Fed Rate Hike

Will they or won't they...hike in July, September...some time this year.

I don't think so. There is no reason to hike. Inflation is low. Growth is subdued. Other countries are cutting their interest rates. Why should the Fed raise rates. The only reason would be if the markets really take off.

Everyone Is Shy Of Calling A Top

Everyone is gun shy about calling a top in equities or bonds.

Too often in the recent past anyone who has called a top has been steam-rolled. As a result it is only ideologues and dogmatists who have been calling a top for years who are left to carry the flag.

I don't think we are in a bubble, but I do think the market is way overextended. The contrarian in me wants to take the under.

Bubble, bubble toil and trouble

Julian Robertson in an interview today speaks about a bubble being blown by the Fed. Like everyone else, he doesn't know when it is going to pop, but he knows it is going to pop.

A bubble is a serially correlated error on a mass scale perpetrated by a blinded marketplace. Herding if you will.

Which leads me to ask myself the question (which I ask periodically), where do I see bubble characteristics?

What are the characteristics to begin with? Substantial increase in leverage and laxity of constraints wrt to access to cheap capital - leads to misallocation of resources and increase in valuation. Unsustainable and undefensible increase in valuation. Area attracts a large flow of new capital. Industry/sector/country is systematically important due to its size and spreading effects throughout the economy. 

In financials? No. Capital has been rebuilt. Lending standards have improved.

In energy? No. The bubble, and there was one in shale, has been popped already. There are dead men walking, but no systematic risk impact on the market.

In technology? No. Not if you look at the balance sheets and valuation of the majors (AAPL, MSFT, SAP, ORCL, QCOM, etc.). I definitely see a bubble in next generation tech (TSLA, NOW, CRM, NFLX, N, etc.) but even many of those have seen their valuations shrink as they grow and market price have come off the boil.

In materials? No. If anything, the bubble has been popped already in that space. Just look at gold, copper, coal, etc.

In industrials? No. Valuation is stretched, but not out of this world.

In consumer discretionary? No.

In healthcare? Don't know. It has had a huge run. Definitely biotech side of sector. But biotech is not a systematically important part of the economy.

In utilties? No.

Dollar. No. That is good for everyone else and the US can handle it. Although if it were to throw the US into recession then that would be bad for everyone. 

In bonds? Possibly. Massive move to bonds over last six years. But bonds don't really pose a systematic risk unless the underlying defaults. And most of the new debt is govt.

In China? Possibly. But I've been calling that one for years, so I have zero credibility. Like Julian Robertson I believe there is a bubble (in China), I just don't know when it will burst.

China looks to me as the best potential for a "bubble." The massive run in the Chinese stock market may be a sign of things getting out of control, or it may simply be a sign of a soft landing.

Or, it could be the whole global system which has increased its leverage significantly in the last six years and susceptible to a rise in interest rates.

Perhaps that is it. Interest rate risk is the largest risk out there.

Jumping the Shark in Financial Advisordom

I am inundated with financial advisor magazines. I could have sworn there were only one or two a couple of years ago. Now there seem to 10 to 20 different magazines all trying to do the same thing - sell services to advisors.

It reminds me of the technology bubble and all those technology magazines I use to get back during that blow-out.

The Art of Short Selling - Wealth With Risk

Short sellers unearth facts from financial statements and from observation to ascertain that a stock is overpriced. Short sellers are information-based traders. Before 1983, no solely short funds existed. Stocks can only go to zero on the way down, but can go to infinity on the way up (reply: I've seen a lot more stocks go to zero than to infinity). Short sellers take greater risk than other investors - they must have strong evidence to support cases for price declines. Becauses reverses are sudden and terrifying, the burden of evidence rests on a solid, careful analysis completed before the stock is shorted.

Short selling is a niche. It is very small relative to the stock market as a whole. The long bias of and in the market creates exploitable inefficiencies for shorters, ie. there are more overpriced stocks than underpriced stocks (Asquith and Meulbroek). Negative earnings surprises affect stock prices to a greater degree than positive earnings surprises, and that effect persists over time. The common wisdom that there is no such thing as one bad quarter has a statistical basis. Stocks become torpedo candidates when very high expectations give way to earnings disappointments.

Short sale candidates cluster in three broad categories:

1. Companies in which management lies to investors and obscures events that affect earnings.
2. Companies that have tremendously inflated stock prices - speculative bubble.
3. Companies that will be affected in a significant way by changing external events. 

The trail signs to look for:

1. Accounting gimmickry: clues that the financial statements 
2. Insider sleaze: inurement, insider sellling.
3. Fad or bubble stock pricing: large price rise over short period.
4. A gluttonous corporate appetite for cash.
5. Overvalued assets or an ugly balance sheet.

The main precept of short selling analysis is bulk. Volumes of disparate facts and observations.

Accounting-based analysis is not difficult to do, but it takes time, patience and a suspension of belief.

The lack of attention by other professional investors to financial details provides the inefficiency in information dissemination that is so central to the short sellers art.

The goal is to identify the tragic flaw in a business long before the company's demise (the death rattle of a company in decline). The art of short selling trains analysts to avoid torpedo stocks or to profit from them.

The main weakness of short sellers is the inability/difficulty in judging the timing of collapse. Short sellers are consistently years too early when they sell stocks. Short sellers fear most a sustained rally in a stock.

How to make money in short selling and how not to lose money by selling are different sides of the same coin.

Short selling is a game of wits with the odds in favor of the analysts who do hard work and think for themselves, who turn jaundiced eyes on what passes for Wall St wisdom.

A "bubble" in growth

The market has experienced a massive run over the past year and a half. Much of that is due to the economic/political clouds clearing, confidence repairing, earnings coming through and ZIRP (and all its manifestations, eg. Bernanke Put, etc.) supporting a one-way trade.

But there is no doubt in my mind we are experiencing a growth bubble not too dissimilar to the internet bubble (which granted was a great deal more diffuse) in a number of places. These companies are characterized by rapid revenue growth, low to no profit, and the prospect/hope of future leveraged profitability - sound familiar. What is scary to me is that like the internet bubble it kept going and going until finally you threw in the towel and drank the kool-aid yourself. There are no signs of multiple expansion declining. No signs of a prick.

We will wake-up one day, two weeks, three weeks, four weeks past the peak and realize the game is up. For me that will mean watching the aftermath. I am hopeless at chasing. I will likely have been burned badly fighting it on the way up only to have capitulated and failed to have a position (or worse had a position but failed to have the conviction/patience to let the position ride) to capitalize on the bursting.

There will no doubt come a time when the market will once again focus on long term sustainable profitability with a degree of scepticism toward these sectors (which will likely result in overshoot on the downside). The scales will fall and the reckoning will begin.

Main areas where a bubble burst in valuation will be felt: SaaS, big data, analytics, cloud, biotech, social media.

What is a bubble? aka A Con Game

The global financial crisis of 2007-09 is often described as a bubble bursting. A bubble implies highly inflated prices.

There were highly inflated asset prices, eg. a variety of housing related leveraged debt instruments, but the general equity markets were not overly inflated on either a trailing twelve month or a forward earnings basis. The bursting of the housing bubble (and I would suggest it was also a localized/regional event) was predicated upon a mountain of easy money which in turn led to a run on the financial system and a consequent financial market panic. The real world came to a stop, earnings consequently collapsed and equity valuations in hindsight looked grotesque. What it really highlighted was that the financial system (and the economy) are based substantially upon confidence. The confidence of bankers to lend, investors to invest and business men to make investment decisions. When that confidence disappears in a tightly coupled, complex system all bets are off. That is what we call systematic risk, where one action begets another and feeds upon itself.  

There was no one singular cause to the global financial crisis. There were myriad factors and contributors. However, when confidence in the whole system evaporated, it led to panic and an exit from all asset positions.

Now, where have I seen this before...

...oh, that's right.

2000-2007. Tech bubble bursts==>Cascading decline in global equities==>Economy in recession==>Fed stimulates with historically low rates==>Govt. provides its share of fiscal stimulus==>Proportional recession averted==>Markets rebound strongly==>Economy gets back on the growth path (although unemployment lagging)==>Global equities continue to demonstrate strength==>Housing and increasing debt become backbones of the recovery==>Energy and commodity prices skyrocket==>All is well with the world.

Fast forward to 2007-2009. Housing bubble bursts==>Cascading decline in global equities==>Financial crisis ensues==>Economy in recession==>Fed stimulates with historically low rates==>Govt. provides its share of fiscal stimulus==>Proportional recession averted==>Markets rebound strongly==>Economy stabilizes (although unemployment lagging)...Increasing debt becomes backbone of the economy==>

I wonder how this ends! The only question is what asset class/area will become the investor's bubble of choice? Stay long until they take the punchbowl away.