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Musings Report 2021-2 1-9-21 Warning Light Flashing Red
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For those who are new to the Musings reports: they're a glimpse into my notebook, the unfiltered swamp where I organize future themes, sort through the dozens of stories and links submitted by readers, refine my own research and start connecting dots which appear later in the blog or in my books. As always, I hope the Musings spark new appraisals and insights. Thank you for supporting the site and for inviting me into your circle of correspondents.
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Warning Light Flashing Red
Not every reader has an IRA or 401K, but for those who do, the red warning light is flashing red: markets are in bubble territory, very similar to the dot-com blow-off top in early 2000.
Just like in 2000, proponents claim "this time it's different." Back then, the claim was that since the Internet would be growing for decades, dot-com stocks could go to the moon and beyond.
The claim the the Internet would continue growing was sound, but the prediction that this growth would drive stock valuations into a never-ending bubble was unsound.
Once again we hear reasonable-sounding claims being used to support predictions of a never-ending rise in stock valuations.
Courtesy of Sven Henrich, here are the charts of Cisco Systems in early 2000 and Tesla in early 2021. There is a remarkable similarity.
Courtesy of Tom McClellan, here is a chart of NASDAQ volume in a ratio with New York Stock Exchange (NYSE) volume. Notice the spike to dot-com era highs.
Lastly, here's a chart of financial assets as a percentage of Gross Domestic Product (GDP). Note that in the "Glorious Thirty" years of the postwar era of broad-based prosperity, financial assets were around 3 times GDP.
This ratio increased with every one of the three bubbles since the mid-1990s: the dot-com bubble in 1999-2000, the Global Financial Meltdown in 2008-09 and now the bubble of 2020-21. Financial assets are now 6 times the size of the "real economy" (GDP).
This reflects the dominance of financial assets based on extreme expansions of debt, leverage and speculation.
Despite all the assurances to the contrary, all bubbles pop because they are based in human emotions, not the real world. We attempt to rationalize them by invoking the real world, but the reality is bubbles are manifestations of human emotions and the feedback of being in a herd of social animals.
As I've noted here several times, extremes can get more extreme, and predicting the final leg higher in an extreme is a fool's game. Nonetheless, the similarities to previous "this time it's different" bubbles that popped spectacularly suggests having a prudent plan to preserve capital in place.
This is not investment advice, of course. I am merely pointing out the similarities and noting that the conventional capital-preservation strategy is to select sell-stops--the point at which you have decided to sell to preserve capital and collect whatever gains you have--and / or establish a hedge, for example, buying puts on the SPY (S&P 500 ETF) that will rise in value should the S&P 500 index drop.
The red warning light of extremes in sentiment, valuation, etc. can flash for quite some time, but as I've noted over the years, speculative bubbles generally display symmetry: those that spike higher tend to collapse in a mirror-image of the manic rise. This symmetry isn't perfect, of course, just as correlations are rarely if ever perfect, but as a generality, bubbles tend to display symmetry as manic greed slips into doubt and then slides into panicked fear.
One condition to keep in mind is the dominance of ETFs (exchange-traded funds) and index funds. As money pours into these passive funds, the funds buy whatever stocks are in the ETF or index. Good, bad and indifferent stocks in each ETF or index are purchased without any assessment of their relative value.
When owners sell, the process is reversed: every stock in the ETF or index is automatically sold to fund the redemption. This leads to "the baby being thrown out with the bathwater" as the best performing companies get sold off with the dregs in the ETF or index.
Another condition to keep in mind is the reliance of bubbles on borrowed money (margin debt) and leverage: 2X and 3X leveraged ETFs and a variety of financialization tricks to increase leverage and thus gains. When assets that have been leveraged reverse even modestly, the losses are quickly consequential, and the "solution" is to liquidate every leveraged asset before the position is wiped out. Selling begets selling, and this is the self-reinforcing feedback of crashes.
A third condition to keep in mind is the decline of short interest to all-time lows. Put another way, the number of speculators who have an incentive to buy shares in a decline is near all-time lows, so the only buyers in a real decline will be "buy the dip" players who will soon be wiped out if the decline continues.
A fourth condition to keep in mind is the narrowing of the speculative universe into a few assets. Telsa (TSLA) and bitcoin (BTC) are leading their sectors higher, but without broad participation. This creates an extreme dependency on the rocket ship to keep soaring lest the entire ETF / index fund world collapse.
A fifth condition to keep in mind is the potential for the Covid virus to spread beyond current expectations. Such an expansion could easily trigger a global slowdown / recession.
A sixth point to keep in mind is that all fiscal and monetary stimulus suffers from diminishing returns: where the first $1 may generate $1.20 of activity, the later $1 may only generate 75 cents of activity--less than the cost.
When the warning light is flashing red, it's prudent to have a capital preservation strategy in place. If the rockets keep soaring ever higher, then your plan remains dormant. But if bubbles burst, then your plan will do its job of preserving your capital.
Highlights of the Blog
Podcasts:
Jay Taylor: The Fourth Estate's Role in Thrusting America into Fascism (27 minutes)
Posts:
The Tyranny Nobody Talks About (1/7/21)
The Coming War on Wealth and the Wealthy (1/5/21)
2020 Was a Snack, 2021 Is the Main Course (1/3/21)
Best Thing That Happened To Me This Week
Harvested large beautiful leaves of malabar spinach. Malabar is easy to grow and delicious/nutritious steamed or stir-fried.
From Left Field
Meet the Woman Making Bamboo Bikes in Ghana
The Hydrogen Hoax: Confessions of a Former Hydrogenist
Artificial intelligence and its limits: An understanding of AI’s limitations is starting to sink in
Shunned, Shattered, Shamate: A New Film Spotlights China’s Most Hated Subculture: Documentary 'We Were Smart' sheds light on the shunned subculture shamate and China’s urban-rural gulf.
The Rich Got Richer During COVID-19. Here's How American Billionaires Performed-- cue the French Revolution Redux....
Viral Video Shows NYC Bike Thugs Attacking BMW In Manhattan--soon to be the New Normal in urban America...
More Than Half Of Chinese Adults Overweight As Obesity Becomes Latest Health Crisis -- diabesity has been soaring in China for 20 years, and the trend continues...
Crowdfunding a monthly income: an analysis of the membership platform Patreon -- "Our data show that the income distribution at Patreon is very skewed. The top 1% of campaigns make at least $2500 monthly while the majority of all campaigns attract only negligible amounts."
Building the Middle Class of the Creator Economy: The American Dream exists, but what is the reality? (via Maoxian) "On Spotify, artists need 3.5 million streams per year to achieve the annual earnings for a full-time minimum-wage worker of $15,080."
When inflation refuses to appear
Polarization, Then a Crash: Michael Hudson on the Rentier Economy
Gunfire and Crashing Cars: In Struggling Neighborhoods, 'We're Losing Our Grip' A year of hardship in parts of Cleveland has left many with the sense that the fabric of their communities was fraying.
"The best way to predict the future is to create it yourself." Peter Diamandis
Thanks for reading--
charles |
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