June 15, 2015
John P. Hussman, Ph.D.
"History teaches that the longer value-conscious investors are wrong, the more seriously their views should be taken (remember Roger Babson)."
When you look back on this moment in history, remember that spectacular extremes in reliable valuation measures already told you how the story would end. Among the measures best correlated with actual subsequent S&P 500 total returns, capitalization-weighted market indices such as the S&P 500 were more richly valued in only 54 weeks of history, 21 of which represented the final advance to the 2000 market peak, with the remaining 33 representing the retreat from that high to present valuation levels, on the way to a 50% loss in the S&P 500 Index and an 83% loss in the Nasdaq 100 Index. Presently, the market has already lost the momentum and favorable market internals that were evident during that final run, so we doubt that the 2000 extreme should be viewed as an objective.
In a nutshell, the normal run-of-the-mill expectation for S&P 500 total returns from present valuations is zero over the coming 10 years, but in the event of a secular low in the future, total returns from current valuations may turn out to be about zero for the coming 20 years. Future generations will likely recognize the current precipice, in hindsight, as The Last Gasp of the Bubble Era.
I have little doubt that we will likely observe strong or outstanding investment opportunities even over the completion of the current cycle, because severe market losses can dramatically change this arithmetic. Presently, however, the prospects for long-term investors remain dismal. Even the 4% annual total return of the S&P 500 in the 15 years since the 2000 peak has been made possible only by driving current valuations to the second most extreme point in U.S. history.
When you look back on this moment in history, remember that dismal return/risk prospects were grounded in objective historical evidence, not simply opinion. Of course, a handful of observers are so self-satisfied with pointing out the challenges since 2009 that I’ve regularly admitted and already addressed that they confuse the message with the messenger; ignoring objective evidence as a consequence. This unfortunately dismisses the central lesson to be drawn from the awkward transition that resulted from my 2009 decision to stress-test our methods against Depression-era data, not to mention the fact that concerns similar to my present ones were rather stunningly vindicated over the completion of prior market cycles. Remember that the 2000-2002 market loss wiped out the entire total return of the S&P 500 – in excess of Treasury bill returns – all the way back to May 1996. Remember that the 2007-2009 market loss wiped out the entire total return of the S&P 500 – in excess of Treasury bill returns – all the way back to June 1995.
Is the bond market ‘bubble’ ready to burst? A look at risk to rising interest rates
1. Duration is the longest in historyDuration is the most common way to measure interest rate risk. If you need a refresher, Morningstar has a great definition of duration.
Simply put, the longer the duration, the greater the potential loss of value when interest rates rise. However, this depends on whether you are a borrower or a lender.
Borrowers — such as corporations, municipalities and the Federal Government — have taken advantage of the current interest rate environment to issue bonds at low rates of interest and with longer maturities.
While these lower interest rates are good for them, they’re not good for lenders such as individual investors. And as borrowers have locked in current low rates for a longer periods of time, the duration of the bond indices has increased to historic lengths.
2. Yields are close to their lowest levels in historyThe yield on the Barclays Aggregate Bond index has steadily declined from 10 percent in March 1989 to its current yield — a paltry 2.4 percent. That’s not a lot of income cushion to offset any potential decline in the price of your bond portfolio as interest rates climb.
Read: The Best Way to Invest in Bonds In A Rising Interest Rate Environment
3. The yield buffer is the lowest in historyIn order to understand the impact of longer duration and low yields, let’s use a real-life example of one of the largest bond funds today and look back at its history.
According to Morningstar, over the past 30 years, the Vanguard Total Bond fund has experienced six years when the principal loss in the portfolio was more than 2 percent. However, because the income return in each of these years was sizable, no single year resulted in a total return loss greater than 3 percent.
For instance, in 1987 the rise in interest rates caused the price of the Vanguard Total Bond fund to plummet by a whopping -7.6 percent. Because the income return was so high at 9.2 percent, the fund still had a total return of 1.5 percent. The income was more than enough to offset the principal loss.
Worst bond crash in almost 30 years is early warning of turmoil to come
The global deflation trade is unwinding with a vengeance. Yields on 10-year Bunds blew through 1 per cent this week, spearheading a violent repricing of credit across the world’s financial system.
The scale is starting to match the “taper tantrum” of mid-2013, when the US Federal Reserve issued its first gentle warning that quantitative easing would not last forever, and that the long-feared inflection point was nearing in the international monetary cycle.
This is shaping up as the worst quarter for sovereign bonds in almost 30 years.The Bank of America Merrill Lynch Global Government Index is down 2.9 per cent since the end of March. If it holds, it’ll be the biggest quarterly loss since the third quarter of 1987.
Paper losses over the past three months have reached $1.2 trillion. Yields have jumped by 175 basis points in Indonesia, 160 in South Africa, 150 in Turkey, 130 in Mexico and 80 in Australia.
The epicentre is the eurozone. Bund yields hit 1.05 per cent Wednesday in wild trading, up 100 basis points since March. French, Italian and Spanish yields have moved in lockstep.
A parallel drama is unfolding in America, where the giant bond fund Pimco slashed its holdings of US debt to 8.5 per cent of total assets in May, from 23.4 per cent a month earlier. This sort of move in the fixed income world is exceedingly rare.
The 10-year US Treasury yield — the global benchmark price of money — has jumped 48 points to 2.47 per cent in eight trading sessions. “It is capitulation out there, and a lot of pain,” said Marc Ostwald from ADM.
It has plainly been a bond market bubble, one that is unwinding with particular ferocity because new rules have driven market-makers out of the business and caused liquidity to evaporate. Funds thought they were on to a one-way bet as the European Central Bank launched quantitative easing, buying 60 billion euros of eurozone bonds each month. They expected Bunds to vanish from the market as Berlin increased its budget surplus to 18 billion euros this year and retired debt.
Instead they have discovered that the reflationary lift from QE overwhelms the “scarcity effect” on bonds.
How Australia’s Big 4 Banks Can Sink the Entire Economy
They’re so huge compared to Australia, they’re “Too Big To Save”
Australia’s Big 4 put the American Big 4 to shame
JP Morgan, Bank of America, Citigroup, and Wells Fargo are the four largest banks in the United States. The total assets on their balance sheets combined equaled the equivalent of 48.3% of total American GDP in 2014.
That sounds like a crazy number until you compare that to the total assets of the Big four Australian banks: ANZ, Commonwealth (CBA), National Australia Bank (NAB), and Westpac (WBC) hold relative to Australian GDP
End of the Line! China and Germany Look Ready to Pop
Consider that Germany exports 50% of its GDP. That’s one of the highest ratios in the world.
Hence, the falling euro gives it a huge advantage. But the euro has barely budged for three months…
That explains why the DAX has fallen 10% since early April, which is when I believe it reached its long-term peak. When the next great crash hits, it’s likely to take the DAX down to its early 2009 low, at least — a 72% crash likely by early 2017.
China’s bubble recently hit 5,500. It’s likely to go a bit higher, but I do not see the Shanghai Composite exceeding its 2007 all-time high of just over 6,000.
I’m expecting China to suffer an 83% crash likely by early 2017, to its 2005 lows near 1,000 — minimum!
The emergence of these late-stage bubbles while the world’s leading economies stall is the clearest sign yet that this global bubble is getting ready to burst.
Two of the Most Economically Sensitive Commodities Suggest a Crash is Coming
The percentage of homes underwater — where the home is worth less than the mortgage — has been dropping as the housing market has recovered, but more than 4 million U.S. homeowners owe the bank at least 20% more than their homes are worth, totaling $579 billion of so-called negative equity, according to real estate company Zillow. “Homeowners who remain underwater will likely be the toughest to free from negative equity,” says Zillow chief economist Stan Humphries.
The rate of underwater homeowners is much higher among the homes with the least value, according to Zillow, which uses data from credit bureau TransUnion. More than 25% of those who own the least valuable third of homes were upside down, compared with about 8% of the most valuable third of homes. In Atlanta, 46% of low-end homeowners were underwater, compared with 10% of high-end homeowners. In Baltimore, 32% of low-end homeowners were in negative equity, compared with 9% of those who own the highest-value homes.
DYI
The Great Wait Continues...
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