"The Ingredients Of A Market Crash": John Hussman Explains "Why Take The Concerns Of A Permabear Seriously"
Why take the concerns of a “permabear” seriously?
The inclination to ignore these concerns is understandable based on the fact that I’ve proved fallible in the half-cycle advance since 2009. That’s fine – my objective isn’t to convert anyone to our own investment discipline or encourage them to abandon their own. Somebody will have to hold equities through the completion of this cycle, and it’s best to include those who have thoughtfully chosen to accept the historical risks of a passive investment strategy, and those who have at least evaluated our concerns and dismissed them. The reality is that my reputation as a “permabear” is entirely an artifact of two specific elements since the 2009 low, but that miscasting may not become completely clear until we observe a material retreat in valuations coupled with an early improvement in market internals.
For those who understand and appreciate our work, I discuss these two elements frequently because a) I think it’s important to be open about those challenges and to detail how we’ve addressed them, and b) it’s becoming urgent to clarify why we view present conditions as extraordinarily hostile, and to distinguish these conditions from others that – despite an increasingly overvalued market – our current methods would have embraced or at least tolerated more than we demonstrated in real-time.
For us, the half-cycle since 2009 has involved the resolution of two challenges.
The first: despite anticipating the 2007-2009 collapse, the timing of my decision to stress-test our methods against Depression-era data – and to make our methods robust to those outcomes – could hardly have been worse. In the interim of that “two data sets” uncertainty, we missed what in hindsight was the best opportunity in this cycle to respond to a material retreat in valuations coupled with early improvement in market internals (a constructive opportunity that we eagerly embraced in prior market cycles, and attempted to embrace in late-2008 after a 40% market plunge).
The second: I underestimated the extent to which yield-seeking speculation in response to quantitative easing would so persistently defer a key historical regularity: that extreme overvalued, overbought, overbullish market conditions typically end with tragic market losses. Those extremes have now been stretched, uncorrected, for the longest span in history, including the late-1990’s bubble advance. My impression is that the completion of the present market cycle will only be worse as a result.
The ensemble approach we introduced in 2010 resolved our “two-data sets” challenge, and was more effective in classifying market return/risk profiles than the methods that gave us a nice reputation by 2009, but our value-conscious focus gave us a tendency to exit overvalued bubble periods too early. During the late-1990’s, observing that stock prices were persistently advancing despite historically overvalued conditions, we introduced a set of “overlays” that restricted our defensive response to overvalued conditions, provided that certain observable supports were present. These generally related to an aspect of market action that I called trend uniformity. In the speculative advance of recent years, we ultimately re-introduced variants of those overlays to our present ensemble approach.
As I observed in June, the adaptations we’ve made in recent years have addressed both of these challenges. See the section “Lessons from the Recent Half-Cycle” in Formula for Market Extremes to understand the nature of these adaptations. When we examine the cumulative progress of the stock market in periods we classify as having flat or negative return/risk profiles (and that also survive the overlays), the chart looks like the bumpy downward slope of a mountain. Present conditions are worse, because they feature both a negative estimated return/risk profile and negative trend uniformity on our measures. The cumulative progress of the stock market under these conditions – representing less than 5% of history – looks like the stairway to hell, and captures periods of negative market returns even during the bull market period since 2009. The chart below shows cumulative S&P 500 total returns (log scale) restricted to this subset of history. The flat sideways sections are periods where other return/risk classifications were in effect than what we observe today.
Though we’ve validated our present methods of classifying market return/risk profiles in both post-war and Depression-era data, in “holdout” validation data, and even in data since 2009, there’s no assurance they’ll be effective in the current or future instances. As value-conscious, historically-informed investors, we remain convinced that the lessons of history are still relevant. Our efforts have centered on embodying those lessons in our discipline.
While all of these considerations are incorporated into our approach, we’ve had little opportunity to demonstrate the impact we expect over the course of the market cycle. Applied to a century of historical market evidence, including data from the present market cycle, we’re convinced that the adaptations we’ve made have addressed what we needed to address.
Our concerns at present mirror those that we expressed at the 2000 and 2007 peaks, as we again observe an overvalued, overbought, overbullish extreme that is now coupled with a clear deterioration in market internals, a widening of credit spreads, and a breakdown in our measures of trend uniformity. These negative conditions survive every restriction that we’ve implemented in recent years that might have reduced our defensiveness at various points in this cycle.
My sense is that a great many speculators are simultaneously imagining some clear exit signal, or the ability to act on some “tight stop” now that the primary psychological driver of speculation – Federal Reserve expansion of quantitative easing – is coming to a close. Recall 1929, 1937, 1973, 1987, 2001, and 2008. History teaches that the market doesn’t offer executable opportunities for an entire speculative crowd to exit with paper profits intact. Hence what we call the Exit Rule for Bubbles: you only get out if you panic before everyone else does.
Meanwhile, with European Central Bank assets no greater than they were in 2008, and more fiscally stable European countries quite unwilling to finance the deficits of unstable ones, the ECB has far more barriers to sustained large-scale action than Draghi’s words reveal. Moreover, to the extent that the ECB intends to buy asset-backed securities (ABS), which have a relatively small market in Europe, the primary effect (much like the mortgage bubble in the U.S.) will be to encourage the creation of very complex, financially engineered, and ultimately really junky ABS securities that can be foisted on the public balance sheet. Watch. In any event, even if such monetary interventions continue indefinitely, I have no doubt that we’ll have the opportunity to respond more constructively at points where we don’t observe upward pressure on risk-premiums and extensive deterioration in market internals.
I should be clear that market peaks often go through several months of top formation, so the near-term remains uncertain. Still, it has become urgent for investors to carefully examine all risk exposures. When extreme valuations on historically reliable measures, lopsided bullishness, and compressed risk premiums are joined by deteriorating market internals, widening credit spreads, and a breakdown in trend uniformity, it’s advisable to make certain that the long position you have is the long position you want over the remainder of the market cycle. As conditions stand, we currently observe the ingredients of a market crash.
When we first covered the Carmen Segarra lawsuit alleging the capture of the NY Fed by Goldman Sachs back in October 2013, we didn't have much hope for justice to get done. We said that "while her allegations may be non-definitive, and her wrongful termination suit is ultimately dropped, there is hope this opens up an inquiry into the close relationship between Goldman and the NY Fed. Alas, since the judicial branch is also under the control of the two abovementioned entities, we very much doubt it."
Sure enough, the lawsuit was dropped (and no inquiry was opened) but not before it became clear that the very judge in charge of the case, U.S. District Judge Ronnie Abrams, was herself conflicted, after it was revealed that her husband, Greg Andres, a partner at Davis Polk & Wardwell, was representing Goldman in an advisory capacity. Curiously, before she assumed her current office in March 2013, back in 2008 Abrams returned to Davis Polk herself as Special Counsel for Pro Bono. She had previously worked at the firm from 1994 to 1998. For the full, and quite amazing, story of how the "Judge" steamrolled Segarra's objections reads this Reuters piece.
As a result of this fiasco, some wondered just how far do Goldman's tentacles stretch not only at the money-printing (i.e., NY Fed) level, not only at the legislative level (see "With Cantor Down, Which Other Politicians Has Goldman Invested In?"), but at the judicial as well.
And then, on Friday, the Segarra case against the Federal Reserve branch of Goldman Sachs got a second wind, when as a result of another disclosure, ProPublica revealed "How Goldman Controls The New York Fed in 47.5 Hours Of "The Secret Goldman Sachs Tapes." That is to say, nothing new was revealed per se, because as anyone who has read this website for the past 6 years knows just how vast Goldman's network is not only at the Fed, but in that all important other continent too, Europe.
Sadly, just like a year ago, so this time too, we are reluctant to say anything will change. In fact, there is too much at stake, for Goldman to drop the reins and disassociate from the NY Fed: for pete's sake, the president of the NY Fed is a former Goldman employee - does it get any more conflicted than that?!
But, wait, Goldman will do penance by "prohibiting its bankers from buying stocks"... the horror. Luckily at least purchasing politicians and Fed presidents is still perfectly allowed.
In fact, what has become clear to everyone is that aside from yet another dog and pony show (led by, you guessed, it the head dog and ponier herself, Elizabeth Warren), not only will nothing change, but in fact the best way to take advantage of a broken, corrupt, sinking system, is to join it. And the best summary of just that sentiment was released over the weekend by Nanex' Eric Hunsader as follows:
— Eric Scott Hunsader (@nanexllc) September 26, 2014
Curious what made up Eric's mind? Then fast forward to minute 24 to hear what it sounds like when a top Fed official "questions" Goldman Sachs:
But before we put this topic to bed, here is Raúl Ilargi Meijer explaining why "The US Has No Banking Regulation, And It Doesn’t Want Any"
* * *
It is, let’s say, exceedingly peculiar to begin with that a government – in this case the American one, but that’s just one example - in name of its people tasks a private institution with regulating not just any sector of its economy, but the richest and most politically powerful sector in the nation. Which also happens to be at least one of the major forces behind its latest, and ongoing, economical crisis.
That there is a very transparent, plain for everyone to see, over-sized revolving door between the regulator and the corporations in the sector only makes the government’s choice for the Fed as regulator even more peculiar. Or, as it turns out, more logical. But it is still preposterous: regulating the financial sector is a mere illusion kept alive through lip service. Put differently: the American government doesn’t regulate the banks. They effectively regulate themselves. Which inevitably means there is no regulation.
The newly found attention for ProPublica writer Jake Bernstein’s series of articles, which date back almost one whole year, about the experiences of former Fed regulator Carmen Segarra, and the audio files she collected while trying to do her job, leaves no question about this.
What’s going on is abundantly clear, because it is so simple. The intention of the New York Fed as an organization is not to properly regulate, but only to generate an appearance – or illusion – of proper regulation. That is to say, Goldman will accept regulation only up to the point where it would cut into either the company’s profits or its political wherewithal.
What the ‘Segarra Files’ point out is that the New York Fed plays the game exactly the way Goldman wants it played. Ergo: there is no actual regulation taking place, and Goldman will comply only with those requests from the New York Fed that it feels like complying with.
In the articles, the term ‘regulatory capture’ pops up, which means – individual – regulators are ‘co-opted’ by the banks they – are supposed to – regulate. But the capture runs much larger and wider. It’s not about individuals, it’s a watertight and foolproof system wide capture.
The government picks a – private – regulator which has close ties to the banks. The government knows this. It also knows this means that its chosen regulator will always defer to the banks. And when individual regulators refuse to comply with the system, they are thrown out.
In one of the cases Segarra was involved in during her stint at the Fed, the Kinder Morgan-El Paso takeover deal, Goldman advises one party, has substantial stock holdings in the other, and appoints a lead counsel who personally has $340,000 in stock involved. Conflict of interest? Goldman says no, and the Fed complies (defers).
The lawsuit Segarra filed against the NY Fed and three of its executives was thrown out on technicalities by a judge whose husband was legal counsel for Goldman in the exact same case. No conflict of interest, the judge herself decides.
This is not regulation, it’s a sick and perverted joke played on the American people, which it has been paying for it through the nose for years, and will for many years to come. Sure, Elizabeth Warren picks it up now and wants hearings on the topic in Congress, but she’s a year late (it’s been known since at least December 2013 that Segarra has audio recordings) and moreover, it was Congress itself that made the NY Fed the regulator of Wall Street. Warren has as much chance of getting anywhere as Segarra did (or does, she’s appealing the case).
The story: In October 2011, Carmen Segarra was hired by New York Fed to be embedded at Goldman as a risk specialist, and in particular to investigate to what degree the company complied with a 2008 Fed Supervision and Regulation Letter, known as SR 08-08, which focuses on the requirement for firms like Goldman, engaged in many different activities, to have company-wide programs to manage business risks, in particular conflict-of-interest. Some people at Goldman admitted it did not have such a company-wide policy as of November 2011. Others, though, said it did.
Let’s take it from there with quotes from the 5 articles Bernstein wrote on the topic over the past year. To listen to the Segarra files, please go to The Secret Recordings of Carmen Segarra at This American Life.
One last thing: Jake Bernstein’s work is of high quality, but I can’t really figure why he says things such as the audio files show: “a New York Fed that is at times reluctant to push hard against Goldman and struggling to define its authority”. Through his work, and the files, it should be clear that just ain’t so. Both the Fed’s policy and authority are crystal clear and ironclad.
When one of the most watched German channels - south German state TV channel ZDF - releases an 8+ minute satirical spoof of all the fabricated "news" surrounding the Ukraine "ïnvasion" by Russia and all the associated newsflow from the region (in which "any similarity to the current news is unintended and accidental, but absolutely inevitable"), you know that the time has come to double down on the propaganda effort because if ground zero of media indoctrination, Germany, is starting to see through the fog of endless media BS, then how long until the rest of the world follows?
Make sure to activate the English subtitles when watching the following clip.
By Charles McFarlane of Modern Farmer
Why Is The USDA Buying Submachine Guns?
“Submachine guns, .40 Cal. S&W, ambidextrous safety, semi-automatic or 2 shot bur[s]t trigger group, Tritium night sights for front and rear, rails for attachment of flashlight (front under fore grip) and scope (top rear), stock-collapsib[l]e or folding, magazine - 30 rd. capacity.”
In May, the USDA's Office of Inspector General filed a request for these weapons. But why exactly do they need them?
According to a USDA press rep, the guns are necessary for self-protection.
“OIG Special Agents regularly conduct undercover operations and surveillance. The types of investigations conducted by OIG Special Agents include criminal activities such as fraud in farm programs; significant thefts of Government property or funds; bribery and extortion; smuggling; and assaults and threats of violence against USDA employees engaged in their official duties,” wrote a USDA spokesperson.
Those seem like legitimate enforcement activities, but still: submachine guns? Not everyone believes the USDA being armed to the teeth is justifiable. On Aug. 2, the Farm to Consumer Legal Defense Fund launched a petition to support a bill that would curb the ability of agencies like the USDA to arm themselves. They see it as overkill and scare tactics, especially for smaller producers.
“What we have seen happen, with the FDA especially, is they have come onto small farms, raw milk producers, and raided the heck out of them with armed agents present,” says Liz Reitzig, co-founder of the Farm Food Freedom Coalition. “Do we really want to have our federal regulatory agencies bring submachine guns onto these family farms with children?”
The Farm to Consumer Legal Defense Fund petition focuses on two now infamous blows to the raw milk community – the 2010 and 2011 raids on Rawsome Food Club in Venice, California. These raids were carried out by armed federal agents, from the FDA and other agencies.
The OIG’s Investigation Development bulletins show there have been three incidents in the last year that involved firearms and two in which USDA agents were verbally threatened. Still, most of their enforcement operations surround white-collar fraud of government programs, often involving SNAP programs. “If there is fraud in the SNAP program, look at how it is implemented and make changes in the entire program,” says Reitzig. “Don’t bring machine guns onto farms.”
The Farm to Consumer Legal Defense Fund are not the only ones interested in taking guns out of the hands of USDA agents. Utah Congressman Chris Stewart is the sponsor of the bill on the FTCLDF petition. “At its heart it comes down to this: To myself, and for a lot of Americans, there is great concern over regulator agencies with heavy handed capabilities,” Rep. Stewart told Modern Farmer.
His bill, H.R. 4934, hopes “to prohibit certain federal agencies from using or purchasing certain firearms, and for other purposes.” When asked about the USDA’s plan for submachine guns, he said, “I can’t envision a scenario where what they are doing would require that.”
Another concern is simply accountability. The request for submachine guns from the USDA doesn’t say how many guns — asking them seems like a non-starter. “They have been very unhelpful in trying to find out any information about this,” said Rep. Stewart. “We couldn’t get answers — it doesn’t seem right to me.”
However, he also cautioned: “We have never argued that federal regulators don’t need to protect themselves.” But if USDA investigations were perceived to be potentially violent he suggested, “They should do what the rest of us do, call the local sheriff.”
There is a saying that you don’t ring bells at the top.
It’s not really true. Every time the market forms a major peak, at least in the last 15 years, there are usually a preponderance of signs of excessive speculation and leverage.
Today we are seeing bells ringing throughout the markets.
For instance, today, we have:
1) Corporate debt is at 2007 peak levels.
2) Investor bullishness is at extremes not seen since the 2007 top.
3) Margin debt (money borrowed to buy stocks) is closing in on its record high.
4) Over 70% of household net worth is based in financial assets. As ZH has noted previously, every time this has happened historically, asset prices have crashed soon after.
5) The Bank of International Settlements and the IMF have both warned of excessive risk taking and market fragility.
6) Market volume is at an absolute trickle, with most volume coming from HFT firms.
Aside from this, we have countless examples of the “smart money” preparing:
1) Billionaires are sitting on record amounts of cash.
2) Warren Buffett is sitting on over $50 billion in cash.
3) George Soros has taken out a record put position to profit from a market collapse.
4) Carl Icahn has warned of a “big drop” coming in stocks.
5) Jeremy Grantham has commented that we are in a “fully-fledged equity bubble.”
6) Corporate insiders are selling stock at a pace not seen since 2000.
7) Financial institutions as well as hedge funds have been net sellers of stocks since 2014 began.
There are literally bells everywhere today. Does this mean that the market will take a nosedive this week? Not necessarily. Tops can take much longer to form that anyone expects.
However, there are clear signs of excessive speculation, leverage, and the like. And the smart money is heading for the exits.
This concludes this article. If you’re looking for the means of protecting yourself from what’s coming, you can pick up a FREE investment report titled Protect Your Portfolio at http://phoenixcapitalmarketing.com/special-reports.html.
This report outlines a number of strategies you can implement to prepare yourself and your loved ones from the coming market carnage.
Phoenix Capital Research
Submitted by Mark St. Cyr
The Shot Heard Round The Valley World
The greatest issue facing Silicon Valley is the one thing many newly minted and aspiring entrepreneurs have taken for granted: the money.
Many believe this gravy train of a never-ending Venture Capital/Angel Investor class will not only always be there, but the ranks will swell becoming even larger with burgeoning pocketbooks filled with their own newly minted IPO greenbacks.
Problem is for a great many, they have never seen the real Jeckyll and Hyde personality of “investor funding.”
Initial Public Offerings (IPO) has been the rallying cry for many over the last 5 years to the detriment of what it really means to be an entrepreneur. (i.e., creating something that becomes bigger than one’s self)
The term has now morphed into something akin to: I’m going to push this idea, get it funded, IPO it, and cash out! Rinse – repeat. For I’m a “Trep!” (For those not familiar with the term, it’s the newest self-appointed moniker for the person who seems to be following this pattern of entrepreneurship.)
For what it’s worth, this style of thinking about entrepreneurship from my perspective is very worrisome. The reason? It’s only about the “Benjamins.”
Is there anything wrong with that? Absolutely not. However: If your purpose was to bring a real company, (what ever the field,) run and grow it to its full potential you’ll find too your detriment – money alone will not do it. Regardless of how much.
And, if your sole focus for your existence hasn’t been on sales, customers, and net profit. Or, you’ve been lackadaisical in any other manner because the dominating thought in your mind is – “I just need to get another round, then I can IPO and be through with this?” Your time is probably up.
Come this October the Federal Reserve will make its final tranche of QE available. The amount assumed by many is that it will be 50% larger than what we’ve seen over these last years. ($15 Billion as opposed to $10)
One may see an increased flurry of buying into anything and everything that has even the slightest possibility of making a profit. Or, what Wall Street cares about even more; a growth story that can be perpetuated via financial engineering that sticks during earnings seasons.
But, one shouldn’t read into this as “confirmation” the risk appetite story is not only alive but growing. For that is all about to change.
Once the Fed shuts down the section of QE that has been pumping Billions upon Billions of dollars every month – it’s over for a great many of today’s Wall Street darlings.
Think of it this way: Who is going to fund your next round when they no longer have access to the Fed.’s piggy bank? Let alone pump more money into older start-ups that just haven’t produced any real money (as in net profit,) but have produced nothing more than great new employee digs or benefits?
Tack along side this the culture shock in what will seem near instantaneous with the shunning that will take place of any business resembling the, 3 employee, menial customer base, Zero if not negative profit margin businesses formed with the implicit intent as to be bought up or “acquired” for Billion dollar pay days.
These will be the first to go. That formulation is going way of the now infamous Pets dot-com sock puppet. This will be the first true shock to Silicon Valley culture that hasn’t been seen in many years. And it will be far from the only one.
Many will point directly at the darling of both Silicon Valley as well as the touchstone of riches for aspiring entrepreneurs; Facebook™ (FB) as proof this line of thinking is off base. And why shouldn’t they? The price has never been higher.
Yet, what many shield their eyes from and a great deal more turn their heads from entirely is what I and very few others have been arguing: “It’s all been possible via the Federal Reserve’s interventionist policies.” And the greatest source of that inflow of cash made available via “investors” is about to be shut down.
Let me go on the record here and point out what I believe will prove my point in the coming weeks and months.
Currently Zuck and crew have been lauded over with the prowess in its acquisition choices. You will know everything has changed when the calls to rescind Mark Zuckerberg’s authority in having carte blanche via not needing board approval for acquisitions going forward is demanded by Wall Street.
And that won’t be the only monumental shift coming. Maybe, one at an even faster pace: The meaning of IPO.
IPO is not going to have the same term of endearment it now has. I believe it will turn into the last and most dreaded three-letter acronym no one ever imagined in Silicon Valley.
The IPO screams of joy will turn into wails of terror when those VC “angels” meet at many “treps” desk and state – they’re IPO-ing.
No, not getting one set up for the big pay-day. No IPO will mean: “I’m pulling out.” i.e., “Have a nice day. Where’s the rest of my money?”
The once renowned purchases of “Billion dollar babies” will prove out not to be worth two cents in this environment.
Valuations will get crushed and people will be shocked at just how fast a company touted across the financial channels and other media as “fantastic buys” are flogged and fleeced when Wall Street comes back for their “investment.”
If the story or the numbers aren’t there – neither will these once darlings of Wall Street. Regardless of size or stature.
People will continue pointing at FB and others as proof that this whole idea of what I’m professing is off base. Again, they’ll point to the stock prices and say, “Look! During the recent sell off some they went higher! This proves, blah, blah, blah.”
What it proves is this in my opinion: It’s a last gasp effort to have exposure in these companies during this newest round of earnings season. i.e., As to have the possibility (more inline with hope) of any earnings windfall, whether it be real, or financially engineered. Because: There isn’t going to be another shot after this one. The money to take these stylized chances will no longer be there. Period.
I watched and read many viewpoints on what has now been circulated throughout Silicon Valley as the “tweet storm” unleashed by well-known Silicon Valley sage Marc Andreessen where he ended his views with the word “WORRY.” I believe he is spot on.
Many in the so-called “know” of any and all related to Silicon Valley pontificate that his alarm bells are a little “over the top.” Some have stated in rather condescending tones that “It’s not like the current crop of Silicon Valley has never had issues with funding. I mean, it was hard in 2009.”
Oh yes, it was – for about a week!
I would remind everyone to remember what took place in 2009? The birth of QE. Then it was off to the races. Or should I say “coding?” And as of today there has been no need to look back. Until now.
This next bout of what I believe to take place will not be limited to just the small-sized, or start-up class. It will be just as abrupt of a sea change for the current crop of Wall Street darlings that have produced what many have seen as “skeptical” results. e.g., FB, Twitter™, Pandora™, LinkedIn™, et al.
They are going to face harsh skepticism this earnings release period. Far more, and certainly more harsh or critical than any previous in my opinion.
The reasoning is: With no more “free money” pouring in from the Fed. for “investors” to slap around anywhere and everywhere in the hopes of something sticking. They’re going to do what anyone would do. Buy Nothing – Sell Anything and everything that isn’t making real money. For they are well aware their bankers or margin clerks – don’t accept “likes” as legal tender for deposits in their accounts either.
One last thing: If you think all this “worry” stuff is just nonsense. Let me leave you with this one line…
Yahoo™ just announced it’s interested in AOL™.
Feel better now?