falls between 4% -- that was its neighborhood in the bad year of 1981, for example -- and 6.5%. For the rate to go above 6.5% is rare. In the very good profit years of 1999 and 2000,the rate was under 6% and this year it may well fall below 5%".

 

It's hard to imagine interest rates getting too much lower (unless we do some Eurozone things) and profitability as a percent of GDP is over 10.5% from what I see. The only thing I can think of that would push prices up much higher is speculative fever. Am I missing something?

 

Buffett also said in that interview (last few paragraphs), that he expected long term equity returns of 7% or so.  And at the time, the Market cap to GNP ratio was at about 130%.  About the same as today.

 

more numbers:

 

        Metric        |      Dec 2001    |    Nov 2014

Mk Cap to GDP    |        133%      |        131%

10yr CAPE          |        30.5        |        26.8

10 bond rate        |          5%        |        2.34%

 

Wouldn't all of this at least imply that we are still in a zone of reasonableness as of Nov 2014??

 

http://archive.fortune.com/magazines/fortune/fortune_archive/2001/12/10/314691/index.htm

[Ham Hockers]

http://www.philosophicaleconomics.com/2014/11/not-everyone-sucks-at-investing/

 

haha. This guy sounds a little like Eric here. ;)

 

Nice slight of hand here

 

"Before frictions (fees, transaction costs, etc.), they cannot underperform."

 

[investor-man]

http://www.philosophicaleconomics.com/2014/11/not-everyone-sucks-at-investing/

 

haha. This guy sounds a little like Eric here. ;)

 

Nice slight of hand here

 

"Before frictions (fees, transaction costs, etc.), they cannot underperform."

 

Best part of the article:

[stahleyp]

I've been going through a 2001 Buffett speech and he talks about the market. He goes discuss interest rates and after tax profit margins as a percent of GDP affect prices.

 

Buffett wrote:

 

"Tow years ago I believed the favorable fundamental trends had largely run their course. For the markets to go dramatically up from where it was then would have required long0term interest rates to drop much further (which is always possible) or for there to be a major improvement in corporate profitability (which seemed, at the time, considerably less possible). If you take a look at a 50-year chart of after-tax profits as a percent of gross domestic product, you find that the rate normally falls between 4% -- that was its neighborhood in the bad year of 1981, for example -- and 6.5%. For the rate to go above 6.5% is rare. In the very good profit years of 1999 and 2000,the rate was under 6% and this year it may well fall below 5%".

 

It's hard to imagine interest rates getting too much lower (unless we do some Eurozone things) and profitability as a percent of GDP is over 10.5% from what I see. The only thing I can think of that would push prices up much higher is speculative fever. Am I missing something?

 

Buffett also said in that interview (last few paragraphs), that he expected long term equity returns of 7% or so.  And at the time, the Market cap to GNP ratio was at about 130%.  About the same as today.

 

more numbers:

 

        Metric        |      Dec 2001    |    Nov 2014

Mk Cap to GDP    |        133%      |        131%

10yr CAPE          |        30.5        |        26.8

10 bond rate        |          5%        |        2.34%

 

Wouldn't all of this at least imply that we are still in a zone of reasonableness as of Nov 2014??

 

http://archive.fortune.com/magazines/fortune/fortune_archive/2001/12/10/314691/index.htm

 

Thanks for finding the article! I tried looking it up to post it but it said it was removed.

 

I just did a quick morningstar check, at it looks like the S&P 500 dropped roughly 25-30% after he wrote this. Even then, the tone of the article was bearish. I'm just kinda wondering though, if after tax profit margins are way, way out of historical averages and so are interest rates, that seems to be a rather risky situation to be in. Also,  keep in mind that Market cap to GDP is quite a bit higher now than what it was in 2007, too. I don't think people are quite as reckless yet.

[jb85]

 

Thanks for finding the article! I tried looking it up to post it but it said it was removed.

 

I just did a quick morningstar check, at it looks like the S&P 500 dropped roughly 25-30% after he wrote this. Even then, the tone of the article was bearish. I'm just kinda wondering though, if after tax profit margins are way, way out of historical averages and so are interest rates, that seems to be a rather risky situation to be in. Also,  keep in mind that Market cap to GDP is quite a bit higher now than what it was in 2007, too. I don't think people are quite as reckless yet.

 

I'm not sure he was all that bearish.  His concluding remarks of that article were: "The country's economy has grown and stocks are lower, which means that investors are getting more for their money. I would expect now to see long-term returns run somewhat higher, in the neighborhood of 7% after costs. Not bad at all--that is, unless you're still deriving your expectations from the 1990s."

 

 

not full on bull, but not bear either. he's in his "Zone of reasonableness" at date of this article imo

 

its really a tough call to call a market top or bottom.  rarely do a bunch of metrics line up.  In the past, most peaks and troughs had one or two metrics that matched up, but others that implied it was still reasonable.  Shows how hard it is to call a top/bottom. 

 

Below i expand a bit more on my previous post, comparing two metrics 1) spread btw 10 yr earnings yield and 10 year bonds and 2)market Cap to GDP.  As you can see below, its pretty rare for both metrics to line up. 

 

2000 was obvious, 1974 was obvious, 1932 was obvious

 

was the 2007 peak obvious? not really.  was 1968 (when buffett wound up his partnership b/c he couldn't find value) obvious? not really...market cap to GDP ratio looked reasonable

 

so just really tough to tell imo. 

 

 

 

Date        |  spread btw 10yr E/Y and 10yr bond      |    market Cap to GNP

sep 1929  |                      -.32%                          |              74%

June 1932 |                      +14.4%                          |              20%

Dec 1968  |                      -1.54%                          |              84%

Dec 1974  |                      +4.63%                        |              30%

May 1980  |                      +2.15%                        |              38%

Jan 2000  |                      -4.37%                          |              153%

Jan 2001  |                      -2.46%                          |              102%

Dec 2001  |                      -1.81%                          |              100%

Mar 2003  |                      +0.88%                        |              80%

Jun 2007  |                      -1.45%                          |              112%

Mar 2009  |                    +4.68%                          |              62%

Nov 2014  |                      +1.38%                          |              131%

 

edit: regarding high margins, the 10 year E/Y should control for that at least to a degree.  and regarding low interests.  I don't have a clue what they will do, but i'm a bit skeptical of folks who think/know they are going to rise a ton in the near future (say 5 years).  There's certainly a chance that we have a lot of deleveraging to go, and deflation could be with us for the foreseeable future.  I'm not sure on that, but it seems that in order to go 100% cash or something close to it, you're betting on rising interest rates. Im not sure enough of that to make a move so my cash position is low.  Maybe i'll get crushed by 50% in the next few years (as i would have in 2007, using my above figures).  but that's life i guess.

[stahleyp]

jb, I agree with you and thanks for the additional insight. I wouldn't say things are super outrageous by most measures (like you pointed out). Personally, I'm mostly invested - but I've been (slowly) bringing up my cash throughout the year. These crazy bear markets tend to happen out of nowhere. I also wouldn't be surprised to see the market do fairly well over the next few years. Buffett also talked about paying a high price for a rosy consensus. I don't think we're that rosy yet.

 

On another note, I read something about Munger saying he hasn't purchased anything in 2 years or so. To me, that's enough to say "be a bit more careful". 

 

Oh and one more, I'm a bit of a worry wart...and I kick myself for listening to this several years ago :P

 

http://www.marketwatch.com/story/buffett-says-subprime-crisis-not-a-big-threat-to-us-economy

[jb85]

 

On another note, I read something about Munger saying he hasn't purchased anything in 2 years or so. To me, that's enough to say "be a bit more careful". 

 

 

i'd be curious what his cash position is currently.  its probably growing a few % per year because of him not reinvesting dividends, but wasn't he basically 100% in wells fargo?  excluding reinvesting dividends and assuming he never sells, he may not need to make another purchase for the next 50 years ;)

[wisdom]

http://www.marketwatch.com/story/china-triple-bubble-points-to-long-slide-for-commodities-2014-11-20?siteid=yhoof2

 

[Ham Hockers]

http://www.marketwatch.com/story/china-triple-bubble-points-to-long-slide-for-commodities-2014-11-20?siteid=yhoof2

 

Is this anything like a double rainbow?

[yadayada]

Some of their arguments are really aweful. I can see how copper and steel could come to an end though. But extrapolating on the past seems stupid. Especially with oil.  If you see almost 20% of earth's population being lifted in the middleclass, going through an enourmous economic boom, I think you can say that that is something that has not really happened before. I don't think it is even comparable to Japan. If you want to compare it to Japan, the average chinese person has not nearly reached the levels of wealth the average Japanese person reached at the height of it's boom.

[stahleyp]

jb, yeah, i think wfc was a huge position for him. haha. by the way, where did you get the current market cap to gdp data?

[Vish_ram]

jb, yeah, i think wfc was a huge position for him. haha. by the way, where did you get the current market cap to gdp data?

 

 

You can get this using FRED data.

 

https://research.stlouisfed.org/fred2/graph/?graph_id=152517&category_id=

 

The more I analyze the economic data, the more I'm convinced that market participants collectively do not pull themselves out of a bull market based on valuations. If you are in a bull market, irrespective of valuations, the market keeps on going up until Fed applies the brake. The braking action acts as a pin that pierces the valuation bubble.

 

The market cap to GDP should be viewed in context of Fed's actions.

 

[jb85]

jb, yeah, i think wfc was a huge position for him. haha. by the way, where did you get the current market cap to gdp data?

 

 

You can get this using FRED data.

 

https://research.stlouisfed.org/fred2/graph/?graph_id=152517&category_id=

 

 

 

yup, FRED is where i got the post 1950 data. 

 

Pre 1950 data is linked below.  Using only the NYSE for pre 1950 data, there's obviously a bit of comparing apples and oranges here, but i think it gets us in the right ballpark

 

http://www.bloomberg.com/image/iZj5ds4HctRo.jpg

[stahleyp]

Thanks guys for the FRED data. I wonder what accounts for the difference with the FRED, Bloomberg and this Fortune graph:

 

http://archive.fortune.com/2009/02/04/magazines/fortune/buffett_metric.fortune/index.htm

 

For instance, the high point on the FRED is 153%, Bloomberg is 174% and fortune is 190%. That's a fairly big range.

 

Vish ram,

 

You certainly might be right. However, if I had to guess, I'm thinking the popping of the bubble will be quite quicker than people think. Look at the flash crash of 2010, for instance. Complex systems tend to behave in ways that we don't understand many times.

 

[Vish_ram]

Thanks guys for the FRED data. I wonder what accounts for the difference with the FRED, Bloomberg and this Fortune graph:

 

http://archive.fortune.com/2009/02/04/magazines/fortune/buffett_metric.fortune/index.htm

 

For instance, the high point on the FRED is 153%, Bloomberg is 174% and fortune is 190%. That's a fairly big range.

 

Vish ram,

 

You certainly might be right. However, if I had to guess, I'm thinking the popping of the bubble will be quite quicker than people think. Look at the flash crash of 2010, for instance. Complex systems tend to behave in ways that we don't understand many times.

 

 

- One is using GDP and other GNP

- In many places i've seen them use non-financial corporate eq , the fortune one may be adding financial ones as well.

 

  I followed the ones in http://www.advisorperspectives.com/dshort/updates/Market-Cap-to-GDP.php

 

- Also the fortune one seems to include OTC stocks, the others may not be including those

- I tried to gauge the impact of adding financial ones and it pushed the ratio to above 3; I dont know why this differs from bloomberg/fortune ones

 

Here is another graph  where i'm showing the fin equity  in right y axis.

 

https://research.stlouisfed.org/fred2/graph/?graph_id=164130&category_id=0

 

The right y axis is interesting as fin co's never dropped much in 2000 and had a real bubble in 2007. Their collapse in 07 was very dramatic compared to 2000.

 

[JEast]

A H/T to the GuruFocus guys as they have some info on market cap to GDP, plus global calculations.

 

US Cap to GDP

Some Global Cap to GDP

 

However, as the large caps continue to rise some small caps are getting crushed around the globe.

 

[ERICOPOLY]

http://www.marketwatch.com/story/china-triple-bubble-points-to-long-slide-for-commodities-2014-11-20?siteid=yhoof2

 

Fallout is being felt:

 

”Everyone in manufacturing is smiling at the moment,” said the ISM’s Mr. Holcomb, because manufacturers benefit twice from cheaper oil. “It costs less to run the plant and input materials cost less.”

 

http://online.wsj.com/articles/ism-manufacturing-index-slows-slightly-in-november-1417446885?mod=WSJ_hp_LEFTWhatsNewsCollection

[wisdom]

Not such a good thing for Canada as we produce commodities unfortunately. I think the consumers, retailers, leisure activities, importers and users of commodities stand to gain.

 

[ni-co]

What's your best guess what would happen if the developed world slipped into a few months or even years of deflation? What would happen to stocks, bonds and commodities?

 

Until recently, I was quite optimistic about equities and bearish about bonds. Now, however, I just can't see equity markets staying at these levels in case of worldwide deflationary tendencies. 

[wisdom]

I read up on what Gary Shiller has to say as he speaks or writes frequently enough to keep up with his toughts as they are evolving.

 

I watch good investors - most of them have higher cash levels or have raised capital and set up new permanent vehiclessince the beginning of 2014.

 

Countering this - there will be winners - I think of Toyota in Japan for example. Even though Japan hasn't done well, several Japanese companies have.

 

Could there be 2 phases:

1) where the consumers have more money to spend and users of commodities have higher margins.

2) where jobs and incomes are impacted and thus, the consumer too slows

 

Difficult to know how it plays out though. Who knows how long China can keep things going. Several China watchers think - another year or 2 at the most without serious changes. I don't think anyone undestood exactly how 2008 would play out either.

 

Best to position yourself to have options no matter what situation plays out, would be my guess. Have hedges or higher levels of cash maybe. Demand a higher margin of safety.

 

EDIT: Or maybe just sit on our butts as Munger seems to be doing right now.

[wisdom]

http://www.bloomberg.com/news/2014-12-04/gross-says-debt-creation-by-policy-makers-akin-to-public-smoking.html