The Line Between Rational Speculation and Market Collapse 

John P. Hussman, Ph.D.

The Shiller P/E (S&P 500 divided by the 10-year average of inflation-adjusted earnings) is now 27, versus a long-term historical norm of 15 prior to the late-1990’s bubble. Importantly, the profit margin embedded into the Shiller P/E is currently 6.7% versus a historical norm of just 5.4%. The implied margin is simply the denominator of the Shiller P/E divided by current S&P 500 revenues (the ratio of trailing 12-month earnings to revenues is even higher at 8.9%). As I showed in Margins, Multiples and the Iron Law of Valuation, taking this embedded margin into account significantly improves the usefulness and correlation of the Shiller P/E in explaining actual subsequent market returns. With this adjustment, the margin-adjusted Shiller P/E is now nearly 34, easily more than double its historical norm.  

 This fact is important, because the Shiller P/E averaged 40 during the first 9 months of 2000 as the tech bubble was peaking. But that Shiller P/E was associated with an embedded profit margin of only 5.0%. Adjusting for that embedded margin brings the margin-adjustedShiller P/E at the 2000 peak to 37.

Current equity valuations provide no margin of safety for long-term investors. One might as well be investing on a dare. It may seem preposterous to suggest that equities are literally more than double the level that would provide a historically adequate long-term return, but the same was true in 2000, which is why the S&P 500 experienced negative total returns over the following decade, even by 2010 after it had rebounded nearly 80% from the 2009 lows. Compared with 2000 when we estimated negative 10-year total returns for the S&P 500 even on the most optimistic assumptions, we presently estimate S&P 500 10-year nominal total returns averaging about 1.3% annually over the coming decade. Low interest rates don’t change this expectation – they just make the outlook for a standard investment mix even more dismal – and the case for alternative investments stronger than at any point since 2000. I’ll repeat that if one associates historically “normal” equity returns with Treasury bill yields of about 4%, the promise to hold short-term interest rates at zero for 3-4 years only “justifies” equity valuations 12-16% above historical norms. Again, at more than double those historical norms, current equity valuations provide no margin of safety for long-term investors.

DYI 

Millionaire Rule 1.49

DYI Comments:  The article above is from none other than Thomas Stanley the author of The Millionaire Next Door.  His work shows the first house these future millionaires bought had a price of less than one and a half times their incomes.  Remember this is when these guys were first starting out and were not not making the big bucks.  In order to build business' and acquire stocks, bonds, real estate they needed low overhead to achieve those ends.  Here is a quote from Thomas Stanley:

"The data strongly indicates that this ratio of wealth building productivity is inversely related to the market value of one's home."

So simple yet almost no one lives below their means.  They all say they do.  We know they don't. So much so that 1/3 of the Boomer's are flat broke and many due to the housing downturn have a negative net worth.  Boomer's were and many still are overly enamored with showing off their wealth by building or purchasing large homes neglecting the three building blocks of wealth.  Stocks, bonds, and income producing real estate.  Their large homes soaked up future investments due to heating, cooling, and maintenance costs.  These aspiring millionaires knew, as compared to their aspiring non-millionaires, the true costs of home ownership, not just the monthly payment plus utilities.

Estimating Expenses Before Buying Your First Home

DYI Comment:  Excellent New York Times article listing the many associated costs of home ownership.  Once you start adding up the potential costs and if you live there long enough all of these potentials will become your actual cash drain.

Renting vs. Buying: The True Cost of Home Ownership

October 31, 2013 By Darrow Kirkpatrick

The Bottom Line

Ok, so we’ve explored most of the obvious and not-so-obvious costs of home ownership. As we went along, we made some simple calculations using assumptions based on my personal experience and national averages, to come up with monthly equivalents of all these home ownership costs. So now let’s add them up:

Cost of Home Ownership per $100,000

Item	Monthly Cost
transaction	$125
property insurance	$42
maintenance	$167
property taxes	$83
interest/opportunity cost	$417
TOTAL	$834

The bottom line for our hypothetical example is that home ownership actually costs about $834/month per $100,000. So, for example, if you’re looking at living in a house valued at $300,000, you could assume that would cost you about 3 x $834 or about $2500/month to own. If you can rent it for less than that — which indeed you can in some U.S. markets right now — then renting is actually the better value.

DYI Comment:  Most folks will quickly discount the $417 interest/opportunity cost as not important but not our future millionaires they see those dollars as crucial to wealth building.

Is It Better to Rent or Buy?

DYI Comment:  Top notch calculator from the New York Times.

Stop Acting Rich: And Start Living Like a Millionaire  

Written by Thomas Stanley

DYI Comment:  A top notch book if you are serious in having your financial house in order.

DYI

 

The Power Of Dividend Growth

Many investors think of dividend-paying companies as boring, low-return investment opportunities. Compared to high-flying small cap companies, whose volatility can be pretty exciting, dividend-paying stocks are usually more mature and predictable. Though this may be dull for some, the combination of a consistent dividend with an increasing stock price can offer an earnings potential powerful enough to get excited about. 

High Dividend Yield?  

Understanding how to gauge dividend-paying companies can give us some insight into how dividends can pump up your return. A common perception is that a high dividend yield, indicating the dividend pays a fairly high percentage return on the stock price, is the most important measure; however, a yield that is considerably higher than that of other stocks in an industry may indicate not a good dividend but rather a depressed price (dividend yield = annual dividends per share/price per share). The suffering price, in turn, may signal a dividend cut or, worse, the elimination of the dividend. 

The important indication of dividend power is not so much a high dividend yield but high company quality, which you can discover through its history of dividends, which should increase over time. If you are a long-term investor, looking for such companies can be very rewarding.

DYI Comments:  Just as the name Dividend Yield Investor indicates is my affinity with dividends; for they have never gone out of style as far as I'm concerned.  In the end they are the real reason investors, as opposed to speculators, why institutions and individuals purchase quality companies with increasing dividends.  In my mind these are the true growth stocks.  As the dividend is increased over time so will the stock price. As the legendary Charles Dow has written:

"To know values is to know the meaning of the market.  And values, when applied to stocks, are determined in the end by the dividend yield."  

The Dividend Room is a new addition to my blog showing a list of high quality dividend paying stocks for your further study.  All picks are based upon basic time tested value approach.  All companies a reasonable low level of debt for their respective industry and a low PE multiple.  Of course a competitive dividend yield with a payout ratio less than 85% for utilities and all others less than 50%.  Also screened companies that have increased their dividends on a regular basis (the true growth stocks).  Included is additional screens based upon Benjamin Graham approach for the defensive investor.

Our attempt is to find high quality companies with yields double that of the S&P 500.

The price of oil is in the news which has pounded down the prices of many of the finest oil/gas/servicing companies in the world.  Let's start there and expand into other industries.

Yield       S&P 500 Dividend Yield 1.84%

                 Oil/Gas/Service 
6.10%      Sasol Limited symbol SSL
4.40%      Helmerich & Payne symbol HP
4.10%      Chevron Corp.  symbol CVX
3.80%      Occidental Petroleum Corp. symbol OXY

                 Utilities
4.40%      Spectra Energy Partners symbol SEP
4.20%      Companhia de Saneamento Basico symbol SBS

                 Apparel Stores
4.40%      Guess' Inc.  symbol GES

                 Tobacco Products
5.00%      Universal Corp. symbol UVV

Today stock prices have been bid up so high the list is small as one would suspect.  I would recommend that you use our stock allocation formula to arrive at your allocation of stocks to bonds. Currently it is at 24% for stocks.  This formula will be updated next month but I don't see much of a change. For your cash holdings Vanguard's Short Term Bond Index symbol VBIRX or for those in a high tax bracket Vanguard's Limited Term Tax Exempt VMLTX.

DYI      
  This blog site is not a registered financial advisor, broker or securities dealer and The Dividend Yield Investor is not responsible for what you do with your money.

This site strives for the highest standards of accuracy; however ERRORS AND OMISSIONS ARE ACCEPTED!

The Dividend Yield Investor is a blog site for entertainment and educational purposes ONLY.

The Dividend Yield Investor shall not be held liable for any loss and/or damages from the information herein.

Use this site at your own risk.

PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS. 

Public Now Gambling “All In” On Soaring Stock Markets

KWN note – look at the remarkable multi-year chart below which shows the massive surge in cash now pouring into the stock market from the general public.  Is this the beginning of a blow-off phase in stocks?

DYI

The Economics of Wasteful Spending: The Deadweight Loss of Christmas

If you haven’t yet finished buying Christmas gifts for your nieces and nephews and the neighbor across the street, maybe you shouldn’t bother. That’s right, don’t buy them gifts this year — or ever; it’s an economic waste, says University of Minnesota economics professor Joel Waldfogel. 

Twenty years ago, Waldfogel coined the “deadweight loss of Christmas” theory in a small paper in the American Economic Review. His research, popular with the media this time of year, has gone on to have a life of its own. And Waldfogel followed it up with the 2009 book “Scroogenomics: Why You Shouldn’t Buy Gifts for the Holidays.” 

On the NewsHour Monday, Paul Solman explores the meaning and limitations of the deadweight theory with the Scroogenomist himself. For more about the economics of gift-giving and its alternatives, here is the edited and condensed transcript of Paul’s extended conversation with Waldfogel.

DYI Comment: Just click on the title for the full transcript.

DYI 

The Conventional Wisdom on Oil is Always Wrong

But there was one thing pretty much everyone agreed on: U.S. oil production was in permanent, terminal decline. U.S. oil fields pumped 5 million barrels of crude a day in 2008, half as much as in 1970 and the lowest rate since the 1940s. Experts disagreed about how far and how fast production would decline, but pretty much no mainstream forecaster expected a change in direction. 

That consensus turns out to have been totally, hilariously wrong. U.S. oil production has increased by more than 50 percent since 2008 and is now near a three-decade high. The U.S. is on track to surpass Saudi Arabia as the world’s top producer of crude oil; add in ethanol and other liquid fuels, and the U.S.is already on top.

It isn’t just that experts didn’t see the shale boom coming. It’s that they underestimated its impact at virtually every turn. First, they didn’t think natural gas could be produced from shale (it could). Then they thought production would fall quickly if natural gas prices dropped (they did, and it didn’t). They thought the techniques that worked for gas couldn’t be applied to oil (they could). They thought shale couldn’t reverse the overall decline in U.S. oil production (it did). And they thought rising U.S. oil production wouldn’t be enough to affect global oil prices (it was). 

Now, oil prices are cratering, falling below $55 a barrel from more than $100 earlier this year. And so, the usual lineup of experts — the same ones, in many cases, who’ve been wrong so many times in the past — are offering predictions for what plunging prices will mean for the U.S. oil boom. Here’s my prediction: They’ll be wrong this time, too.

It isn’t surprising that experts aren’t good at predicting prices. Global oil markets are a function of countless variables — geopolitics, economics, technology, geology — each with its own inherent uncertainty. And even if you get those estimates right, you never know when a war in the Middle East or an oil boom in North Dakota will suddenly turn the whole formula on its head.

 Oh, right, and geology: It’s easy to forget, but just a few years ago people were fretting about “peak oil,” the idea that global oil production had reached its maximum capacity and was doomed to start falling. The shale boom pushed those fears out of the mainstream, but the underlying questions remain. The shale boom is still young, and it was unclear how long it could last even when prices were higher. The U.S. government’s official production forecasts are subject to an almost comical level of uncertainty, and independent researchers have called even those estimates into question. The government didn’t see the boom coming, after all; there’s no guarantee it will see the end coming, either.

DYI Comment:  Oil prices are well known for their UNpredictable volatility in the short term, longer term due to dwindling reserves energy prices are in a secular bull market. Technologies such as fracking will extend the life of oil fields but major new discoveries arrive at a snails pace far slower than the world's growth.  

As long as prices rise in a slow and orderly pace our economy can adjust to those changes, however if prices spike (international tensions, war etc.) high energy costs behave as a massive deflationary tax. This will send our economy tumbling down and very possibly the U.S. stock market.

If oil prices rise greater than 75% from one year-earlier level, investors at that time should shift their portfolio geared towards deflationary times.  This would be oil indicator as negative.

If oil prices rise from one year-earlier less than 10% or drop then the inflationary play is in effect; a positive for economic growth along with possible higher stock prices.

Where to find one year-earlier oil prices?  Alaska Department of Revenue 

Going back a year ago West Texas Intermediate (WTI) was $98.66 and currently based on cash prices for today is $54.11 for a decline of 45%.  The reflationary play is in effect which historically has been positive for stock prices for the Fed's will feel embolden to goose the economy with little fear of pushing up consumer prices.  Even though they have ended QE low interest rates will still be with us.  If they do raise rates in 2015 it will be more symbolic than substance with slow 25 basis point increases.  They are more interested in reducing their balance sheet for the next economic downturn which may arrive quicker than they think.  Of course predicting recessions is fraught with the same results as predicting oil prices.

Today we are caught between the "rock and the hard place" as no doubt the reflationary play is in effect (the rock) unfortunately share prices are starting out at high levels in relationship to earnings and dividends (the hard place).  Currently Shiller PE10 is at 27.19 or 64% above its average since 1881 of 16.58.  Using DYI's averaging formula an allocation of 24% in stocks is warranted the remainder placed into high quality corporate and/or Treasury notes/ bonds.

Dividends which comprise historically two thirds of an investors return the remaining one third being the change in PE.  This two third return being so high is why DYI stresses dividends.  Today the market is 135% above its average.  Using DYI's averaging formula for dividends we have been completely thrown out of the market!  Make no mistake this is one nose bleed high market, in my opinion, market gains from here will be transitory!

AGGRESSIVE PORTFOLIO - ACTIVE ALLOCATION - 12/1/14

Active Allocation Bands (excluding cash) 0% to 60%

83% - Cash -Short Term Bond Index - VBIRX

17% -Gold- Precious Metals & Mining - VGPMX

 0% -Lt. Bonds- Long Term Bond Index - VBLTX

 0% -Stocks- Total Stock Market Index - VTSAX
 0%-REIT's- REIT Index Fund - VGSLX

[See Disclaimer]

THE GREAT WAIT CONTINUES

DYI

 This blog site is not a registered financial advisor, broker or securities dealer and The Dividend Yield Investor is not responsible for what you do with your money.

This site strives for the highest standards of accuracy; however ERRORS AND OMISSIONS ARE ACCEPTED!

The Dividend Yield Investor is a blog site for entertainment and educational purposes ONLY.

The Dividend Yield Investor shall not be held liable for any loss and/or damages from the information herein.

Use this site at your own risk.

PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS.

***********

Generational dynamics

 John J. Xenakis

Stock market continues parabolic climb with high volatility

Dow bounces back

As I've written several times recently, the extreme volatility of the stock market is very dangerous, because it indicates that the stock market is being used as a gambling parlor completely unrelated to the company stock shares underlying the market. As we reported ten days ago, the Bank of International Settlements has taken the same view. ( "8-Dec-14 World View -- Bank of International Settlements warns of 'fragile' and 'sensitive' markets") 

The drunken euphoria that I heard from analysts today, after the parabolic 421 point surge in the Dow Jones Industrial Average, is a sign of just how dangerous the situation. They don't seem to realize that if the Dow can go up 428 points in one day, then it can just as easily go down 428 points in one day. And with the S&P 500 price/earnings ratio at around the astronomically high 19, well above the historical level of 14, it's only a matter of time before the stock market bubble bursts. 

And that's exactly the kind of situation that triggers a panic. These swings are getting wider and wider, just as they did prior to the 1929 crash. 

The stock market fell 90% following the 1929 panic, but that didn't happen all in one day. It fell 13% on Black Monday, and then another 12% the next day, but then it gained back 17% on the next two days, so by the end of the week, people were wondering whether it would recover completely. But it kept relentlessly falling, and only bottomed out in the summer of 1932, despite repeated interventions by the Fed, and repeated claims by President Herbert Hoover that "Prosperity is just around the corner." 

It shouldn't be called the "Crash of 1929," since the stock stock market didn't really crash in 1929. It should be called the "Panic of 1929" since, after all this time, the day that America remembers is the day of the panic, October 28, 1929. That's how it will happen again. These wild swings will keep increasing, until one day these computerized trading computers ("algos," as they're now called) will take over and produce some sort of "flash crash," and a lot of people will lose a lot of money. That will be the panic that everyone remembers. Then the stock market will partially recover, and people will cross their fingers, but the worst will be yet to come.

December 22, 2014

Iceberg at the Starboard Bow

John P. Hussman, Ph.D.

When rich valuations are coupled with tame credit spreads and uniform strength across a broad range of market internals and security types, one can infer that investors remain tolerant toward risk. In that environment, risk premiums may be low, but there’s no particular pressure for them to normalize. Trend uniformity and well-behaved credit spreads are an indication of risk tolerance, which allows overvalued markets to remain overvalued without immediate consequence. In stark contrast, increasing dispersion across securities and sectors, deteriorating market internals, and widening credit spreads are all subtle indications of growing risk aversion – icebergs that can easily rupture the Titanic of severe overvaluation. This risk-aversion creates upward pressure on low risk premiums, which normalize not smoothly but in spikes, resulting in air-pockets, free-falls and crashes.

Coupled with an increasingly synchronized global economic downturn, we’ve seen a particular collapse in oil prices. Some observers view this as if it is “stimulative” to the economy, but that perspective confuses the price decline resulting from an inward shift of the demand curve as if it was caused by an outward shift of supply. Our view is that the concerted decline in commodity prices, foreign currencies, and Treasury yields, coupled with a blowout of credit spreads in junk debt (particularly energy-related debt) is all consistent with weakening global economic prospects. Given the “cleanest dirty shirt” perception of the U.S. dollar, the greenback has certainly benefited from this dynamic. But to expect this benefit to persist assumes that a) the dispersion between U.S. and global prospects will continue to widen, and b) that widening is not already priced into the currency markets.

DYI 

Swiss National Bank will cut interest rate to minus 0.25%

Switzerland's National Bank (SNB) will bring in a negative interest rate cutting the value of large sums of money left on deposit in the country. 

The Bank is imposing a rate of minus 0.25% on "sight deposits" - a form of instant access account - of more than 10m Swiss francs ($9.77m). 

It is trying to lower the value of the Swiss franc, which has risen recently. 

Russia's market meltdown and a dramatic plunge in the oil price have led investors to seek "safe havens".

 Deflation Warning Sounds as 2-Year Break-Even Rates Go Negative

Even with the Federal Reserve reminding investors that policy makers remain on course to raise interest rates next year, one corner of the bond market is warning of the risk of deflation.

The difference in yields between Treasury two-year notes and comparable maturity inflation-indexed securities turned negative yesterday for the first time since the aftermath of the global financial crisis in 2009. The measure, known as the break-even rate, is generally seen as reflecting investors’ expectations for inflation over the life of the securities. 

The negative break-even rate represents “an uncertainty premium that maybe oil could fall to $40 a barrel,” said Donald Ellenberger, who oversees about $10 billion as head of multi-sector strategies at Federated Investors in Pittsburgh. “The shortest-term TIPS are very influenced by the direction of the consumer price index. It’s telling you inflation on the short-end could turn negative.”

Dollar surge endangers global debt edifice, warns BIS

Bank for International Settlements concerned about underlying health of world economy as dollar loans to emerging markets increase rapidly

Off-shore lending in US dollars has soared to $9 trillion and poses a growing risk to both emerging markets and the world's financial stability, the Bank for International Settlements has warned. 

The Swiss-based global watchdog said dollar loans to Chinese banks and companies are rising at annual rate of 47pc. They have jumped to $1.1 trillion from almost nothing five years ago. Cross-border dollar credit has ballooned to $456bn in Brazil, and $381bn in Mexico. External debt has reached $715bn in Russia, mostly in dollars. 

Cross-border lending in dollars has tripled to $9 trillion in a decade. Some $7 trillion of this is entirely outside the American regulatory sphere. "Neither a borrower nor a lender is a US resident. The role that the US dollar plays in debt contracts is very important. It is a global currency, and no other currency has this role," he said. 

The implication is that there is no lender-of-last resort standing behind trillions of off-shore dollar bank transactions. This increases the risks of a chain-reaction if it ever goes wrong. China's central bank has ample dollar reserves to bail out its companies - should it wish to do so - but the jury is out on Brazil, Russia, and other countries.

It now warns that the world is in many ways even more stretched today than it was in 2008, since emerging markets have been drawn into the global debt morass as well, and some have hit the limits of easy catch-up growth. 

Debt levels in rich countries have jumped by 30 percentage points since the Lehman crisis to 275pc of GDP, and by the same amount to 175pc in emerging markets. The world has exhausted almost all of its buffer.

The repurchase revolution

Companies have been gobbling up their own shares at an exceptional rate. There are good reasons to worry about this.

IN THE decade before America’s housing bubble burst, Home Depot, an American home-improvement chain, spent heavily on building new shops to meet rampant demand for everything from taps to timber. For every dollar of operating cashflow the firm generated, it ploughed back 65 cents into capital investment. The financial crisis hit hard, and demand for some products has yet to recover fully. Sales of kitchens are only 60% of their peak level. But Home Depot has evolved into a very different kind of beast. Its capital investment has fallen by two-thirds and it is investing heavily in something else: its own shares. Yet share repurchases also have many critics. They fall into two camps. Some view buy-backs as a form of financial sorcery, on a par with all those abstruse credit derivatives that helped cause the financial crisis. Others accept that buy-backs are a legitimate way to return cash to shareholders but worry about their extent. They fear they have become a kind of corporate cocaine that induces a temporary feeling of invincibility but masks weakness and vacuity. They worry the boom will damage firms and the economy. “You have to save shareholders from themselves,” says the finance chief of one of the world’s biggest multinationals, who thinks there may be a buy-back bubble. Jim Chanos, a short-seller who helped expose the Enron scandal, says the rate at which firms are repurchasing their shares is reckless.

Surprise! Guess which currency has stronger fundamentals - the dollar or… ruble?Simon Black

Facebook’s Popularity Among Teens Dips Again

One reason for the decline in teen Facebook usage is due to concerns that the service may not be trustworthy. Just 9 percent of those surveyed described the website as “safe” or “trustworthy,” while almost 30 percent of people said they would use those words to describe Pinterest. Pinterest also ranked higher in “fun,” with 40 percent saying so compared with 18 percent for Facebook. 

“Facebook has been so deeply embedded in the lives of the people that the fade is going to be slow,” Kuittinen said. “People just start being vaguely dissatisfied and then after a while they stop using it.”

DYI

Empire State
Manufacturing Survey

The December 2014 Empire State Manufacturing Survey indicates that business activity declined for New York  manufacturers. The headline general business conditions index dropped fourteen points to -3.6, its first negative reading in nearly two years.

DYI Comments:  Why are oil prices dropping?

BIG REASON #1
 

No doubt America is on a tear for producing oil and natural gas as well.

Big Reason #2
The world economy is slowing down with many countries in outright recession.  China is slowing along with Central Europe with the exception of Spain and Italy who are in recession.  Greece continues to be in an on going depression.  Canada is in the mist of a real estate boom that will soon go bust bringing an American style deflationary smash.

Big Reason #3a. 3b. & 3c.
a.) OPEC and all of their member nations are pumping oil as they all cheat on their quota's.
b.) U.S. State Department is encouraging Saudi Arabia to produce to punish Putin.  The State Department didn't engineer the downturn they are only taking advantage.
c.)  Iranian embargo on exporting oil lifted to further punish Russian economy is possible.

Big Reason #4
North American and European trucks/autos have increased their fuel economy.

Junk Bond Selloff Is a Warning for Retirees Who Reached for Yield

Risky assets have paid off well the past few years. But tremors in the junk bond market signal time for a gut check.

The junk bond selloff began in the energy sector, where oil prices recently hitting a five-year low set off alarms about the future profits—and ability to make bond payments—of some energy companies. In the past month, the selling has spread throughout the junk-bond universe, as mutual fund managers have had to sell to meet redemptions and as worries about further losses in a possibly stalling global economy have gathered steam. 

Retirees have been reaching for yield in junk bonds and other relatively risky assets since the financial crisis, which presumably is partly what prompted Yellen’s warning last summer. It’s hard to place blame with retirees. The 10-year Treasury bond yield fell below 2% for a while and remains deeply depressed by historical standards. By stepping up to the higher risks of junk bonds, retirees could get 5% or more and live like it was 10 years ago. Many also flocked to dividend-paying stocks.

Is This The Start Of The Next Major Financial Crisis?

Is this the start of the next major financial risk?  The nightmarish collapse of the price of oil is creating panic in financial markets all over the planet.  On June 16th, U.S. oil was trading at a price of $107.52.  Since then, it has fallen by almost 50 dollars in less than 6 months.  This has only happened one other time in our history.  In the summer of 2008, the price of oil utterly collapsed and we all remember what happened after that.  Well, the same patterns that we witnessed back in 2008 are happening again.  As the price of oil crashed in 2008, so did prices for a whole host of other commodities.  That is happening again.  Once commodities started crashing, the market for junk bonds started to implode.  That is also happening again.  Finally, toward the end of 2008, we witnessed a horrifying stock market crash.  Could we be on the verge of another major one?  Last week was the worst week for the Dow in more than three years, and stock markets all over the world are crashing right now.  Bad financial news continues to roll in from the four corners of the globe on an almost hourly basis.  Have we finally reached the “tipping point” that so many have been warning about?

DYI 

Vanguard Energy from Peak to Now is DOWN 30%! Excellent Time to Dollar Cost Average.

Oil Bust Contagion Hits Wall Street, Banks Sit on Losses

by Wolf Richter • December 11, 2014

Oil swooned again on Wednesday, with the benchmark West Texas Intermediate closing at $60.94. And on Thursday, WTI dropped below $60, currently trading at $59.18. It’s down 43% since June. 

Yesterday, OPEC forecast that demand for its oil would further decline to 28.9 million barrels a day next year, after having decided over Thanksgiving to stick to its 30 million barrel a day production ceiling, rather than cutting it. It thus forecast that there would be on OPEC’s side alone 1.1 million barrels a day in excess supply. 

So the bloodletting continues: the Energy Select Sector ETF (XLE) is down 26% since June; S&P International Energy Sector ETF (IPW) is down 34% since July; and the Oil & Gas Equipment & Services ETF (XES) is down 46% since July.
They all got hit. And in the junk-bond market, investors are grappling with the real meaning of “junk.” 

Six years of the Fed’s easy money policies purposefully forced even conservative investors to either lose money to inflation or venture way out on the risk curve. So they ventured out, many of them without knowing it because it happened out of view inside their bond funds. And they funded the fracking boom and the offshore drilling boom, and the entire oil revolution in America, no questions asked.

Generational Dynamics

John J. Xenakis

Oil prices have been plunging due to increased supply from US shale production (fracking), and due to falling demand caused by a slowing world economy. The oil importing countries (Indonesia, India, Taiwan, South Korea, Japan) are benefiting enormously from the plunge in oil prices, while it's a disaster for several oil exporting countries -- Venezuela, Russia, Iran, Iraq, Nigeria. Saudi Arabia has announced it will try to increase oil production, presumably in the hope of putting the US fracking industry out of business. 

An analysis by the US Energy Information Administration (EIA) that may shed some light on what's going on. Even though the price of oil is plummeting, US fracking production is going to continue increasing, though perhaps slightly less rapidly than has been previously predicted.

Oil production in 2014. WTI is West Texas Intermediate (EIA)

The graph on the left shows that drilling permits have been holding steady, while the number of rigs has fallen slightly. The graph on the right shows that oil production continues to increase, despite the fall in oil prices.

The existing wells are backed by hedge funds and junk bonds that are now in distress because of the fall in prices. As a result, production in the existing wells will actually be increased as much as physically possible, to generate revenue at low oil prices to meet margin calls for these junk bonds. 

It occurs to me that the Saudis may be in a similar situation. They may also have shaky investments backing up their oil wells, and so they too would have to keep production as high as possible to make their own margin calls. 

This is a good illustration of how deflation feeds on itself, and how some deflation causes more deflation, almost as if were caused by a deflationary attitude. By the law of supply and demand, falling prices normally should cause production to decrease. But the current situation we're in, a highly leverage debt bubble, is an anomalous situation. Falling oil prices are causing production to increase, not because of the oil market, but because of the debt market, resulting in a deflationary spiral. Businesses desperately increase production and sales in the hope of making up for lost earnings, in order to meet their debt margin calls, but the increased supply simply causes prices to fall even faster, resulting in more deflation. 

This is a dangerous situation because, as the price of oil continues to fall, one or more of these funds may go bankrupt, and that may cause a chain reaction of multiple bankruptcies.

Retailer’s Subprime Explodes, Shares Crash 40%, Junk Bonds Fall into “Price Discovery”

by Wolf Richter • December 10, 2014

When Conn’s – a retailer of furniture, home appliances, and consumer electronics with 91 stores in Texas and surrounding states – announced earnings on Tuesday, its stock crashed 29% premarket and ended the day down 41%. It has lost 73% from its peak a year ago when it still had been a hot miracle retailer that could do no wrong. And the junk bonds it issued six months ago at the very peak of the junk-bond bubble went into “price discovery.” 

Turns out, it also finances in-house about 75% of what its customers buy. 

And people buy at Conn’s because they can’t buy anywhere else. They’re subprime. They’re the strung-out consumers with bad credit and no cash, the modern American proletariat, the hollowed-out, hard-working middle class whose real wages have declined for years. They’ve been turned down elsewhere. Their credit cards are maxed out, have been cancelled, or are past due. And they walk into Conn’s, and the pressure is on to buy, buy, buy what they can’t afford and didn’t want and may not need. But no problem because Conn’s is going to finance it all.

Subprime Blows up on Retailer, CEO Warns on ALL Subprime, Hits Auto Sales

by Wolf Richter • September 3, 2014

A Sensible Proposal and a New Adjective 

John P. Hussman, Ph.D.

Policy makers learned little from that episode. In recent years, a similar reach-for-yield has driven equity valuations to levels that are now about double their historical norms, based on historically reliable measures that are about 90% correlated with actual subsequent 10-year market returns. Suppressed interest rates do not “justify” this elevation. Any standard discounting approach can be used to demonstrate that if “normal” valuations are associated with short-term interest rates averaging say 4%, the promise of even 3-4 years of zero short-term interest rates should result in longer-term risk assets being priced only 12-16% above their respective valuation norms. Likewise, current or year-ahead earnings projections do not “justify” present equity valuations, unless one ignores a century of evidence that major peaks in the equity market are always associated with cyclically elevated earnings well above their long-term trend, which in turn always understates observed price/earnings multiples at major peaks. A century of historical evidence can also easily be brought to bear to demonstrate that valuation measures having limited sensitivity to cyclical swings in profit margins have a dramatically stronger correlation with actual subsequent equity market returns.

Once again, investors and speculators have also reached for yield in low-quality debt, producing a boom in junk bond issuance and leveraged loans (loans to already indebted borrowers), with the majority of those new loans having “covenant-lite” features that reduce the protection of the lender in the event of bankruptcy. Moreover, much of the trillion dollars of outstanding leveraged loans are held by major U.S. banks in the form of “participating shares,” an indirect form of ownership that has been repudiated by the FDIC. As KBRA bond rating agency recently observed, “Today, many leveraged loans continue to be participated to banks, insurers, and bond funds in a manner that raises similarly questionable rights in the event that the lead bank or non-bank sponsor fails. The intense competition for assets among institutional investors caused by low interest rate policies has, it appears, caused a deterioration in both the perception and the terms of structural protections that we believe could create future risks for investors and the global financial system. The lesson of finance and financial law is that protection which ends at the doorstep of a trustee or receiver is no protection whatsoever.”

DYI Comments:  The U.S. along with many other countries (China, Central Europe, Canada etc.) are in the mist of a boom bust cycle all caused by excessive amounts of debt.  So much for deleveraging! When this deflationary economic smash occurs our central bank will not be able to lower interest rates for they are now already at sub atomic low levels.  All they have left is money printing.  The Federal Reserve is in a big hurry to reduce their balance sheet for some form of bullets left to shoot at the next recession.

If the big banks get into trouble I don't believe the American public will stand for a bailout.  All they will accept is a protection for depositors, the owners and debt holders will take their lumps.  If they are bankrupt the FDIC will recommend they be cut up into 25 or more new banks along with the existing managers and board of directors be summary dismissed.

Vanguard's Energy Fund VGENX from its peak on June 23, 2014 at $77.57 is currently at $54.06 for a 30% decline.  This is an excellent time to dollar cost average while waiting for the opportunity to lump sum when this industry goes into disrespect as the market puts their shares on the give away table.   

DYI

Oil crash is not the biggest story in global markets right now

But there is another major move in markets that has flown a bit under the radar: US Treasury bonds.The yield on long-dated US Treasury bonds — meaning the 10- and 30-year bonds — has been falling sharply over the last week.When long-dated bonds rally, it is taken as a sign that investors are “fleeing to safety” or “seeking protection,” as US Treasury bonds are considered the safest investment you can make.And so while the stock market usually garners the most headlines, investors are increasingly watching the bond market, as strength in longer-dated Treasuries indicates increasing concern about the short-term prospects for the economy and other assets.

Black Friday's fizzle: when the consumer shrugs

The greatest shopping day of the year wasn’t, according to a survey released by the National Retail Federation, which polled 4,631 consumers and estimated that sales at stores and online dropped by 11%. Sales were $50.9bn, $6.5bn less than 2013, and the overall haul was 6% smaller, with consumers spending, on average, $380.95 each over the holiday weekend.

As the economic recovery sputters on, millions of Americans are living paycheck-to-paycheck. According to IHS Global,more than 10 million Americans did not receive their pay on Black Friday, since it was over a holiday weekend. Instead, they will be getting paychecks today – just in time for Cyber Monday. 

Spending hundreds of dollars on gifts and big-ticket items might seem frivolous to some Americans as 14% of households continue to struggle with food insecurity and about 2.8 million Americans have been out of work for more than 27 weeks.

A drop-off in start-ups: Where are all the entrepreneurs?

The image of the U.S. as bursting with entrepreneurial zeal, it turns out, is more myth than reality. In truth, the rate at which new companies are being formed has fallen steadily for more than three decades.The decline has occurred nationwide — even in Silicon Valley. Business creation there is still high compared with most of the country, but it's down markedly from the past, according to the Brookings Institution.

Unsteady Incomes Keep Millions Behind on Bills

DYI