"Investor's seem to have entirely forgotten that there’s quite a good chance from current valuations that they’ll lose about half of their money in the next few years!" John Hussman

Cahm Viss Me Eef You Vahn to Live 
John P. Hussman, Ph.D.

We’ve recently emphasized that our estimates for probable S&P 500 nominal total returns have now declined below zero on every horizon of 7 years and shorter. At longer horizons, the 6.3% growth rate that we’ve assumed for nominal GDP over the coming years will begin to bail investors out given enough time, and as a result, our projection for 10-year S&P 500 nominal total returns peeks its head up above zero, at about 2.4% annually from current levels. Looking out 15 years, the expected 15-year total return approaches 4.4% annually, and at that horizon, investors are unlikely to lose money even if actual returns are a standard deviation below our expectations. To the extent that 6.3% growth in nominal GDP seems too high (and there are certainly reasons to think so), just reduce those annual return projections accordingly. 

We very much agree with Grantham’s sentiment in that investors can only be expected to adhere to a given discipline if they fully understand the potential risks that might emerge over the course of the market cycle. The greatest discomfort for us is that in speculative, overvalued, overbought, overbullish markets, we’ll often look like idiots, lose credibility, and later recover a flood of followers who were bloodied in a completely predictable collapse that makes us look like evil geniuses. Years ago, Grantham noted the same tendency to “arrive at the winning post with good long-term results and less absolute volatility than most, but not necessarily the same clients that we started out with.” Having addressed our earlier stress-testing concerns, we certainly expect a much easier time in future cycles even if Fed-induced bubbles become the rule. 

We have the reverse concern about buy-and-hold investors in the major indices here – they seem to have entirely forgotten that there’s quite a good chance from current valuations that they’ll lose about half of their money in the next few years, even if stocks turn out to recover those losses with enough time (though probably more than about 7 years). As I noted in 2000 and 2007, the phrase “I’m a long-term investor” and the commitment to passive strategies often does not survive the full course of a bear market.

Money printing, search for yield and the mirage of financial stability

Unfortunately, the near free money environment has gone on for much longer than anyone anticipated, and we seem incapable of easing ourselves off the life support.

So when the BIS’s Claudio Borrio warns about the return of “search for yield”, everyone should sit up and take notice. 

The BIS’s latest quarterly review points out that yield compression is back with a vengeance, and in some respects is actually now worse than it was in the lead-up to the crisis. With interest rates at rock bottom, lenders are again throwing caution to the wind, and investing indiscriminately. There was a brief return to saner conditions last summer when the Fed suggested it might end quantitative easing, but the consequent widening of spreads was viewed as so alarming by policymakers that the threat was soon withdrawn, and now we are back to where we were. 

Remarkably, leveraged loans are now a higher proportion of new signings than they were before the crisis. Corporate credit spreads have sunk to record lows, debt funding for private equity takeovers is once more on a strongly rising trend, and mortgage real estate investment trusts, which fund long-term mortgage assets with short-term money, have come surging back. 

The search for yield is also evident in renewed investor appetite for “payment in kind notes”, a form of credit that gives the borrower the option to repay lenders by issuing additional debt. Roughly a third of those who issued such debt in the run-up to the crisis ended up defaulting, yet this has failed to act as a deterrent. New issuance of these instruments rose by a third in the first three quarters of this year. 

Every time central bankers try, the economy stalls anew and they are forced to backtrack. Capital misallocation and asset bubbles are just some of the side-effects. We inhabit an Alice Through the Looking Glass world in which – bizarrely, in view of the depth and length of the recession – ultra-low interest rates have helped to contain default rates at close to pre-crisis levels. In the eurozone, default rates have actually fallen during the recession of the past two years, the very reverse of what you would expect and indeed what is needed for the economy to reboot and start growing again. This in turn has encouraged investors to think of what is essentially junk as comparatively risk-free, and spray their money around accordingly. Policymakers find it progressively more difficult to re-establish normality monetary policy for fear of the en masse rise in defaults that would follow.

'Savings crisis’ wrecks pensions of the under-50s

Millions of people are facing financial insecurity in which they will retire poorer than their parents, new study says

Working people currently aged 45 will be the first generation to retire with lower pensions than their predecessors as a result of the UK’s “savings crisis”, a report by Britain’s leading banks, insurers and investment firms warns. 

According to the study, millions of people are facing a future of financial insecurity in which they will retire poorer than their parents because families are saving far less than they used to. 

Those aged 35 and under are likely to suffer the most as they are hit by rising house prices, less generous pensions and higher debts, the report says. 

In a highly unusual coordinated move, senior executives from 20 of Britain’s biggest financial services firms – including Lloyds, Nationwide, NatWest, BlackRock, and Axa – call on ministers and the industry to work together to replace the country’s debt-fuelled spending culture with a new ethos of saving.

DYI Comments: NONE