Early Retirement Extreme Forums

For almost ten years I've been asking myself this. And for ten years, I haven't been able to figure it out yet because after all, there hasn't been a popping sound yet. I thought for awhile it was emerging market investments, but those didn't pop they just fizzled out a bit.

My only current guess is something with our information age. Is it tied to social media being such a big influencer on all of us? Is it all the "free" stuff we're used to, like 99% of online content? Is it such a political divide that soon we'll only be patronizing businesses that clearly label themselves "Conservative" or "Liberal" (depending on our team), like a "civil" virtual civil war?

I questioned the tech bubble when it was happening but was too young to know "what was wrong". The housing bubble and ridiculous housing prices never made sense to me, but I didn't know the underlying causes at the time. But there's very likely something happening, right now, that's going to pop. What is it???

The USD

What is in a bubble at the moment that is likely to burst is US stocks.
That is S&P, Dow Jones and Nasdaq - all of them.
I'm saying this based upon the CAPE/Shiller index which is currently 30.38 which is approximately twice the historical valuation.
https://www.multpl.com/shiller-pe
It indicates how many dollars stock you need to own for that stock to earn a dollar in profit. (Cyclically Adjusted Price to Earnings ratio).

Trump seems to be on a mission to pop this bubble by starting a trade war with China or Europe or anyone else he can think off.
I think the next couple of years could be a roller-coaster for US stocks.

Some other markets are not in a bubble. China is quite normal and UK is depressed due to 'Brexit uncertainty'.

The next bubble is whatever everybody believes that just ain't so, so look for something that people have or is developing great confidence in but which does not have any natural (physical, economical, legal, ... ) foundation. In order for the bubble to pop, the mismatch between perception and reality has to be there. Otherwise, it's just a reset of expectations(*). And in order it spot it, you have to know what the natural foundations are.

(*) Some perceptions generate their own reality. E.g. we associate digits on a computer screen with wealth because we all agree to make it so.

Here's a suggestion for a bubble detector:
1) Always invert! It's easier to start with what everybody believes. (Presuming that "everybody" is like 75%+ of everybody or whatever the float is ... a certain fraction of people never change their mind no matter what.)
2) Does this belief have a natural foundation? If yes, go to 3. If no, go to 4.
3) There is no bubble. (Alternatively, you're part of the bubble because you're confusing reality with expert statements/assumptions.)
4) Does it matter that the price is essentially made up? If yes, go to 6. If no, got to 5.
5) Carry on. What you have here is essentially a social convention. It may even be "new" (as in era) and not abide your fancy mean reversion framework. For example, the use of paper money as a representative of wealth is likely here to stay.
6) Where does it matter? As in, in which sector. For example, inflated markets don't matter for pension payouts or retirement savings as long as there are enough fools who keep paying in, but they do matter in making equity funding too cheap to avoid silly acquisitions and investments in the actual economy.
7) There's your bubble.

However, just identifying it is only 1/3 of the work. Then there's 1/3 of how to deal with it. The last 1/3 is what to do after it pops, that is, where and how to get back in.

To explain the "reset to expectations" a bit better ... it's the difference between the market reverting to the mean (say going from 12 to the historical 10) and the mean trending towards the market (say the historical 10 converging on the new 12). The problem here is that the mathematical tools to detrend data tend to be weak and if you can't count on the trend being 0, you can't count on your mean being true either. What people usually do in this situation is just to presume that the data will be detrended once the sample is large enough. IOW, they wave their hands and say "historically" just like speculators wave their hands and say "in the long run" when they invest in trends.

Nomad wrote: ↑

Sat May 11, 2019 9:29 am

China is quite normal

China now has more debt than any country, ever. And that’s saying something because the US has $22 trillion of sovereign debt and over $8 trillion of corporate debt.

https://www.bloomberg.com/quicktake/chinas-debt-bomb

Regarding the question of “what and where is the bubble,” I think the answer is “because of central banks, everything.” Or at least, everything that has a yield.

If you look at US Treasury yields, as I write this the 2-year yield is currently 2.26% and the 7-year yield is 2.37% compared to 2.42% for the 1-month bill. Why? Because investors anticipate that that in response to a recession the Fed will drive short term rates to zero. The 1-month bill pays more than everything from the 1-year to 7-year.

https://www.treasury.gov/resource-cente ... &year=2019

So even though it is a tiny little profit, investors are piling into intermediate Treasuries, and massively leveraging up on them, so desperate they are for yield. In the Central Bank Everything Bubble, anything that can be levered, will be.

Now, if you could identify an asset that has monetary value that has no yield, you have probably identified an asset that has not been levered, and therefore has not been inflated, and therefore can protect your capital. Grow your capital, even, when the Everything Bubble deflates, or is later reinflated by central banks. Paper money will always be used for it’s convenience, but my dollar doesn’t buy at McDonald’s what it used to, and in the future it will buy even less.

I don't know, but it's probably waiting patiently to pop until the day after I retire to pop for maximum effect.

Mister Imperceptible wrote: ↑

Sat May 11, 2019 3:53 pm

Regarding the question of “what and where is the bubble,” I think the answer is “because of central banks, everything.” Or at least, everything that has a yield.

An investment analyst named Graham Summers wrote a great book about this, aptly titled "The Everything Bubble." US Treasuries are the standard for measuring all risk in the global financial system. The yield on the 10-Year US Treasury is considered the “risk free” rate of return: the rate against which all other risk assets are compared and priced.

Stocks, commodities, oil, mortgage rates, home prices, literally everything, is valued based on its risk level relative to this yield. So, if this yield is pushed to abnormally low levels (creating a bubble in bonds forces bond prices up and yields down) then all risk assets in the financial system would adjust accordingly.

Thanks to Ben Bernanke, who has written extensively about his mission to ensure that debt deflation (lower bond prices, higher yields, makes it expensive for US to issue debt) never hits the US, this is exactly what happened.

Infantry

RFS wrote: ↑

Sat May 11, 2019 8:48 pm

The yield on the 10-Year US Treasury is considered the “risk free” rate of return: the rate against which all other risk assets are compared and priced.

Not quite correct.

The RFR is the interest rate one can expect to achieve with certainty over the short term. Ten years is nobody's definition of "short-term", and even if you hold a 10-year Treasury to maturity (so no interest rate risk) you still face reinvestment risk of the coupon payments. Over 10 years there is also a slight risk the Federal government will default -- according to credit default swaps this is greater than the risk that some blue-chip companies such as MCD and KO will default. It is obviously greater than the default risk of a Treasury bond of shorter maturity.

The most commonly cited risk-free asset is three-month T-bills. As it turns out, these currently yield about the same as the 10-year does (2.42% vs 2.47%), but before the current cycle of rate hikes started they were at virtually zero.

unemployable wrote: ↑

Sat May 11, 2019 10:51 pm

Not quite correct.

The RFR is the interest rate one can expect to achieve with certainty over the short term. Ten years is nobody's definition of "short-term", and even if you hold a 10-year Treasury to maturity (so no interest rate risk) you still face reinvestment risk of the coupon payments. Over 10 years there is also a slight risk the Federal government will default -- according to credit default swaps this is greater than the risk that some blue-chip companies such as MCD and KO will default. It is obviously greater than the default risk of a Treasury bond of shorter maturity.

The most commonly cited risk-free asset is three-month T-bills. As it turns out, these currently yield about the same as the 10-year does (2.42% vs 2.47%), but before the current cycle of rate hikes started they were at virtually zero.

The 10 year rate seems to be the academic answer I've seen a few times (learned in school but also in a book "The Warren Buffet Way."). This is often the rate used in discounted cash flow models. http://www.streetofwalls.com/finance-tr ... -analysis/

These days though...the 3 month and 10 year are very close. I'd probably just go with the 3 months since the spread is so thin.

Lemur wrote: ↑

Mon May 13, 2019 10:28 am

The 10 year rate seems to be the academic answer I've seen a few times (learned in school but also in a book "The Warren Buffet Way.").

Definitely not on the CFA exam, unless CFAI changed it because it was at zero for so long. Doesn't really make intuitive sense. Back in the old days when the 3-month may have been 3% and the 10-year 6% no one would think the RFR was 6%.

unemployable wrote: ↑

Mon May 13, 2019 11:15 am

Definitely not on the CFA exam, unless CFAI changed it because it was at zero for so long. Doesn't really make intuitive sense. Back in the old days when the 3-month may have been 3% and the 10-year 6% no one would think the RFR was 6%.

Well I should stand corrected as I guess it would really depend...

Aswath Damodaran: What is the riskfree rate? A Search for the Basic Building Block
http://people.stern.nyu.edu/adamodar/pd ... eerate.pdf

Mister Imperceptible wrote: ↑

Sat May 11, 2019 3:53 pm

China now has more debt than any country, ever. And that’s saying something because the US has $22 trillion of sovereign debt and over $8 trillion of corporate debt.

https://www.bloomberg.com/quicktake/chinas-debt-bomb

What I was saying is normal is the company valuations in Price to Earnings ratio.
In terms of debt, their debt to GDP I thought was about 44% which isn't too bad in comparison to most.
https://tradingeconomics.com/country-li ... tinent=g20

So, I'm happing investing in China at the moment but probably not US tracker funds.

I still wonder how long China can continue as an autocratic regime. I know we all expected they would become more democratic as they developed and this hasn't happened. I can imagine people accepting this as they get richer but will they when there is a major economic downturn.

In lieu of any directly observable trigger, I offer a random one ...

https://www.vox.com/future-perfect/2019 ... -un-report

Experts like Mathers are increasingly warning that drug-resistant superbugs pose a huge threat to our health. Now, the UN report adds that drug resistance could also severely mess up our economy. By causing health care expenditures to skyrocket, it could prompt economic damage on a par with the 2008-2009 financial crisis.

As an example, consider the African swine fewer for which there is no treatment. It has gone pandemic and will likely require culling 100-150 million pigs this year. There are ~600 million pigs in the world total. In contrast, the Spanish flu killed ~4% of the world's human population.

tonyedgecombe wrote: ↑

Tue May 14, 2019 2:41 am

From what I understand though for much of the last decade they have been getting less so, the last year this has seen a shift back in the other direction. Hopefully this is just temporary, but there is no way to know for certain.

Augustus wrote: ↑

Mon May 13, 2019 5:59 pm

I would not invest in China. They have huge amounts of bad corporate/overall debt, most economic statistics are a total sham. It's gotten so bad that most people with money are trying to funnel it all out of the country using things like bitcoin and smurfing (money laundering). The government recently cracked down on that and sent a bunch of people to prison. Capital flight is usually a bad sign.

I recently lost a RE deal to Chinese investors not being to move funds out of the country. Or at least that was the explanation. It happened around the Chinese New Year's. Someone asked what animal was at the center of this year's celebration. I said it "Must be the donkey because my ass just got fucked." That didn't go over too well.

There was a never a discussion of China's political system changing. It's experiment with capitalism was always perilous - an autocratic political system temporarily removing some fetters over one aspect of its society. It was never fully capitalistic in our sense - IPO's were always state controlled, there cannot be grass roots protest against things like environmental issues. It has done better than India which is nominally a democracy.

I believe Beijing's official line is that democracy wouldn't work in a country as huge as China, and whilst this is obviously self-serving they might have a point. India, as the only comparable case study, suggests not, which many have argued has basically been a failure as a modern state. Its kinda like having one government by election for the whole of Africa or the whole of the Americas and then some.

Western commentators seem a bit reluctant to fully acknowledge China's immense economic achievement. We get loads of Chinese tourists where I live and you think they grew up hungry during the cultural revolution, their parents were probably illiterate peasants. 40 years later they are taking package holidays to Europe and quaffing wine served to them by white people. That must feel fucking awesome.

I expect China will evolve its own political system which need not emulate western models. Indeed its perhaps more likely the west will emulate China to some degree.

The problem with India as a democracy is that notions of equality conflict with its entrenched caste system.

Frontline has a documentary on the trade war. I found it to be informative. When their government wants something, it gets done. Fast. And they no longer emulate us. They are doing it their way and the market dependence appears to be turning in their favor. They are four times our size and their middle class is the size of our entire population.