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Welcome To The Everything Bubble

This post first appeared on The Felder Report Premium on May 2nd:

Everything is overvalued. Stocks are extremely overvalued. An incredible amount of bonds have negative yields; how much more overvalued can they get? Investment-grade and high-yield credit spreads are near all-time lows on top of some of the lowest rates we’ve ever seen! Prices for high-end real estate, art and other collectibles are off the chart. I’ve thought of calling this the “everything bubble,” because looking at each one on its own (outside of small cap stocks which are largely obscured from view) there’s no obvious bubble similar to the dotcom or real estate bubbles. But taken together we’ve never seen anything like this ever before.

I believe the real problem lies in the growth of “price-insensitive buyers,” as GMO recently labeled them. I’ve also called them “value agnostic.” Ultimately, there’s a growing class of investors (though I believe they don’t deserve that term) who are buying assets like stocks and bonds regardless of their valuations. They will buy stocks to the moon simply because their methodology dictates they do so. I’m referring mainly to so-called “passive” investors here.

Then we also have investors who will buy bonds no matter how negative they get because their methodology dictates it. Just look at pension funds, insurers and central banks. Their policies ensure they continue buying bonds even when that means locking in deeply negative returns over long periods of time.

The incredible growth in this class of price-insensitive buyers is responsible for the everything bubble. Just think about the growth of passive investing over the course of just the past five years or so. Buy and hold has gone from being mocked and disparaged only five years ago to the most popular investment style there is. Witness the growth of robo-advisors as evidence. And how long have central banks been buying assets? It’s only been over the past five or six years. This is a wholly new phenomenon in the markets and it’s now become a huge segment.

Make no mistake. The incredible growth of “value agnostic” investors is just another form of mania pushing asset prices to extremes. These investors use their returns over the past five years as proof that their methodology has merit when simple common sense shows that you can’t possibly be an investor while denying the definition of an “investment,” as Ben Graham defined it:

An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.

Buying stocks or bonds today provide neither “safety of principal” nor “adequate return.” In fact, these “price-insensitive buyers” don’t even attempt to begin any sort of “thorough analysis.” For this reason they are nothing more than speculators. That they believe themselves to be otherwise despite the obvious fact that they are just the opposite may be the surest sign there is that this is indeed another mania. Sadly, it will only be evident to them in hindsight.

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Why A Stock Market Crash May Once Again Be Inevitable

Don’t confuse brains with a bull market. -Humphrey B. Neill

Spending as much time as I do on social media, namely Twitter and StockTwits, I’ve been absolutely astounded by how many traders have begun to “confuse brains with a bull market.” We joke about it on these platforms but there is an amazing amount of hubris out there right now.

One of my favorite investing quotes comes from an interview Paul Tudor Jones gave just after the financial crisis had ended:

Clearly, many fundamental investors were caught off guard by the crisis. Stocks they thought were cheap in 2007 got far cheaper over the coming couple of years. Being unable to “read the tape,” these investors suffered the full force of the stock market crash.

As a response to this failure, many investors have seemingly tried to adapt by becoming “tape readers.” Most notably I have seen an explosion in the number of traders calling themselves, “trend followers.”

Now I have great respect for trend-following. Some of the greatest investors on the planet are trend followers, employing a very simple yet very effective and intuitive strategy across a wide variety of markets.

That said, the problem with most of these newbie trend followers is they ignore one of the key components of the strategy: diversification. They are involved only in one asset class, the stock market. Though they respect the trend, they don’t appreciate just how exposed they are to liquidity risk right now, something experienced trend followers ameliorate by broadening out into as many uncorrelated asset classes as possible.

Emboldened by 3+ years of very low volatility, these traders have become the exact opposite of what PTJ was referring to. Their inability to understand the fundamentals, relying solely on the trend, puts them at great risk, especially in an environment of problematic liquidity.

As I’ve demonstrated over the past several months, this stock market is one of the most overvalued, overbought and overbullish in history. Julian Robertson, Stan Druckenmiller, Ray Dalio, Mohamed El-Erian and other super-investors have recently warned about this in one way or another.

However, when I have shared the their concerns via social media, I’m regularly met with dismissal or disdain. These trend followers have become so emboldened by the bull market that they now believe their brains to be even bigger than these giants of the industry.

I have been bearish but have avoided using the “c-word” until now because crashes, by their nature, are impossible to predict. But the hubris on display in the market by those who believe themselves immune to these massive risks has me wondering if some sort of liquidity event in the stock market isn’t inevitable.

If everyone is a trend follower and the stock market begins to sell off, how can everyone get out at the same time? And in a market already plagued by severe liquidity challenges? It seems to me that there is a lesson here that should have been learned a long time ago.

The quote above comes from a fantastic piece Mark Yusko recently wrote about his personal experience with Julian Robertson, who recently said it is, ‘not at all ridiculous to expect another 2008-style decline in the stock market.’

To turn the PTJ quote on its head, counting on being able to sell once it’s clear to all that the trend has shifted may be precisely how those in the trend following space get annihilated in the future. Certainly, we have seen this movie before. Doesn’t anyone else remember “portfolio insurance”?

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Why Record-High Margin Debt Should Make You More Cautious

It’s recently become popular to dismiss the record level of margin debt in the market as meaningless. Notable bloggers like Josh Brown, Barry Ritholtz and Chris Kimble have all written some sort of “it just doesn’t matter” commentary recently. Barry went so far as to call it, “statistically bogus.” To me, this sounds like just another version of, “it’s different this time.”

Here are the real statistics: Over the past 20 years, the level of margin debt relative to the economy has had nearly an 80% negative correlation to future 3-year returns in the stock market. What this means is, the higher the level of margin debt relative to GDP, the lower the returns for the stock market over the coming 3 years and vice versa. “Statistically bogus?” I think not.

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So what is the current level of margin debt suggesting for the next 3 years in stocks? Considering that margin debt-to-GDP is near an all-time record high, it forecasts returns over the coming 3 years could very well be as bad as any bear market we have witnessed over the past 20 years. Specifically, it forecasts a negative 3-year return of 50%. Maybe this is one reason Julian Robertson recently said it’s not “ridiculous” to expect another 2008-size decline in the stock market.

Screen Shot 2015-05-06 at 9.46.52 AMNow I’m not saying that this one indicator should be relied upon on its own in making investment decisions. 20 years of data is not much and it’s only one of many valuable indicators. But to call it meaningless is either willful ignorance (aka, cognitive dissonance) or disingenuousness.

Because it is statistically significant, it is very valuable in, as Howard Marks says, “having a sense for where we stand.” From The Most Important Thing:

As difficult as it is to know the future, it’s really not that hard to understand the present. What we need to do is “take the market’s temperature.” If we are alert and perceptive, we can gauge the behavior of those around us and from that judge what we should do… Simply put, we must strive to understand the implications of what’s going on around us. When others are recklessly confident and buying aggressively, we should be highly cautious.

In my view, margin debt is a very good way to “take the market’s temperature.” The extreme level of margin debt-to-GDP clearly shows investors have become “recklessly confident.” Prudent investors should react by becoming more cautious. And, from a contrarian standpoint, the fact that popular bloggers are dismissing this idea despite its mathematical validity adds an exclamation point to that idea.

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StockTwits Q&A

Last week I did a question and answer session over at StockTwits. I thoroughly enjoyed it and sincerely hope it helped a few folks. Here’s a teaser:

We’ve written about Jesse Felder before. In-fact, we’re giving away $1,000 to the charity of your choice if you get this question right. Business Insider has a post up about this story too – Felder is growing his beard out until the next 10% correction. We recently sat down with Felder and talked about his beard, and thoughts on the next 10% correction:

Check out the highlights over at my Tumblr: jessefelder.tumblr.com

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Playing Defense In The Stock Market Right Now Doesn’t Make You An Idiot

I’ve taken some flak recently for my persistently bearish views of the stock market over the past year. Rightfully so. I’ve been dead wrong. And with a record level of bulls it should come as no surprise that they’d like gloat.

But I’d like to make a few things clear. First, I’m not a perma-bear. Far from it. I was rip-snorting bullish on stocks back in early 2009 when it was very painful and lonesome to be such. And when the broader stock market presents investors with another good buying opportunity I won’t hesitate to get bullish again.

Second, just because I “worry top down” that doesn’t prevent me from successfully investing “bottom up.” I was very bullish on Apple a couple of years ago when it was also painful and lonesome to be such. I also turned very bullish on Herbalife earlier this year. Even if these trades were fully hedged they would have crushed the S&P. My worries are also one reason I’ve been bullish long bonds, another trade that has crushed the stock market.

I really find it funny that stocks are the only asset class where if you don’t own them – and today that means owning the index – when they go up you’re an idiot. What about those who didn’t own gold in the 2000’s? Or those who didn’t short financials in 2008? Or those who haven’t owned long bonds over the past few years? Why aren’t you an idiot for missing these trades?

Right now there’s a zeitgeist. It’s a mantra among investors that if you don’t own stocks 100% of the time you’re a loser. To me this is asinine. There have been plenty of times throughout history where owning stocks was a loser’s game and today has all of the makings of another one. And the zeitgeist, itself, is compelling anecdotal evidence of that!

One of the best rules anybody can learn about investing is to do nothing, absolutely nothing, unless there is something to do… I just wait until there is money lying in the corner, and all I have to do is go over there and pick it up… I wait for a situation that is like the proverbial “shooting fish in a barrel.” -Jim Rogers in Market Wizards

I look for compelling risk/reward setups. That’s my personal style and it works for me. As I see it, the current risk/reward equation for owning an equity index fund is all risk and no reward. And some very smart people agree with the idea.

Ultimately, I still believe it’s time to play defense:

Marks became bearish on “riskier debt markets” way back in 2004. Just because he was three or four years early does that make him an idiot? Of course not. Did playing defense cost him performance during those years? Yes. But was it worth it? Absolutely. Playing defense was critical to surviving the financial crisis.

Knowing when it’s time to play defense versus offense is critical to staying power in this game. I’ve been through a number of cycles now in my career. I’m not going to simply decide one day to ignore the risks I see just because they haven’t materialized over the past 12 months. I don’t need to own an S&P 500 index fund to make money when there are plenty of other far more compelling ways to do so.

And the single reason I continue to share my bearish views on stocks is that I truly care about trying to help long-term investors avoid another painful lesson. In fact, that’s exactly what I’ve been doing here for nearly a decade now.

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