Posts tagged ‘investment bubbles’

‘Tis the Season for Giving

This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (December 1, 2017). Subscribe on the right side of the page for the complete text.

Holiday season is in full swing, and that means it’s the primetime period for giving. The stock market has provided its fair share of giving to investors in the form of a +2.7% monthly return in the S&P 500 index (up +18% in 2017). For long-term investors, stocks have been the gift that keeps on giving. As we approach the 10-year anniversary of the 2008 Financial Crisis, stocks have returned +68% from the October 2007 peak and roughly +297% from the March 2009 low. If you include the contributions of dividends over the last decade, these numbers look even more charitable.

Compared to stocks, however, bonds have acted more like a stingy Ebenezer Scrooge than a generous Mother Theresa. For the year, the iShares Core Aggregate bond ETF (AGG) has returned a meager +1%, excluding dividends. Contributing to the lackluster bond results has been the Federal Reserve’s miserly monetary policy, which will soon be managed under new leadership. In fact, earlier this week, Jerome Powell began Congressional confirmation hearings as part of the process to replace the current Fed chair, Janet Yellen. As the Dow Jones Industrial Average rose for the 8th consecutive month to 24,272 (the longest winning streak for the stock index in 20 years), investors managed to take comfort in Powell’s commentary because he communicated a steady continuation of Yellen’s plan to slowly reverse stimulative policies (i.e., raise interest rate targets and bleed off assets from the Fed’s balance sheet).

Because the pace of the Federal Funds interest rate hikes have occurred glacially from unprecedented low levels (0%), the resulting change in bond prices has been relatively meager thus far in 2017. In that same deliberate vein, the Fed is meeting in just a few weeks, with the expectation of inching the Federal Funds rate higher by 0.25% to a target level of 1.5%. If confirmed, Powell plans to also chip away at the Fed’s gigantic $4.5 trillion balance sheet over time, which will slowly suck asset-supporting liquidity out of financial markets.

Economy Driving Stocks and Interest Rates Higher

Presents don’t grow on trees and stock prices also don’t generally grow without some fundamental underpinnings. With the holidays here, consumers need money to fulfill the demanding requests of gift-receiving individuals, and a healthy economy is the perfect prescription to cure consumers’ empty wallet and purse sickness.

Besides the Federal Reserve signaling strength by increasing interest rates, how do we know the economy is on firm footing? While economic growth may not be expanding at a barn-burning rate, there still are plenty of indications the economy keeps chugging along. Here are a few economic bright spots to highlight:

  • Accelerating GDP Growth: As you can see from the chart below, broad economic growth, as measured by Gross Domestic Product (GDP), accelerated to a very respectable +3.3% growth rate during the third quarter of 2017 (the fastest percentage gain in three years). These GDP calculations are notoriously volatile figures, nevertheless, the recent results are encouraging, especially considering these third quarter statistics include the dampening effects of Hurricane Harvey and Irma.

Source: Bloomberg

  • Recovering Housing Market: The housing market may not have rebounded as quickly and sharply as the U.S. stock market since the Financial Crisis, but as the chart below shows, new home sales have been on a steady climb since 2011. What’s more, a historically low level of housing inventory should support the continued growth in home prices and home sales for the foreseeable future. The confidence instilled from rising home equity values should also further encourage consumers’ cash and credit card spending habits.

Source: Calculated Risk

  • Healthy Employment Gains: Growth in the U.S. coupled with global synchronous economic expansion in Europe, Asia, and South America have given rise to stronger corporate profits and increased job hiring. The graph highlighted below confirms the 4.1% unemployment rate is the lowest in 17 years, and puts the current rate more than 50% below the last peak of 10.0% hit in 2009.

Source: Calculated Risk

Turbo Tax Time

Adding fuel to the confidence fire is the prospect of the president signing the TCJA (Tax Cuts and Jobs Act). At the time this article went to press, Congress was still feverishly attempting to vote on the most significant tax-code changes since 1986. Republicans by-and-large all want tax reform and tax cut legislation, but the party’s narrow majority in the House and Senate leaves little wiggle room for disagreement. Whether compromises can be met in the coming days/weeks will determine whether a surprise holiday package will be delivered this year or postponed by the Grinch.

Unresolved components of the tax legislation include, the feasibility of cutting the corporate tax rate from 35% to 20%; the deductibility of state and local income taxes (SALT); the potential implementation of a tax cut limit “trigger”, if forecasted economic growth is not achieved; the potential repeal of the estate tax (a.k.a., “death tax”); mortgage interest deductibility; potential repeal of the Obamacare individual mandate; the palatability of legislation expanding deficits by $1 trillion+; debates over the distribution of tax cuts across various taxpayer income brackets; and other exciting proposals that will heighten accountants’ job security, if the TCJA is instituted.

Bitcoin Bubble?

If you have recently spent any time at the watercooler or at a cocktail party, you probably have not been able to escape the question of whether the digital blockchain currency, Bitcoin, is an opportunity of a lifetime or a vehicle to crush your financial dreams to pieces (see Bitcoin primer).

Let’s start with the facts: Bitcoin’s value traded below $1,000 at the beginning of this year and hit $11,000 this week before settling around $10,000 at month’s end (see chart below). In addition, blogger Josh Brown points out the scary reality that “Bitcoin has already crashed by -80% on five separate occasions over the last few years.” Suffice it to say, transacting in a currency that repeatedly loses 80% of its value can pose some challenges.

Source: CoinMarketCap.com  

Bubbles are not a new phenomenon. Not only have I lived through numerous bubbles, but I have also written on the topic (see also Sleeping and Napping through Bubbles). I find the Dutch Tulip Bulb Mania that lasted from 1634 – 1637 to be the most fascinating financial bubble of all (see chart below). At the peak of the euphoria, individual Dutch tulip bulbs were selling for the same prices as homes ($61,700 on an inflation-adjusted basis), and one historical account states 12 acres of land were offered for a single tulip bulb.

Forecasting the next peak of any speculative bubble is a fool’s errand in my mind, so I choose to sit on the sidelines instead. While I may be highly skeptical of the ethereal value placed on Bitcoin and other speculative markets (i.e. ICOs – Initial Coin Offerings), I fully accept the benefits of the digital blockchain payment technology and also acknowledge Bitcoin’s value could more than double from here. However, without any tangible or intellectual process of valuing the asset, history may eventually place Bitcoin in the same garbage heap as the 1630 tulips.

For some of you out there, if you are anything like me, your digestion system is still recovering from the massive quantities of food consumed over the Thanksgiving holiday. However, when it comes to your personal finances, digesting record-breaking stock performance, shifting Federal Reserve monetary policy, tax legislation, and volatile digital currencies can cause just as much heartburn. In the spirit of “giving”, if you are having difficulty in chewing through all the cryptic economic and political noise, “give” yourself a break by contacting an experienced, independent, professional advisor. That’s definitely a gift you deserve!

www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.

December 2, 2017 at 6:30 am Leave a comment

Sleeping and Napping Through Bubbles

We have lived through many investment bubbles in our history, and unfortunately, most investors sleep through the early wealth-creating inflation stages. Typically, the average investor wakes up later to a hot idea once every man, woman, and child have identified the clear trend…right as the bubble is about burst. Sadly, the masses do a great job of identifying financial bubbles at the end of a cycle, but have a tougher time realizing the catastrophic consequences of exiting a tired winner. Or as strategist Jim Stack states, “Bubbles, for the most part, are invisible to those trapped inside the bubble.” The challenge of recognizing bubbles explains why they are more easily classified as bubbles after a colossal collapse occurs. For those speculators chasing a precise exit point on a bubblicious investment, they may be better served by waiting for the prick of the bubble, then take a decade long nap before revisiting the fallen angel investment idea.

Even for the minority of pundits and investors who are able to accurately identify these financial bubbles in advance, a much smaller number of these professionals are actually able to pinpoint when the bubble will burst. Take for example Alan Greenspan, the ex-Federal Reserve Chairman from 1987 to 2006. He managed to correctly identify the technology bubble in late-1996 when he delivered his infamous “irrational exuberance” speech, which questioned the high valuation of the frothy, tech-driven stock market. The only problem with Greenspan’s speech was his timing was massively off. Stated differently, Greenspan was three years premature in calling out the pricking of the bubble, as the NASDAQ index subsequently proceeded to more than triple from early 1997 to early 2000 (the index exploded from about 1,300 to over 5,000).

One of the reasons bubbles are so difficult to time during their later stages is because the deflation period occurs so quickly. As renowned value investor Howard Marks fittingly notes, “The air always goes out a lot faster than it went in.”

Bubbles, Bubbles, Everywhere

Financial bubbles do not occur every day, but thanks to the psychological forces of investor greed and fear, bubbles do occur more often than one might think. As a matter of fact, famed investor Jeremy Grantham claims to have identified 28 bubbles in various global markets since 1920. Definitions vary, but Webster’s Dictionary defines a financial bubble as the following:

A state of booming economic activity (as in a stock market) that often ends in a sudden collapse.

 

Although there is no numerical definition of what defines a bubble or collapse, the financial crisis of 2008 – 2009, which was fueled by a housing and real estate bubble, is the freshest example in most people minds.  However, bubbles go back much further in time – here are a few memorable ones:

Dutch Tulip-Mania: Fear and greed have been ubiquitous since the dawn of mankind, and those emotions even translate over to the buying and selling of tulips. Believe it or not, some 400 years ago in the 1630s, individual Dutch tulip bulbs were selling for the same prices as homes ($61,700 on an inflation-adjusted basis). This bubble ended like all bubbles, as you can see from the chart below.

Source: The Stock Market Crash.net

British Railroad Mania: In the mid-1840s, hundreds of companies applied to build railways in Britain. Like all bubbles, speculators entered the arena, and the majority of companies went under or got gobbled up by larger railway companies.

Roaring 20s: Here in the U.S., the Roaring 1920s eventually led to the great Wall Street Crash of 1929, which finally led to a nearly -90% plunge in the Dow Jones Industrial stock index over a relatively short timeframe. Leverage and speculation were contributors to this bust, which resulted in the Great Depression.

Nifty Fifty: The so-called Nifty Fifty stocks were a concentrated set of glamor stocks or “Blue Chips” that investors and traders piled into. The group of stocks included household names like Avon (AVP), McDonald’s (MCD), Polaroid, Xerox (XRX), IBM and Disney (DIS). At the time, the Nifty Fifty were considered “one-decision” stocks that investors could buy and hold forever. Regrettably, numerous of these hefty priced stocks (many above a 50 P/E) came crashing down about 90% during the 1973-74 period.

Japan’s Nikkei: The Japanese Nikkei 225 index traded at an eye popping Price-Earnings (P/E) ratio of about 60x right before the eventual collapse. The value of the Nikkei index increased over 450% in the eight years leading up to the peak in 1989 (from 6,850 in October 1982 to a peak of 38,957 in December 1989).

Source: Thechartstore.com

The Tech Bubble: We all know how the technology bubble of the late 1990s ended, and it wasn’t pretty. PE ratios above 100 for tech stocks was the norm (see table below), as compared to an overall PE of the S&P 500 index today of about 14x.

Source: Wall Street Journal – March 14, 2000

The Next Bubble

What is/are the next investment bubble(s)? Nobody knows for sure, but readers of Investing Caffeine know that long-term bonds are one fertile area. Given the generational low in yields and rates, and the 35-year bull run in bond prices, it can be difficult to justify heavy allocations of inflation losing bonds for long time-horizon investors. Commercial real estate and Silicon Valley unicorns could be other potential over-heated areas. However, as we discussed earlier, identifying and timing bubble bursts is extremely challenging. Nevertheless, the great thing about long-term investing is that probabilities and valuations ultimately do matter, and therefore a diversified portfolio skewed away from extreme valuations and speculative sectors will pay handsome dividends over the long-run.

Many traders continue to daydream as they chase performance through speculative investment bubbles, looking to squeeze the last ounce of an easily identifiable trend.  As the lead investment manager at Sidoxia Capital Management, I spend less time sucking the last puff out of a cigarette, and spend more time opportunistically devoting resources to valuation-sensitive growth trends.  As demonstrated with historical examples, following the popular trend du jour eventually leads to financial ruin and nightmares. Avoiding bubbles and pursuing fairly priced growth prospects is the way to achieve investment prosperity…and provide sweet dreams.

investment-questions-border

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), MCD, DIS and are short TLT, but at the time of publishing SCM had no direct positions in AVP, XRX, IBM,or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.

November 26, 2016 at 9:09 am 3 comments

Sleeping Through Bubbles and Decade Long Naps

We have lived through many investment bubbles in our history, and unfortunately most investors sleep through the early wealth-creating inflation stages. Typically, the average investor wakes up later to a hot idea once every man, woman, and child has identified the clear trend…right as the bubble is about burst. Sadly, the masses do a great job of identifying financial bubbles at the end of a cycle, but have a tougher time realizing the catastrophic consequences of exiting a tired winner. Or as strategist Jim Stack states, “Bubbles, for the most part, are invisible to those trapped inside the bubble.” The challenge of recognizing bubbles explains why they are more easily classified as bubbles after a colossal collapse occurs. For those speculators chasing a precise exit point on a bubblicious investment, they may be better served by waiting for the prick of the bubble, then take a decade long nap before revisiting the fallen angel investment idea.

Even for the minority of pundits and investors who are able to accurately identify these financial bubbles in advance, a much smaller number of these professionals are actually able to pinpoint when the bubble will burst. Take for example Alan Greenspan, the ex-Federal Reserve Chairman from 1987 to 2006. He managed to correctly identify the technology bubble in late-1996 when he delivered his infamous “irrational exuberance” speech, which questioned the high valuation of the frothy, tech-driven stock market. The only problem with Greenspan’s speech was his timing was massively off. Stated differently, Greenspan was three years premature in calling out the pricking of the bubble, as the NASDAQ index subsequently proceeded to more than triple from early 1997 to early 2000 (the index exploded from about 1,300 to over 5,000).

One of the reasons bubbles are so difficult to time during their later stages is because the deflation period occurs so quickly. As renowned value investor Howard Marks fittingly notes, “The air always goes out a lot faster than it went in.”

Bubbles, Bubbles, Everywhere

Financial bubbles do not occur every day, but thanks to the psychological forces of investor greed and fear, bubbles do occur more often than one might think. As a matter of fact, famed investor Jeremy Grantham claims to have identified 28 bubbles in various global markets since 1920. Definitions vary, but Webster’s Dictionary defines a financial bubble as the following:

A state of booming economic activity (as in a stock market) that often ends in a sudden collapse.

 

Although there is no numerical definition of what defines a bubble or collapse, the financial crisis of 2008 – 2009, which was fueled by a housing and real estate bubble, is the freshest example in most people minds.  However, bubbles go back much further in time – here are a few memorable ones:

Dutch Tulip-Mania: Fear and greed have been ubiquitous since the dawn of mankind, and those emotions even translate over to the buying and selling of tulips. Believe it or not, some 400 years ago in the 1630s, individual Dutch tulip bulbs were selling for the same prices as homes ($61,700 on an inflation adjusted basis). This bubble ended like all bubbles, as you can see from the chart below.

Source: The Stock Market Crash.net

British Railroad Mania: In the mid-1840s, hundreds of companies applied to build railways in Britain. Like all bubbles, speculators entered the arena, and the majority of companies went under or got gobbled up by larger railway companies.

Roaring 20s: Here in the U.S., the Roaring 1920s eventually led to the great Wall Street Crash of 1929, which finally led to a nearly -90% plunge in the Dow Jones Industrial stock index over a relatively short timeframe. Leverage and speculation were contributors to this bust, which resulted in the Great Depression.

Nifty Fifty: The so-called Nifty Fifty stocks were a concentrated set of glamour stocks or “Blue Chips” that investors and traders piled into. The group of stocks included household names like Avon (AVP), McDonald’s (MCD), Polaroid, Xerox (XRX), IBM and Disney (DIS). At the time, the Nifty Fifty were considered “one-decision” stocks that investors could buy and hold forever. Regrettably, numerous of these hefty priced stocks (many above a 50 P/E) came crashing down about 90% during the1973-74 period.

Japan’s Nikkei: The Japanese Nikkei 225 index traded at an eye popping Price-Earnings (P/E) ratio of about 60x right before the eventual collapse. The value of the Nikkei index increased over 450% in the eight years leading up to the peak in 1989 (from 6,850 in October 1982 to a peak of 38,957 in December 1989).

Source: Thechartstore.com

The Tech Bubble: We all know how the technology bubble of the late 1990s ended, and it wasn’t pretty. PE ratios above 100 for tech stocks was the norm (see table below), as compared to an overall PE of the S&P 500 index today of about 14x.

Source: Wall Street Journal – March 14, 2000

The Next Bubble

What is/are the next investment bubble(s)? Nobody knows for sure, but readers of Investing Caffeine know that long-term bonds are one fertile area. Given the generational low in yields and rates, and the near doubling of long-term Treasury prices over the last twelve years, it can be difficult to justify heavy allocations of inflation losing bonds for long time-horizon investors. Gold, another asset class that has increased massively in price (over 6-fold rise since about 2000) and attracted swaths of speculators, is another target area. However, as we discussed earlier, timing bubble bursts is extremely challenging. Nevertheless, the great thing about long-term investing is that probabilities and valuations ultimately do matter, and therefore a diversified portfolio skewed away from extreme valuations and speculative sectors will pay handsome dividends over the long-run.

Many traders continue to daydream as they chase performance through speculative investment bubbles, looking to squeeze the last ounce of an easily identifiable trend.  As the lead investment manager at Sidoxia Capital Management, I spend less time sucking the last puff out of a cigarette, and spend more time opportunistically devoting resources to less popular growth trends.  As demonstrated with historical examples, following the trend du jour eventually leads to financial ruin and nightmares. Avoiding bubbles and pursuing fairly priced growth prospects is the way to achieve investment prosperity…and provide sweet dreams.

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs) and are short TLT, but at the time of publishing SCM had no direct positions in AVP, MCD, XRX, IBM, DIS, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.

October 15, 2012 at 4:38 pm 1 comment


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