Dismal Future Financial Asset Returns:

Commentary by J.P. Morgan Asset Management

Revised on Dec. 5, 2016 as follows: In addition to the reference to John Hussman (see below at the very end), I added references to Robert Shiller and Fama & French.

On page 12 of the Nov. 28, 2016 issue of the magazine Pensions & Investments was printed an article authored by John Bilton, the London-based managing director and global head of multi-asset strategy at J. P. Morgan Asset Management. The article caught my attenion.

The article's title was "Asset owners face daunting path from continuing central bank challenges." Below are some salient excerpts. Emphasis mine.

"The extremely accommodative central bank policy of recent years may well have prevented economic Armageddon, but it also drove asset returns far in excess of underlying economic growth. In the past 50 years, U.S. stocks have, on average, outrun gross domestic product growth threefold during phases of economic expansion. In this post-financial crisis expansion, U.S. stock markets have outstripped the U.S. economy by almost eight times. Absenting a remarkable sustained and successful period of fiscal stimulus, an inescapable conclusion is that this extended period of policy largesse -- designed to stabilize the economy -- resulted in asset returns being borrowed from the future, and now that future is here."

Some comments for readers who may be less familiar with facets of what's being said: 

• The "accommodative central bank policy" and "period of policy largesse" both refer to policies of quantitative easing since the Great Financial Crisis of 2008/2009.
• The author is making the valid comparison between stock market growth rates and growth rates in the real economy. Think of it in these steps: (1) The real economy grows. (2) Company earnings grow. (3) Stock prices rise. Withouth (1), (3) is not based on fundamentals but on what we can call investor sentiment or risk tolerance.
• The author's mention of "fiscal stimulus" is reference to president-elect Donald Trump's intention to spend $1 trillion on infrastructure projects over a 10-year period. (The media has reported on this at the following sources: Washington Post, CNN, CNN Money, Politico, FiscalTimes, BusinessInsider)
• The author wants readers to understand that equity markets cannot go up forever and that if they have already gone up too much, they are likely to either not go up for a while or worse, drop.
• Personally, I found the contrast between a "threefold" increase from history and the "almost eight times" increase in the current cycle jaw-dropping.

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On to the next excerpt. Emphasis mine.

"We find ourselves caught in an uncomfortable, but potentially enduring equilibrium: growth is unlikely to be strong enough to support a sharp rise in interest rates, yet at the same time the exuberance and excess that often mark the end stage of an economic cycle are palpably absent. Some may call this a "Goldilocks" scenario; but if it is, then it's a rather bleak read of the fairytale [sic]. Poor demographics and weak productivity combine to peg the long-term outlook for developed market real growth at just 1.5% over the next decade. This translates to a significantly slower and shallower path of global interest rate increases, and lower terminal rates for both the cash rate and 10-year yields. In turn, any hope asset owners have for higher yields or better growth is likely to be a long time coming."

My comments:

• If the current situation is indeed an equilibrium, meaning that if we believe that it will persist, it characterizes quite a strange world because of the following. (A) Economic growth is anemic and as a result, interest rates won't be able to go up, but still, the Fed intends to raise them. (B) Despite the fact that we are most likely at the end of a business cycle, sentiment among people and investors is not one of exuberance and excess.
• The fact of the matter is that we face a future characterized by "poor demographics" and "weak economic productivity", neither of which signals strong economic growth. Therefore, we should expect a slow path of interest rate increases across the globe.
• The bottom line is that bond investors hoping for "higher yields" (in order to buy bonds) should restrain their hope. So should equity investors hoping for higher stock prices based on "better growth".

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On to the next excerpt. Emphasis mine.

"A future in which returns are expected to be muted means that reaching the hurdle rate to meet long-term objectives -- like the increasingly elusive but still psychologically powerful 8% annual return target historically considered achievable for a balanced, moderate risk portfolio -- is going to require a lot more creative thinking and much more active diversification."

My comments:

• It is a mathematical fact that at 8% annual growth, capital doubles every 9 years. In contrast, at a 1.5% annual growth rate, capital doubles every 47 years! (Assuming annual compounding) There is a generation of difference between 9 years and 47 years.
• The future does not look good for investors. This includes pension funds and insurance companies! It should also be a wake-up call for retirees and those approaching retirement age.

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On to the next excerpt. Emphasis mine.

"Based on a multidecade [sic] set of assumptions that underscores the economic and capital market estimates we have been compiling for the past 21 years, on a 10- to 15-year outlook, ... real assets are likely to hold up best in a world of challenged growth and lackluster returns."

My comments:

• The author's observations about "real assets" is based on historical data. It is not an opinion. (However, one could argue that 21 years is too short of a look-back period, and especially given the strange nature of the "current equilibirum," that we ought to be looking back all the way to the 1929 Great Depression and even further back ... This is easier said that done because it is certainly not be easy to obtain the data. Some have tried, successfully. E.g. (1) quantitative equity manager John Hussman, (2) Robert Shiller, (3) Fama & French.)
• "Real assets" consist of the following, which is not necessarily exhaustive list: real estate, infrastructure (toll roads and bridges, oil & gas pipelines), timberland, farmland, precious metals, fine art, and collectibles.

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US Interest Rate Forecasts:

On Eve of Rate Hike #2 since 2008/2009

Back in early 2015 or about 3 months shy of 2 years ago, I blogged about the Fed's intentions to raise rates through the end of 2017. (Here's the link to that blog post).

In this blog, I will state what has occurred so far. But first, let me reiterate the Fed's plans from back in early 2015.

Back in early 2015, the Fed had projected the following rate increases:

• 0.5% increase by 2015 year end,
• 1.25% increase by 2016 year end, 
• 1.25% increase by 2017 year end.

Back in early 2015, the futures market had the following expectations for rate increases:

• 0.38% increase by 2015 year end,
• 0.75% increase  by 2016 year end,
• 0.6% increase by 2017 year end.

So, what transpired?

1) The Fed raised rates by 0.25% in December 2015. They are now 0.5%; see this source or this other source. (With time, the data at these sources may change and become irrelevant ...)

2) The Fed is expected to raise rates by another 0.25% when it meets later this month on Dec. 13 and 14.  See this source. The futures market is predicting with almost certainty that this raise will occur.

It is noteworthy that so far, the Fed has fallen short of not only its own projections but also the futures market's smaller projections.

What does this mean? I think it means that the economy is not strong enough to handle a higher interest rate.

For future reference, the following Wikipedia article documents the history of Fed's actions.

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The Part of Life We Really Live

On July 31, 2016, Northman Trader, whom I follow on Twitter, wrote: One of my favorite historical writers is Seneca the Younger. He, like all of us, was a flawed human being but I appreciate his wisdom, realism and philosophical musings. Born in Spain he became a personal tutor and advisor to Emperor Nero and had a front row seat to power in Rome during some of its glory days and time of madness. In the “Shortness of Life” he, a man in his own time, wrote among other things:

“The part of life we really live is small….Consider how much of your time was taken up with a moneylender, how much with a mistress, how much with a patron, how much with a client, how much in wrangling with your wife, how much in punishing your slaves, how much in rushing about the city on social duties. Add the diseases which we have caused by our own acts, add, too, the time that has lain idle and unused; you will see that you have fewer years to your credit than you count. You will hear many men saying: “After my fiftieth year I shall retire into leisure, my sixtieth year shall release me from public duties.” And what guarantee, pray, have you that your life will last longer? Who will suffer your course to be just as you plan it? Are you not ashamed to reserve for yourself only the remnant of life, and to set apart for wisdom only that time which cannot be devoted to any business? How late it is to begin to live just when we must cease to live! What foolish forgetfulness of mortality to postpone wholesome plans to the fiftieth and sixtieth year, and to intend to begin life at a point to which few have attained!”

Excerpted from the following Tweet: https://twitter.com/northmantrader/status/759700492691787776  

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How can central banks impose negative interest rates without causing cash hoarding?

or

A primer on negative interest rate policy as a new tool in the monetary policy toolkit

or

Eliminating the Zero Lower Bound on Interest Rates

(I recommend that readers not follow any of the links until they had read this blog post in its entirety. The links are intended to provide supporting evidence and make further exploration possible.)

(I have provided key dates so that readers can get a sense of the time lag associated with the dissemination of a new idea such as the one being discussed in this article.)

I performed a Google search on "negative interest rate policy theoretical underpinnings". The 4th highest result was a link to an academic paper by Harvard-educated economist Miles Kimball, published by National Institute Economic Review in Nov. 2015.

Here's my own concise summary of negative interest rate policy.

Why impose a negative interest rate as monetary policy? 

In order to lower the profitability hurdle on investment projects: it reduces the cost of debt financing. For example, in housing, mortgage rates would drop as a result. 

On some level, it's the same old matter of cutting interest rates to stimulate growth.  During serious recessions, negative interest rates are the key to quick economic recovery. 

Which interest rate are we talking about? 

The shortest term interest rate, the one that can be set by a central bank. Whatever happens to yields on longer maturity bonds is a separate matter, i.e. a matter of market clearing.

But won't this cost savers and depositors? 

No, because having, say, a negative 4% interest rate for one year is better than essentially a 0% interest rate from 2009 and ongoing. Once economic growth resumes, a central bank can raise interest rates into the positive range.

But won't this cause hoarding of cash? 

No, because paper money will be "made" to be less valuable than electronic money. E.g. A $100 bill would be made to have the purchasing power of, say, $96 of electronic money. By analogy, today when a consumer uses a credit card to make a $100 purchase, the retail store receives about $97 because of the cut taken by the credit card company.

How will they "make" paper money less valuable than electronic money? 

By imposing a deposit fee on paper money. I.e. Depositing paper money into a bank account will incur a fee. (Kimball says that this fee would need to be charged only when banks deposit cash at the central bank. I'm guessing that banks would charge savers a similar fee when they make deposits into their bank accounts.) This fee ought to reduce savers' incentive to hoard cash. 

This deposit fee should grow with time so long as negative interest rats are in effect. Kimball says, "From a technical point of view, we know how to eliminate the "zero lower bound"".

What will happen to other asset prices such as gold? 

Any asset whose price is free to fluctuate will rise under negative interest rates in order to result in a lower future rate of return. Examples: gold, IG (investment grade) corporate bonds, consumer staples equities, telecom equities, utilities equities. (I ask myself how this is different from hoarding; it may not be hoarding, but it would be shifting out of cash.) 

This is also bullish for the US dollar as an international currency if we believe that other countries will implement negative interest rate policies before the US, as is the case today in 6 countries.

List of countries with negative interest rates today

Japan, Euro area, Sweden, Switzerland, Denmark, Hungary. A total of six.

Earliest to implement was Sweden sometime after May 2015. 

Largest negative interest rate today is -0.75% in Switzerland. 

Japan announced negative interest rates in Jan 2016, but they didn't become effective until April 2016, but they didn't implement a deposit fee on paper money.

None of the others in the above list have depreciated paper currency relative to electronic currency. If Twitter postings are good evidence, they are watching and monitoring cash hoarding. (The hashtag #NegativeRates is a good one to search on. Click here to perform this search in Twitter.)

Here's a list of countries by central bank interest rates, possibly not up to date.

(This begs the question as to why the Japanese yen has been strengthening given a negative interest rate policy in that country since last April ... Alternatively, it could be that negative interest rates are a tool for countering a country's appreciating currency ...)

What is the essential idea behind implementing negative interest rates? 

The essential idea is to make paper money separate and distinct from electronic money; to make paper money less valuable than electronic money. In a sense, the real money would be electronic money. There would be an exchange rate between the two types of money. In normal times, this exchange rate would be 1:1. Whenever negative interest rates prevailed, the exchange rate would be something like 1 unit of electronic money being worth 0.96 of paper money.

Political & psychological hurdles

All of the following have to come on board: economist community, the public, legislature, the central bank. 

Ben Bernanke's primer on negative interest rate policy fails to mention that paper money would take on an inferior role (less valuable) to electronic money. This may be the biggest hurdles.

Discussion

It's not clear whether we should try fiscal policy before trying negative interest rates. Perhaps "helicopter money" will be tried first. 

It's also not clear whether investment rates will increase as a result of a lower cost of debt financing: if there's no aggregate demand, who is going to buy the newly produced goods and services? Nevertheless, cutting interest rates in order to stimulate economic growth is standard monetary policy, but in the past, this has always entailed dropping rates from a higher positive rate to a lower positive one (but never to a negative one).

Negative rate policy assumes that the long run equilibrium interest rate is positive (which is a reasonable assumption), meaning that negative short term interest rates will be nothing but transitory.

Further exploration

Coming up to speed on negative interest rate policy

1. Kimball's 5-minute video on negative interest rate policy, May 2015. 
2. Economic underpinnings of negative interest rates, blog article dated July 2013. Conceptually important!
3. A qualitative introduction to the economics of negative interest rate policy, blog article dated Oct. 2013.
4. Kimball's 20-minute video on negative interest rate policy, June 2016. This was a talk given at the Brookings Institute in the presence of Ben Bernanke and other central bankers and economists. Kimball thinks that the US won't need to go to negative interest rates for another five years, i.e. not before 2021. The moderator thought it wouldn't happen in his lifetime and he stated his age as 73. Ken Rogoff has a relevant book coming out in August 2016 entitled "The Curse of Cash" which calls for eliminating paper money; it is apparently endorsed by Ben Bernanke and Mohammed El-Erian. 

Dissemination of this idea

1. Total of 36 talks given by Miles Kimball over 33 months from May 2013 to Jan 2016. See list here.
2. Central banker support for negative interest rate policy, as of July 2015. 

Academic papers authored or co-authored by Miles Kimball on the subject

1. IMF working paper, Oct. 2015. 
2. Paper published in National Institute of Economic Review, Nov. 2015.

Information vault

1. Kimball's homepage for "crossing the zero lower bound" on interest rates. 

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Effect of Debt on Economic Growth:

Is it positive or negative?

or

Is Austerity the Right Policy Response to High Debt Levels?

This article introduces Miles Kimball, a Harvard-educated macroeconomist. It also shows how current macroeconomic thinking is in flux.

(I recommend reading this blog post in its entirety before following any of the links. The links are intended to serve as supporting evidence and provide the opportunity to explore further.)

Around 2009, Harvard economists Carmen Reinhart and Kenneth Rogoff performed data analysis to conclude that high debt levels slow down economic growth. I happened to read about this in their 500-page book entitled "This Time Is Different", published in 2009 and reprinted in 2011, wherein they examined 8 centuries worth of historical evidence. 

Later, in 2013, Reinhart and Rogoff's conclusion was refuted through further data analysis by Amherst researchers and also by Harvard-educated economist Miles Kimball and colleagues. (Link to Kimball's profile on Wikipedia; link to his home page; link to his blog.)

The controversy itself is described in Wikipedia here.  At the end of this Wikipedia article, there's a quote from Nobel Prize-winning Princeton economist Paul Krugmann indicating that he agrees with Kimball's and others' refutation of Reinhart and Rogoff's assertion.

• Kimball's first blog on this matter. (This was the starting point for my article. Before that, I stumbled upon Miles Kimball through the following Tweet and listened to him firsthand in this podcast dated May 9, 2016. There, I found out that he had recently spoken at the Bank of England along with Kenneth Rogoff who had sided with him, apparently.)

• Kimball's second blog on this matter. 

• Kimball's blog home page containing both blogs. This home page is a subset of his blogs and is confined to "short run fiscal policy".

My summary of Kimball's analysis is the following.

Although low economic growth causes high debt levels, it's not true that high debt levels cause low economic growth. 

Policy implication: austerity is not the right policy response to high debt levels.

Kimball isn't all out in favor of debt either. He ends his second blog with the following:

"It is painful enough that debt has to be paid back (with some combination of interest and principal), and high levels of debt may help cause debt crises like those we have seen for Ireland and Greece. But the bottom line from our examination of the entrails is that the omens and portents in the Reinhart and Rogoff data do not back up the argument that debt has a negative effect on economic growth." [emphasis mine]

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Excerpts from James Grants' 

Talk at Google

I Tweeted about James Grant's Google talk here.

The following are some excerpts. 

Material in blue font is Jim's. Material in black font is mine.

In the old days, when a bank needed additional capital, its shareholders would provide it. This was a legal requirement. Nowadays, it's the government that provides it from taxpayer money.

We need to restore individual responsibility on Wall St. Those who benefit from the upside are not bearing any of the costs on the downside. Interpretation: This is testimony to the power of Wall St. Note the array of public officials who have worked on Wall St. before assuming public office.

The only banking institution that didn't receive or require any government bailout during the 2008/2009 Great Financial Crisis was a New York bank named Brown Brothers Hariman. Why? Because they are a partnership where the partners are personally liable for the bank's liabilities. The partners are individually responsible for the risks taken on by the bank.

The 1920/1921 depression self-corrected in 18 months. The 2008/2009 Great Financial Crisis hasn't been set right after 7-8 years of Fed intervention.

The US no longer believes in Adam Smith's invisible hand. Instead it believes in command and control. It's like Poland in the 1950s.  But it's not working!

The Fed employs 700 PhD economists. They are well-intentioned and well-trained, but lack in common sense. Why? Because they missed the subprime mortgage crisis not by 5 miles but by 5,000 miles.

The Swiss national bank creates Swiss francs with the click of a mouse. It then buys shares in American companies. Thus, it gets "something from nothing." How does this make any sense? Money needs to be tied to some kind of material object that has value. Grant is a self-declared gold bug.

Prices, in this case the interest rate (which is the price of credit), need to be "discovered" through the market mechanism, not "administered". The Fed has been doing the latter! Yet the Fed continues to believe that it is better for society that interest rates be administered rather than discovered. This isn't a market economy, but this is the US that we're talking about! 

On US defaulting on its debt. It has already defaulted twice: 1933 and 1975. When inflation exceeds the Treasury bond yield, that's also a form of default.

The present value of US public unfunded liabilities is $120 trillion. Source: Cato Institute, Jeffrey Miron. The US is bound to default in some nuanced form, but it won't necessarily be perceived as outright default.

The US Fed is a monopoly and we all know that monopolies aren't good for society. So why not create competition for it and see what happens? The competition would be to allow, for example, for gold and silver to act as money.

In 1979/1980 when long-term Treasuries were yielding 15%, investors were scared to buy them because previously, they had yielded 9% or less. This meant that bond holders looking backward in time had suffered capital losses due to the fall in bond prices; bond prices fall when yields rise. However, that would have been a great buy because the investor would be locking in a 15% annual yield for 25-30 years. Incredible returns by today's standards.

Today, Treasuries are yielding around 2% and investors still scramble to buy them because since 1980, bond yields have been dropping and so bond holders have experienced capital gains due to a rise in the bond price level; bond prices rise when yields fall.  Interpretation: humans aren't good at detecting turning points in the market. They think that the future will be a continuation of the past. 

Today, there's over $10 trillion worth of government bonds around the globe that have a negative yield. (See the evidence here.) This means that holders of these bonds are paying the issuer for lending it their money! Why is this happening? Because many institutions (insurance companies, pension funds) are mandated to invest in nothing but "safe" securities. There's nothing safe about a negative yielding bond! Central banks are another buyer.

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James Grant gave the above talk in May 2016. In the prior month, he wrote an article that appeared in Time Magazine which I wrote about. See my Tweet and blog post about that article.

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Added on June 7, 2016.

The British author Trevor-Roper has said that the history of thought has not been a straight path from darkness to lightness. Grant seems to be suggesting that monetary policy today may be in the dark and that the US economy in 1920/1921 was in some ways operating better than today.

Description of 1920/1921 Depression

The following description is interesting because it shows how market forces when left unrestricted can lead to self-correcting adjustments that lead to economic recovery and coming out of a depression.

Industrial production fell by 30% between 1920 and 1921 from peak to trough. There was severe unemployment, certainly in the double digits. The stock market was down by half. Commodity prices were down by 40 odd percent. Corporate profits were down by 90%.

The government met this situation with a balanced budget, and with higher not lower interest rates. The latter was perhaps a mistake. 

What proceeded to happen was that markets adjusted.  Prices fell. Wages fell. Because wages fell, profit margins were restored at lower levels of selling prices. So, prices came down. Wages came down too. Equilibrium was restored at lower levels of activity. Because things were cheap, profit seeking individuals sought opportunities. Foreigners sent money to the US for that very purpose.

The gold price was fixed. But the cost of mining it fell. And because the cost of mining it fell, profit margins for the miners increased, and they proceeded to produce more of what in a depression the world needs more, which is money. So automatic forces, or quasi-automatic forces in the marketplace proceeded to do what government actions in this particular long-running cycle -- i.e. 2008 to 2016 -- have so far simply failed to do.

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My Personal Reaction

to Stanley Druckenmiller's Presentation

at Sohn Conference

So, if Druckenmiller sees the world this way (see full article at ZeroHedge or my excerpts of it), why doesn't the mainstream media see it his way? By reading the mainstream media, you would think that everything was normal ...

Maybe that's not their job ....

Or maybe they aren't independent ....

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So, what is an investor to do? Maybe, borrow cheap capital and invest in private projects. Maybe, invest in income-producing hard assets.

Or, short the equity market(s)?

Or, buy gold? Which is what Druckenmiller claims to have done.

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Easy questions to ask. Answers, not that easy. 

Which reminds me: 

When they asked Soros in an interview what he has learnt when he looks back at history and his own investing experience, he answered, "I learnt to expect the unexpected." It's a hard lesson to digest because our natural tendency as humans is to think/believe that tomorrow will be the same as today.

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Excerpts from Stanley Druckenmiller's

Talk at the Sohn Conference,

May 4, 2016

Stanley Druckenmiller spoke at the Sohn Conference recently. ZeroHedge printed an article on it which I Tweeted. See link to that article here.

Below, I present excerpts from that article which I have prefaced with my own questions. So, it's as though Druckenmiller was answering my set of questions. I think this makes for a more interesting read.

Anything in bold or underlined is from the original article except, of course, the questions themselves which are mine.

What has been the goal of most policymakers since the 2008/09 Great Financial Crisis? Has it been to leverage or deleverage?

Druckenmiller: The policy response to the global crisis was, and more importantly, remains so forceful that it has prevented any real deleveraging from happening. Leverage has actually increased globally. Ironically from where I stand, that has been the intended goal of most policymakers today.

Is the Fed being as "data dependent" as they claim to be?

Druckenmiller: If the Fed was using an average of Volcker and Greenspan’s response to data as implied by standard Taylor rules, Fed Funds would be close to 3% today. In other words, and quite ironically, this is the least “data dependent” Fed we have had in history. 

How does today's investment environment compare to the early 1980's? Which one promises superior returns to investors?

Druckenmiller: When I started Duquesne in February of 1981, the risk free rate of return, 5 year treasuries, was 15%. Real rates were close to 5%. We were setting up for one of the greatest bull markets in financial history as assets were priced incredibly cheaply to compete with risk free rates and Volcker’s brutal monetary squeeze forced much needed restructuring at the macro and micro level. It is not a coincidence that strange bedfellows Tip O’Neill and Ronald Reagan produced the last major reforms in social security and taxes shortly thereafter. Moreover, the 15% hurdle rate forced corporations to invest their capital wisely and engage in their own structural reform. If this led to one of the greatest investment environments ever, how can the mirror of it, which is where we are today, also be a great investment environment? 

What seems to be the vision of today's central bankers?

Druckenmiller: The obsession with short-term stimuli contrasts with the structural reform mindset back in the early 80s. Volcker was willing to sacrifice near term pain to rid the economy of inflation and drive reform. The turbulence he engineered led to a productivity boom, a surge in real growth, and a 25 year bull market. The myopia of today’s central bankers is leading to the opposite, reckless behavior at the government and corporate level. Five years ago, one could have argued it was in search of “escape velocity.” But the sub-par economic growth we are experiencing in the 8th year of a radical monetary experiment and in Japan after more than 20 years has blown that theory out of the water.

What is the Fed's end game?

Druckenmiller: The Fed has no end game. The Fed’s objective seems to be getting by another 6 months without a 20% decline in the S&P and avoiding a recession over the near term.

What is the major divergence between EBITDA and corporate debt today?

Druckenmiller: As you can see, the growth in operating cash flow peaked 5 years ago and turned negative year over year recently even as net debt continues to grow at an incredibly high pace. Never in the post-World War II period has this happened. 

How would you summarize the American corporate sector today?

Druckenmiller: The corporate sector today is stuck in a vicious cycle of earnings management, questionable allocation of capital, low productivity, declining margins, and growing indebtedness. And we are paying 18X for the asset class.

How would you summarize the Chinese debt situation today?

Druckenmiller: China: As a result, unlike the pre-stimulus period, when it took $1.50 to generate a $1.00 of GDP, it now takes $7. This is extremely rare and dangerous. The most recent historical analogue was the U.S. in the mid- 2000’s when the debt needed to generate a $ of GDP increased from  $1.50 to $6 during the subprime mania. 

Do you perceive the US stock market as overvalued or undervalued today?

Druckenmiller: If we have borrowed more from our future than any time in history and markets value the future, we should be selling at a discount, not a premium to historic valuations. It is hard to avoid the comparison with 1982 when the market sold for 7x depressed earnings with dozens of rate cuts and productivity rising going forward vs. 18x inflated earnings, productivity declining and no further ammo on interest rates.

What are your recent observations on global equity markets?

Druckenmiller: The lack of progress and volatility in global equity markets the past year, which often precedes a major trend change, suggests that their risk/reward is negative without substantially lower prices and/or structural reform. Don’t hold your breath for the latter. While policymakers have no end game, markets do.

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US stock market: How much can it drop?

The Historical Context

The following is an excerpt from John Hussman's weekly commentary dated April 18, 2016 (link). It lists the relative drop in the US stock market when previous bubbles burst.

Based on valuation measures having the strongest correlation with actual subsequent market returns across history, equity valuations have approached present levels in only a handful of instances: 1901 (followed by a -46% market retreat over the following 3-year period), 1906 (followed by a -45% retreat over the following year), 1929 (followed by a -89% collapse over the following 3 years), 1937 (followed by a -48% loss over the following year), 2000 (followed by a -49% market loss over the following 2 years), and 2007 (followed by a -57% market loss over the following 2 years). A few lesser extremes occurred in the 1960’s and 1970’s, followed by market losses in the -35% to -48% range.

Note added on Aug. 14, 2016: I Tweeted a relevant chart. Click here.

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Market Topping Process

US Equities

The following is an excerpt from John Hussman's weekly commentary dated April 25, 2016 (link). The excerpt appears in blue font and my comments appear in black font.

Still, even if the major indices were to register fresh highs, my impression would remain that the market is in the process of tracing out the arc of an extended top formation.

2000 Top Formation

It’s largely forgotten that during the 2000 top formation, the S&P 500 lost 12% from July-October 1999, recovered to fresh highs, retreated by nearly 10% from December 1999 to February 2000, recovered to fresh highs, experienced another 10% correction into May, recovered to a new high in total return (though not in price) on September 1, 2000, retreated 17% by December, and by January 2001 had recovered within 10% from its all-time high, and was unchanged from its level of June 1999.

Total time taken = June 1999 to January 2001; 20 months

2007 Top Formation

Likewise, during the 2007 top formation, the S&P 500 corrected nearly 10% from July to August, recovered to a fresh high in October, corrected over 10% into November, recovered nearly all of it by December, followed with a 16% loss, and by May 2008 had recovered within 9% of its all-time high, and was unchanged from its level of October 2006.

Total time taken = October 2006 to May 2008; 20 months, again!

Prediction. The current cycle: peak was May 2015. Add 20 months. Result is Dec. 2016.

1928 Top Formation

In 1954, John Kenneth Galbraith offered a similar narrative of the top-formation leading up to the 1929 crash: “The temporary breaks in the market which preceded the crash were a serious trial for those who had declined fantasy. Early in 1928, in June, in December, and in February and March of 1929 it seemed that the end had come. On various of these occasions the Times happily reported the return to reality. And then the market took flight again. Only a durable sense of doom could survive such discouragement. The time was coming when the optimists would reap a rich harvest of discredit. But it has long since been forgotten that for many months those who resisted reassurance were similarly, if less permanently, discredited.”

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Excerpts from James Grant's 

Time Magazine Article

The Time article in question was Tweeted here.

The following are some excerpts:

• The very language of government debt is calculated to tranquilize the critical mind. 
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• Today’s miniature interest rates constitute another form of public sedation. You’d suppose the doubling of the debt would jack up the cost of servicing the debt. Nothing of the kind. As the debt has doubled, the rate of interest has halved.
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• In 2007, we owed $5 trillion and paid an average interest rate of 4.8%. Net interest expense: $237 billion. In 2016 we’ll owe $14.1 trillion and pay the average interest rate I already mentioned: 1.8%. Net interest expense: $240 billion. 
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• The public debt will fall due someday. (Some of it falls due just about every day.) It will have to be repaid or refinanced. If repaid, where would the money come from? It would come from you, naturally. The debt is ultimately a deferred tax. You can calculate your pro rata obligation on your smartphone. Just visit the Treasury website, which posts the debt to the penny, then the Census Bureau’s website, which reports the up-to-the-minute size of the population. Divide the latter by the former and you have the scary truth: $42,998.12 for every man, woman and child, as I write this.
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• In the short term, the debt would no doubt be refinanced, but at which interest rate? At 4.8%, the rate prevailing as recently as 2007, the government would pay more in interest expense–$654 billion–than it does for national defense. At a blended rate of 6.7%, the average prevailing in the 1990s, the net federal-interest bill would reach $913 billion, which very nearly equals this year’s projected outlay on Social Security.
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• To understand our financial fix, put yourself in the position of the government. Say you earn the typical American family income, and you spend and borrow as the government does. So assuming, you would earn $54,000 a year, spend $64,000 a year and charge $10,000 to your already slightly overburdened credit card. I [James Grant] say slightly overburdened–your outstanding balance is about $223,000.
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• According to the Government Accountability Office, unpaid taxes add up to more than $450 billion a year. Even so, according to the Tax Foundation, Americans spend 6.1 billion hours and $233.8 billion each tax season complying with a federal tax code that runs to 10 million words. 
• We owe more than we can easily repay. We spend too much and borrow too much. Worse, we promise too much. We conjure dollar bills by the trillions–pull them right out of thin air. I [James Grant] won’t insist that this can’t go on, because it has. I only say that it will eventually stop.
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• I [James Grant] don’t know the date, but I believe that I know the reason. It will stop when the world loses confidence in the dollars we owe. Come that moment of truth, the nation will resemble Chicago, a once prosperous polity now trying to persuade its once trusting creditors that it is actually solvent.

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Richest 1 per cent and the Gilded Age redux

Sir, Alan Rohrbach (Letters, March 5) says that there is no obvious bubble. I disagree. In 1979 the richest 1 per cent of Americans took home 9 per cent of gross domestic product. Today they earn one in four of all dollars earned in the US. In 1979 the bottom 99 per cent of Americans earned 60 per cent of GDP. Today they earn 50 per cent of GDP. For the weaker sections of society the fall in income has been even worse.

The bubble is visible politically. Donald Trump draws his support from generally uneducated white southerners. Their standard of living has been decimated for the benefit of the Trump class. Fed chair Janet Yellen can’t generate 2 per cent inflation since her dynamic stochastic general equilibrium model with its Phillips curve assumption is misfiring due to the hold the 1 per cent have on the US economy.

It also appears as though corporate America has given up on investment to drive growth. Last year C-suites took $1tn out of the national corporate balance sheet in the form of buybacks. This is how the 1 per cent works.

It is all very Gilded Age redux. As Scott Fitzgerald wrote in The Great Gatsby: “So we beat on, boats against the current, borne back ceaselessly into the past.”

Cathal Rabbitte Villars sur Ollon, Switzerland

Financial Times, March 12, 2016

China Income Gap is Among World's Widest

China has one of the world's highest levels of income inequality, according to an article published in the Financial Times on Jan. 15, 2016, page 5.

• The richest 1% of households in China own 1/3 of the nation's wealth, according to a report from Peking University. This report is based on a survey of 15,000 households in 25 provinces.
• The poorest 25% of Chinese households own just 1% of the nation's total wealth, according to the same study.
• China's Gini coefficient, a measure of inequality, was 0.49 in 2012, according to the same report.
• Its Gini coefficient was 0.3 in the 1980s.

Separately, the Hurun Report indicates that the number of dollar millionaires in China is 3.14Mn, up 8% over the past year.

According to Hurun's 2015 China Rich List, China has 596 dollar billionaires, which is more than the US.

The World Bank considers a coefficient above 0.40 to represent severe income inequality. In comparison to China,

• Only South Africa and Brazil have higher Gini coefficients at 0.63 and 0.53, respectively.
• In contrast, the figures for US and Germany are 0.41 and 0.3 respectively.

Turning to the US, the Gini coefficient doesn't tell the whole story. 

In the US, the wealthiest 1% of households own 42% of all US wealth as of 2012 (vs. 1/3 for China). This is according to UC Berkeley economist Emmanuel Saez.

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My analysis

Putting things in perspective, since US population is almost 319Mn (as of 2014) versus 1,393Mn (as of 2014) for China, 1% of the population of each country equals 3.2Mn in the US versus 13.9Mn in China. (Source: Google.) There's a factor of 4.4 in difference here.

But we are dealing with household wealth not per-capita wealth, so population is irrelevant.

The number of households in the US was 123.2Mn as of 2014. (Source: Google.) The number of households in China was 455.9Mn but that was as of 2012, not 2014. (Source: Wikipedia.) Google reports the average household size in China as 3.0 as of 2012. Using this figure of 3.0, I'll estimate the number of Chinese households as of 2014 to be 1.393Mn / 3.0 = 464.3Mn. Here, there's a factor of 3.8 in difference. (US households are smaller than their Chinese counterparts: 2.6 people  per household vs 3.0.)

So, 1% of households in US vs China amount to 1.2Mn and 4.6Mn households respectively.

So, we can say the following. 1.2Mn households in the US control 42% of all US wealth whereas in China, 4.6Mn households control 1/3 ie 33% of all China wealth. This statement implies that there's more wealth concentration in the US: You have a fewer number of households controlling a larger percentage of each nation's wealth.

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It would also be interesting to look at the amount of total wealth in each country. Credit Suisse's Annual Global Wealth Report estimates total global wealth at $250 trillion as of June 2015, with the US owning $86 trillion and China at $23 trillion. Here, the difference is a factor of 10 4; (error corrected on June 6, 2016). (Source: Barrons.) 

So, we can say the following. 1.2Mn households in the US control 42% of all US wealth with this 42% amounting to $36 trillion whereas in China, 4.6Mn households control 33% of all China wealth with this 33% amounting to $7.6 trillion.

Using division, in the US, the average wealth per household within the top 1% of households amounts to $30 million per household. In China, the average wealth per household within the top 1% of households amounts to $1.6 million. Here, the difference is 20 times.

Google reports US and China median per-capita income in PPT (purchasing power parity) terms as $53,750 and $11,850 respectively, as of 2013. Here, the difference is 4.5 times. (I chose to work with median per-capita income rather than median household income because I couldn't find data on the latter for China. However, I will note that median household income being $51,939 in the US as of 2013 is very close to the figure I'm using for US median per-capita income, $53,750.)

So, if we adjusted the 20 times difference associated with the top 1% for the fact that median per-capita income exhibits a 4.5 times difference across the two countries, we can say that the top 1% of households in US are 4 times wealthier than their Chinese counterparts, i.e. 20x / 4.5x = 4.4x which is about 4x.

Within each country, we can say the following. In the US, household wealth for the top 1% of households is 558 times median per-capita income (i.e. $30Mn / $53,750) whereas it is 135 times in China (i.e. $1.6Mn / $11,850). Measured this way, the wealth gap is wider in the US than China. On the other hand, the Gini coefficient indicates a larger wealth gap in China than in the US. That's probably because it also takes into account wealth at the bottom end too.

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Takeaways

Gini coefficients by country:

• 0.63 South Africa
• 0.53 Brazil
• 0.49 China
• 0.41 US
• 0.3 Germany

Aggregate household wealth by country:

• $86 trillion US
• $23 trillion China
• $250 trillion World

Average household wealth for the top 1% of households by country:

• $30 million US
• $1.6 million China

Median per-capita income by country:

• $53,750 US
• $11,850 China
• $9,733 World

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War and Price

As the five-year civil war in Syria between President Bashar al-Assad and the rebels seeking to overthrow him continues, sieges have become a policy by all sides in the conflict.

Estimates on the number of people trapped in besieged areas vary from 1 to 4.5 million. For reference, Syria's population has shrunk to 16.6 million, down from a pre-war level of 22 million, according to the Economist as of Sept. 2015.

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A kilogram of of rice in the besieged town of Madaya, Syria, 40km from Damscus the capital, cost $450 last week.

Sugar is like gold. You can sell it for SPY 3,000 a kilo. It used to cost SPY 70.

Checkpoints controlled by groups besieging each other are an opportunity for both combatants and traders to make money on desperately needed goods, with prices marked up quadruple, or more.

Only corruption can explain how this siege can last so long.

Excerpted from an article that appeared in the Financial Times on January 16, 2016, page 2.

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How your mind & emotions affect your health

Examples:

1) Pessimistic personality has higher correlation with disease

2) So does depression

3) So does a hostile mental attitude

4) Positive attitude increases life expectancy

5) Marriage improves life expectancy

6) Both number and quality of social relationships has positive correlation with good health

There's a 1 hour+ video covering this by UCSF's Kevin Barrows, MD here or here.

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