John Hussman makes an entirely unscientific but still very interesting point about market euphoria — as epitomised by a recent Barron’s professional survey leading a magazine cover triumphantly proclaiming “Dow 16000” — as a contrarian indicator:
I have no idea whether or not the Dow Jones Industrial Average will hit 16,000 anytime soon. A P/E ratio of 15.84 seems relatively modest even in the context of some weakish macro data (weak employment numbers, weak business confidence, high energy input costs) and that priced in real GDP they look considerably more expensive, but it’s healthy to keep in mind the fact that euphoria and uber-bullishness very often gives way to profit-taking, stagnating prices, margin calls, shorting, panic and steep price falls. That same scenario has taken place in both gold and Bitcoin in the past couple of weeks. Leverage has been soaring the past couple of months, implying a certain fragility, a weakness to profit-taking and margin calls.
Psychologically, there seems to be a bubble in the notion that the Fed can levitate the DJIA to any level it likes. I grew up watching people flip houses in the mid-00s housing bubble, and there was a consensus among bubble-deniers like Ben Stein that if the housing market slumped, central banks would be able to levitate the market. Anyone who has seen the deep bottom in US housing best-exemplified by a proliferation of $500 foreclosed houses knows that even with massive new Fed liquidity, the housing market hasn’t been prevented from bottoming out. True, Bernanke has been explicit about using stock markets as a transmission mechanism for the wealth effect. But huge-scale Federal support could not stop the housing bubble bursting. In fact, a Minskian or Austrian analysis suggests that by making the reinflation of stock indexes a policy tool and implying that it will not let indexes fall, the Fed itself has intrinsically created a bubble in confidence. Euphoria is always unsustainable, and the rebirth of the Dow 36,000 meme is a pretty deranged kind of market euphoria.
Nonetheless, without some kind of wide and deep shock to inject some volatility — like war in the middle east or the Korean peninsula, or a heavy energy shock, a natural disaster, a large-scale Chinese crash, a subprime-scale financial blowup, or a Eurozone bank run — there is a real possibility that markets will continue to levitate. 16,000, 18,000 and 20,000 are not out of the question. The gamble may pay off for those smart or lucky enough to sell at the very top. But the dimensions of uncertainty make it is a very, very risky gamble.
So what’s Osborne’s plan to generate growth?
Today we seem to have an answer.
As Anatole Kaletsky sarcastically put it:
New UK mortgage guarantees huge news. Revives zero-equity mortgages, relaunches sub-prime and creates UK-style Fannie May. Very prudent!
— Anatole Kaletsky (@Kaletsky) March 20, 2013
That’s right — aside from an underfunded infrastructure pledge, a duty cut on beer and cigarettes, and a tiny and delayed corporation tax and national insurance decrease, George Osborne’s plan is to throw money at housing and hope for the best.
Sounds markedly similar to the American strategy following 2001 when Greenspan “created a housing bubble to replace the NASDAQ bubble”, and we all know how that ended.
I’d tend to argue that the opposite is a much better idea. Instead of propping up the housing market, Cameron and Osborne should deregulate construction and planning (getting planning permission can be a long, costly task in the UK, and planning restrictions are estimated to add up to £40,000 to house prices) so that housing prices fall (if not absolutely at least priced in median wages) and Generation Y can start getting on the housing ladder.
As Faisal Islam put it:
Radical idea: Why not let house prices fall a little, and help clear the market? Is that not capitalism? #Budget2013
— Faisal Islam (@faisalislam) March 20, 2013
But alas no. Instead of using the ultra-low interest rate environment and idle resources to invest in a quality business infrastructure — high speed broadband, roads, railways, energy — and lower unemployment, Osborne has chosen to throw his stock in with the malinvestment-loving property speculators.
Unfortunately, pumping up credit bubbles can win elections (as we saw with Bush in 2004), so this may have improved the Tory electoral chances for 2015. But in the long run, we will see this as a dire move.
On the surface, it looks like it:
My main caveat here is that the United States is — for many reasons including geopolitics, demographics energy, monetary policy, etc — in a completely new historical period, so it is plausible that we are moving toward a new normal.
The persons-per-household numbers have remained low, even in spite of the house price slump, suggesting there is no latent surge in demand waiting to burst forth and pick up prices:
Most worryingly, prices have kept falling even in spite of the fact that there is very little building:
So while prices are falling to historic lows it is difficult to say where demand will come from. Certainly —and wrongheadedly, because America is relatively underpopulated — America does not appear willing to liberalise immigration laws. In nominal terms, house prices somewhat stabilised due to the post-2008 money printing operations. But in terms of purchasing power (i.e. in ounces of gold, barrels of oil, calories of food) there does not seem to be much reason to believe house prices will be rising any time soon.
The talking is over; it is finally happening. For the first time since World War Two, a developed nation is going into default.
That’s the significance of the events of the past 24 hours, with Greece’s debt being classified as in “selective default” and the European Central Bank banning it from its cash window. Months of planning by both banks and policymakers have gone into ensuring that Greece’s negotiated default will be a smooth painless process. We are about to find out whether that planning pays off.
Now, we shouldn’t be surprised by Standard & Poor’s decision to cut the rating on Greece’s sovereign debt from CC to SD (which stands for “selective default”). The ratings agencies had always said that, given private investors are about to lose just over half the value of their debt (through a complex bond swap), this downgrade would be a natural consequence.
Nor should we be shocked that the ECB says it will no longer accept Greek debt as collateral: in fact, the only surprise is that it’s taken this long – on the basis of the ECB’s previous policy, the bonds should have become ineligible when were first downgraded from investment status two years ago.
Peter Tchir thinks all the hullabaloo is a lot of sound and fury, signifying nothing:
So far there are no dramatic consequences of the Greek default. The ECB did say they couldn’t accept it as collateral, but national central banks (including Greece’s somehow solvent NCB) can, so no real change. We will likely get a Credit Event prior to March 20th once CAC’s are used to get the deal fully done. Will the market respond much to that? Probably not, though there is a higher risk of unforeseen consequences from that, than there was from the S&P downgrade.
It just strikes me that Europe wasted a year or more, and has created a less stable system than it had before. A year ago, Europe was adamant about no haircuts and no default. I could never understand why. Let Greece default, renegotiate terms, stay in the Euro and move on.
I suppose the magnitude of the problem depends on just which kind of credit event. And that mostly depends on how well-insulated the financial system is, and market psychology. A full-blown Lehmanesque credit shock? Who knows — certainly banks are fearful. Certainly, the problem of default cascades has been out in the open for a while. But most of the attempts to deal with the prospect of such things have mostly been emergency room treatment, and not preventative medicine — throwing liquidity at the problem. Certainly, it is possible the system is in a worse shape than 2008.
- The derivatives web is (nearly) as big as ever:
- There are still a myriad of European housing bubbles ready to pop.
- American banks are massively exposed to Europe.
- China’s housing bubble is bursting Surely their reserves will go into bailing out their own problems, and not those of Europe and America?
- Rising commodity prices — especially oil — are already squeezing consumers and producers with cost-push inflation.
Meanwhile, the only weapon central bankers have in their arsenal is throwing more money at the problem.
Will throwing more money at the problem work? Yes — in the short term. The danger is that creditor nations will not be prepared to throw enough to shore up balance sheets.
Will throwing money at the problems cause more problems in the long run? Yes — almost certainly.
Ultimately, we must look at preventative medicine — to stop credit bubbles expanding beyond the productive capacity of the economy. We should also look at insulating the economy from the breakdown of any credit bubbles that do form.