Tag Archives: asset bubbles

“Taylor Rule” Chart – June 13, 2018 Update

On January 9, 2017 I wrote a post (“Low Interest Rates And The Formation Of Asset Bubbles“) that mentioned the “Taylor Rule.”  As discussed in that post – and for other reasons – the level of the Fed Funds rate – and whether its level is appropriate – has vast importance and far-reaching consequences with regard to many aspects of the economy and financial system.

For reference, below is an updated chart depicting the “Taylor Rule” prescription and the actual Fed Funds rate, provided by the Federal Reserve Bank of Atlanta, updated as of June 13, 2018:

Taylor Rule chart

For additional reference, below is a long-term chart showing, among other measures, the Real Fed Funds rate.  This chart is from the Doug Short site post of June 19, 2018 titled “Treasury Yields – A Long-Term Perspective.”  Of particular note is the post-2000 persistently negative Real Fed Funds rate, which is shown in red:

Real Fed Funds Rate chart

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The Special Note summarizes my overall thoughts about our economic situation

SPX at 2762.59 as this post is written

“Taylor Rule” Chart – February 14, 2018 Update

On January 9, 2017 I wrote a post (“Low Interest Rates And The Formation Of Asset Bubbles“) that mentioned the “Taylor Rule.”  As discussed in that post – and for other reasons – the level of the Fed Funds rate – and whether its level is appropriate – has vast importance and far-reaching consequences with regard to many aspects of the economy and financial system.

For reference, below is an updated chart depicting the “Taylor Rule” prescription and the actual Fed Funds rate, provided by the Federal Reserve Bank of Atlanta, updated as of February 14, 2018:

Taylor Rule chart

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The Special Note summarizes my overall thoughts about our economic situation

SPX at 2698.63 as this post is written

“Taylor Rule” Chart – August 11, 2017 Update

On January 9, 2017 I wrote a post (“Low Interest Rates And The Formation Of Asset Bubbles“) that mentioned the “Taylor Rule.”  As discussed in that post – and for other reasons – the level of the Fed Funds rate – and whether its level is appropriate – has vast importance and far-reaching consequences with regard to many aspects of the economy and financial system.

For reference, below is an updated chart depicting the “Taylor Rule” prescription and the actual Fed Funds rate, provided by the Federal Reserve Bank of Atlanta, updated as of August 11, 2017:

Taylor Rule prescription

 

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The Special Note summarizes my overall thoughts about our economic situation

SPX at 2435.14 as this post is written

Low Interest Rates And The Stock Market Bubble

The existence of various immensely large asset bubbles continues to be among the most worrisome aspects of today’s financial and economic system.

I have written extensively about this asset bubbles issue.

One aspect that is particularly notable is the cause(s) of such bubbles.  As I wrote in the January 9, 2017 post (“Low Interest Rates And The Formation Of Asset Bubbles“):

There are many theories as to why asset bubbles form.  My own thoughts on the matter are highly complex, especially concerning the current-era bubbles.

One common theory as to why asset bubbles form is the existence of (ultra-) low interest rates.  I have discussed this facet previously, including in the December 2, 2009 post titled “Bubbles.”

Many believe that keeping interest rates “too low” for an extended period of time leads to a variety of risks and adverse conditions, including excessive speculation and (future) financial instability.  As an example, the period of ultra-low interest rates is often named as a primary factor in the housing market “crash.”

For reference purposes, shown below is a chart comparing the effective Federal Funds rate and the S&P500, on a daily LOG basis since the year 2000:

(click on chart to enlarge image)(chart courtesy of StockCharts.com; chart creation and annotation by the author)

S&P500 and Effective Fed Funds rate

One of the asset classes that is an immensely large asset bubble is the stock market.  Aside from conclusions derived from analyses concerning stock market valuations, the stock market also has the “look” and “feel” similar to past large asset bubbles.

The existence and size of the stock market bubble – along with other attributes and characteristics of the financial and economic system – continue to create a highly hazardous environment.  What my analyses continue to indicate – and as I stated (in part) in the March 18, 2014 post titled “Was A Depression Successfully Avoided?” –

While no one likes to contemplate a future rife with economic adversity, I do believe that our current economy and financial system on an “all things considered” basis have vastly problematical working dynamics much more pernicious than those existent prior to and during The Great Depression.

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The Special Note summarizes my overall thoughts about our economic situation

SPX at 2363.64 as this post is written

Low Interest Rates And The Formation Of Asset Bubbles

The existence of asset bubbles continues to be among the most critical – and troubling – characteristics of the current-era U.S. economy.  I have written extensively on the subject for a number of reasons, including its monumental importance as well as its poorly understood nature.

There are many theories as to why asset bubbles form.  My own thoughts on the matter are highly complex, especially concerning the current-era bubbles.

One common theory as to why asset bubbles form is the existence of (ultra-) low interest rates.  I have discussed this facet previously, including in the December 2, 2009 post titled “Bubbles.”

One prominent way to measure as to whether interest rates are “abnormally low” is by comparing rates – typically the “Fed Funds” rate – to the rate implied by the “Taylor Rule.”  A simple description of that rule can be seen in the December 20, 2016 Wall Street Journal op-ed (“The Case for a Rules-Based Fed“) written by John B. Taylor, creator of the Taylor Rule.  An excerpt:

Mr. Kashkari’s argument against rules-based strategies focuses on the “Taylor rule,” which emerged from my research in the 1970s and ’80s and has been used in virtually every country in the world. The rule calls for central banks to increase interest rates by a certain amount when price inflation rises and to decrease interest rates by a certain amount when the economy goes into a recession.

While my thoughts on the “Taylor Rule” are complex and aren’t suitably discussed in a brief manner, I will say that I don’t necessarily agree with its theoretical framework and/or the methodologies employed, or implications.  However, I do think that its current readings are both notable and informative.  Among notable aspects, one can clearly see that the Fed Funds rate has been far below the “Taylor Rule” prescription for a protracted time period.

The Federal Reserve Bank of Atlanta provides detailed information concerning the “Taylor Rule,” which includes the chart shown below.  One should note that the readings are influenced by a number of assumptions, and thus it is both possible and likely that the readings of the model can change significantly with changes in the assumptions.

The chart below is updated through December 22, 2016:

Taylor Rule chart

 

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The Special Note summarizes my overall thoughts about our economic situation

SPX at 2270.16 as this post is written

The Bond Bubble – July 2016 Update

In previous posts I have discussed the Bond Bubble and its many facets, as my analyses indicates that the overall bond market is an exceedingly large asset bubble with immensely large and wide-ranging economic implications.

Since my last post on the Bond Bubble (the June 24, 2014 post titled “The Bond Bubble – June 2014 Update“) I have written various posts about interest rates and associated dynamics.

It should be noted that current rates on 10-Year Treasury Yields, from a (ultra) long-term historical view, remain extremely depressed.  Of note, recent yields have reached all-time lows, as mentioned in the July 6, 2016 post titled “10-Year Treasury Yields – Two Long-Term Charts As Of July 6, 2016.”

This can be seen in the following chart of 10-Year Treasury Constant Maturity Yields:

10-Year Treasury Constant Maturity

Data Source: FRED, Board Of Governors Of The Federal Reserve System; accessed July 27, 2016:

https://research.stlouisfed.org/fred2/series/DGS10

Here is another chart of the 10-Year Treasury Yield, from 1980 on a LOG scale, with a long-term trendline.  The current yield is 1.563%:

(click on chart to enlarge image)(chart courtesy of StockCharts.com; chart creation and annotation by the author)

10-Year Treasury Yields

As seen in practically all economic forecasts, the belief that the ultra-low interest rate environment will continue to be sustained is widespread.

There are various highly notable aspects of the Bond Bubble that lack general awareness.  While a comprehensive discussion can’t be done in a brief manner, many of my previous posts have discussed certain aspects.

Of particular concern is the financial and economic impact resulting from the “bursting” of the Bond Bubble.  As I mentioned in my post of February 6, 2013 (“The Bond Bubble – February 2013 Update“) my expectation at that time – and what I continue to believe – is that after the bursting of the Bond Bubble the rate on the 10-Year Treasury will be far higher than it has been in recent years.  As stated in that post:

While I have not spent considerable effort trying to ascertain the level of this “natural” interest rate, I have little doubt that such a “natural” rate on the 10-Year Treasury would be at least 5%-10% and most likely considerably higher (possibly multiples thereof).  Of course, such rates would have massive implications on a number of fronts.

The prospects of such a large increase in interest rates – which, due to many dynamics of the bursting of this particular bubble – will likely happen in a short period of time.  Overall, this situation is of tremendous concern on many levels, including the impact such rising interest rates will have on other immensely large asset bubbles, including the stock market.

As I stated in the aforementioned February 6, 2013 post;

The perils of this bond bubble and its future “bursting” can hardly be overstated.

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The Special Note summarizes my overall thoughts about our economic situation

SPX at 2169.18 as this post is written

The Stock Market Bubble – February 2015 Update

This post is an update to various past posts concerning the stock market bubble, most recently that of November 21, 2013 titled “Is The Stock Market Experiencing A Bubble?”

Many people don’t believe that we are currently experiencing a stock market bubble because their primary reference regarding stock market bubbles is that of the mid- to late-1990s, in which there was a stock market bubble with immense speculative activity, wildly resplendent “price action” in the technology and internet sectors, and many exceedingly high (in some cases stratospheric) company valuations.  It was an amazingly notable period for many reasons.

Today’s overall stock market bubble is not as “overt” and “flamboyant” in nature and many “bubble” aspects aren’t necessarily (widely) recognized or necessarily understood.  However, just because the obvious signs aren’t glaringly obvious doesn’t mean that the bubble’s magnitude is smaller.

One of the problems in identifying an asset bubble is that there is no standard definition of one, and many – if not most – bubbles are identified “after the fact.”  As there is no standard definition of an asset bubble, there is no definitive measures to “prove” or “disprove” of one’s existence.

However, there are many underlying financial conditions that historically have led to asset bubbles.  While the list is extensive, among the more notable conditions are (ultra) easy monetary policy and the accompanying ultra-low interest rate environment, both of which have been extant for a number of years now.

My posts concerning the existence of the stock market as being in an asset bubble date back to 2011.  While I base this view both on technical analysis and fundamental analysis factors, in this post I will primarily focus on fundamental measures.  While a full discussion of these factors would be exceedingly lengthy and, at times, very complex, below is discussion of some of the more notable factors, including earnings and valuations.

Earnings

Perhaps the most common equity valuation metric in use today is the P/E ratio.  By this measure, stocks don’t necessarily appear exceedingly expensive.  One way to look at it is the from the FactSet Earnings Insight of February 13, 2015 (pdf), which says:

The current 12-month forward P/E ratio is 17.1. This P/E ratio is well above the 5-year (13.6) average and the 10-year (14.1) average.

However, my analyses indicate that earnings are being impacted by a variety of special factors that likely will prove transitory in nature.  Among these factors – which are further discussed in the November 21, 2013 post mentioned above – are ultra-low interest rates and share buybacks.  As well, the decline in corporate taxes has played a role, as discussed in the June 3, 2014 ProfitabilityIssues.com post titled “Long-Term Trends And Sources Of Corporate Profitability Growth.”

Other factors that have increased profitability is cost-cutting, subdued hiring, and continually-low increases in (nominal) labor costs.

As a result of myriad factors, the S&P500 net profit margin is notably high from a historical perspective.  According to the Wall Street Journal article of February 1, S&P500 net profit margins “averaged 8.4% between 1999 and 2013,” and are now 10.1%  (Historical and projected S&P500 net profit margins are seen in the February 5, 2015 ProfitabilityIssues.com post titled “S&P500 Net Profit Margins – 2 Charts.”)

Of note, this occurred during a recent period of low revenue growth.  Additionally, as one can see from both the net profit margins chart mentioned above as well as in the Wall Street Journal article, consensus analyst expectations are for a further rise of net profit margins to over 11% by 2016.

Other metrics illustrate how distended the aggregate level of profitability is from a long-term historical perspective.  One measure that can be used is (After-Tax) Corporate Profits as a Percent of GDP.  This chart is seen below.  From 1947 through the 3rd quarter of 2014, the average is 6.5% and the median is 6.2%.  The Q3 2014 value is 10.8%:

After-Tax Corporate Profits As A Percent Of GDP

US. Bureau of Economic Analysis, Corporate Profits After Tax (without IVA and CCAdj) [CP], retrieved from FRED, Federal Reserve Bank of St. Louis https://research.stlouisfed.org/fred2/series/CP/, February 13, 2015.
US. Bureau of Economic Analysis, Gross Domestic Product [GDP], retrieved from FRED, Federal Reserve Bank of St. Louis:

Stock Market “Price Action” And Valuations

Stock market “price action” and valuations are other notable aspects of today’s stock market bubble.  For reference, here is a long-term chart of the S&P500 since 1925 (depicted on a LOG scale through February 13, 2015):

(click on charts to enlarge image)(chart courtesy of StockCharts.com)

S&P500 since 1925

While, admittedly, the recent overall stock “price action” isn’t as “frenzied” as it was in the late 1990s, there are many pockets of extreme stock valuations and/or continuously sharply rising stock prices.  With regard to the former, there are many large-cap stocks that appear highly overvalued based upon measures including (continual) lack of profitability.  With regard to the latter, there are many stocks – including those in the biotech sector – that exhibit “frothy” stock “price action.”  This can be seen in the parabolic advance seen in various biotech indices, including the BTK Biotechnology Index seen below:

(click on charts to enlarge image)(chart courtesy of StockCharts.com)

BTK since 2009

As well, there are many valuation measures that would indicate that stocks are expensive, if not very much so.  When one uses stock market valuation measures other than the P/E ratio, one often sees the stock market as either being (very) expensive or in “bubble” territory.  These other valuation measures include the Q-Ratio and CAPE (“Shiller PE”), etc.  (note:  these factors are discussed in Doug Short’s “Market Valuation Overview.”)

As well, there is the stock market capitalization to GDP measure,  which is seen in Doug Short’s post of January 7, 2015 (“Market Cap to GDP:  The Buffett Valuation Indicator“):

market capitalization to GDP

In addition to these many instances of notably rich public stock valuations, there is also the tangential issue of notably high private company valuations.  This issue has been recently discussed in the January 22, 2015 Fortune article titled “The Age of Unicorns,” subtitled “The billion-dollar tech startup was supposed to be the stuff of myth.  Now they seem to be … everywhere,” as well as the Barron’s article of December 8, 2014 titled “This Time It’s Different.”

Size Of The Stock Market Bubble

While the above discussion indicates a stock market that is overvalued, if not very much so, there are many reasons why the stock market bubble is far larger than any before it.  One of the reasons is the current distension – and forthcoming mean reversion – of many of the measures discussed above.

While a detailed mean reversion discussion would be very lengthy and complicated – and as such isn’t suitably discussed in a brief manner – it is highly relevant with regard to the potential downside and associated financial and economic dynamics that will come into play.  As well, the consequences of mean reversion will determine the magnitude of the ultimate stock market price decline, which will be the main measure as to this bubble’s magnitude.

While projections are difficult to make due to a number of factors and the uncertainty that would accompany such a rapidly changing environment, changes in overall stock market valuations will certainly be far greater than most would assume.  It appears that this issue of mean-reversion and the resulting revaluation greatly lacks recognition.

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The Special Note summarizes my overall thoughts about our economic situation

SPX at 2096.99 as this post is written

The Bond Bubble – June 2014 Update

In previous posts I have discussed the Bond Bubble and its many facets, as my analyses indicates that the overall bond market is an exceedingly large asset bubble with immensely large and wide-ranging economic implications.

Since my last post on the Bond Bubble (the February 6, 2013 post titled “The Bond Bubble – February 2013 Update“) I have written various posts about interest rates and associated dynamics.

It should be noted that current rates on 10-Year Treasury Yields, from a long-term historical view, remain extremely depressed.  This can be seen in the following chart of 10-Year Treasury Yields:

10-Year Constant Maturity Treasury Yield

Data Source: FRED, Board Of Governors Of The Federal Reserve System; accessed June 23, 2014:

https://research.stlouisfed.org/fred2/series/DGS10

Here is another chart of the 10-Year Treasury Yield, from 1980 on a LOG scale, with a long-term trendline, and currently yielding 2.623%:

(click on chart to enlarge image)(chart courtesy of StockCharts.com; chart creation and annotation by the author)

10-Year Treasury Yield

Perhaps one of the more striking aspects of the bond environment is that although 10-Year Treasury Yields are up significantly from their lows, various interest rates on less creditworthy securities are at or near their lows.  This can be seen in various securities and bond segments, both domestically and internationally, including the BofA Merrill Lynch US High Yield Master II Index chart, which shows a current yield (as of June 20, 2014) of 5.18% and its OAS Spread at 3.36%.

Of course, the question remains as to which direction interest rates, especially on the 10-Year Treasury, will take from here.

While there have been many arguments – including economic weakness – put forth that would indicate 10-Year Treasury Yields will fall from here, there are also many other (including those lesser-recognized) factors that indicate that the next sustained move on 10-Year Treasury Yields will continue upward.  While the “up vs. down” argument is complex, my analyses indicate that the trend in the 10-Year Treasury Yield will continue upward.

As I have explained in previous posts on interest rates and the Bond Bubble, such as the August 22, 2013 post “The Impact Of Rising Interest Rates,” what is particularly intimidating is the prospects for the economy and financial markets when the bond bubble finally “bursts.”  While the duration of this bond bubble makes (ultra) low interest rates seem sustainable – and by extension, “natural” – my analyses indicate that this interest rate environment is nothing of the sort.

Furthermore, relative to past rising interest rate environments, due to various current dynamics the coming increase in interest rates will be far more pernicious to the overall economy.

As I stated in the aforementioned February 6, 2013 post;

The perils of this bond bubble and its future “bursting” can hardly be overstated.

_____

The Special Note summarizes my overall thoughts about our economic situation

SPX at 1962.61 as this post is written

The Perils Of Asset Bubbles

I have written many posts concerning asset bubbles as my analyses indicate that:

  • many immensely large asset bubbles currently exist
  • today’s asset bubbles are exceedingly complex in nature
  • asset bubbles are largely misunderstood
  • asset bubbles pose an immense threat to the financial system
  • their future resolution is profoundly problematical

Of course, asset bubbles are often referred to as “speculative bubbles,” which is especially apropos.

While asset bubbles form for a variety of reasons, one primary factor in their recent (from a historical perspective) formation is abnormally low interest rates.  While there are many ways to depict this, one way is to view the real Federal Funds rate.  A recent chart from Doug Short is seen below:

Dshort 1-28-14 Real-FFR

–

As one can see from the above chart, prolonged negative periods of the real Fed Funds rate has proven very problematical in subsequent periods.  Whereas in the ’70s it led to high inflation, in the early 2000’s it first distended the housing bubble, and post-2008 has led to the distension – to grotesque dimensions – of various asset bubbles.

While this negative real Federal Funds Rate factor is a notable one, it should be noted that it is but one of many factors that cumulatively have resulted in a highly fetid “witches’ brew.”

Despite asset bubbles’ problematical aspects, many asset holders have benefited immensely from them.  As I mentioned in the January 30, 2012 post, titled “A Note On Asset Bubbles” :

It should be noted that asset bubbles are often widely seen as attractive and/or beneficial during their expansion phase.

However, as I also noted in that post, few people foresaw the longer-term ramifications of the housing bubble, which is especially problematical as the housing bubble’s existence was obvious and the consequences of its “deflation” or “bursting” should have been easily envisioned.

Given the (vastly) prolonged nature of some of the current asset bubbles, many undoubtedly see them as being enduring “fixtures” in the financial system.  By outward appearances, it would likely seem absurd to even contemplate draconian downside price targets for various asset classes.  Similarly, it would seem equally difficult to envision those who are ultra-wealthy suffering vast percentage losses of their net worth.

However, in the United States we do have a prior post-Federal Reserve period in which many ultra-wealthy people “lost everything,” with that period being the Great Depression.  This loss of wealth was highlighted in the October 7, 2011 post titled “The Plight Of The Wealthy During Depressions.”

While, in an overall sense, I believe there to be similarities between the current economic period and that preceding The Great Depression, I do believe that our current economy and financial system on an “all things considered” basis have vastly problematical underlying dynamics that dwarf those existent prior to and during The Great Depression.

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The Special Note summarizes my overall thoughts about our economic situation

SPX at 1794.19 as this post is written

Additional Thoughts Concerning Rising Interest Rates

On August 22, 2013 I wrote a post titled “The Impact Of Rising Interest Rates,” in which I discussed various wide-ranging impacts of the rising interest rate environment that I believe lack recognition.  In this post, I would like to make additional comments regarding the future level of interest rates, and specifically the 10-Year Treasury Note yield.

First, for reference, here is a long-term chart of the 10-Year Treasury yield from 1965, as seen in Doug Short’s post of November 29 titled “Treasury Yields In Perspective” :

Dshort 11-29-13 - 10-year-yields-since-1965-log-scale

Second, for reference, is a daily 5-year chart of the 10-Year Treasury Note yield on a LOG scale, through December 9, with a current value of 2.857%.  As one can see, recent resistance has been near the 3.0%-level:

(click on chart to enlarge image)(chart courtesy of StockCharts.com; chart creation and annotation by the author)

EconomicGreenfield 12-10-13 TNX Daily LOG 5 Year

The November Wall Street Journal Economic Forecast Survey shows an average expectation of 10-year Treasury Note yields of 3.43% in December 2014 and 3.89% in December 2015. As well, many observers of interest rates have stated, due to either technical and/or fundamental reasons, that the 10-Year Treasury Note yield should peak at 3.5%-4.0%.  While their reasoning and analyses for such a conclusion seems reasonable – if not compelling – my analyses indicate that interest rates will climb to far higher levels, with the outsized adverse consequences I discussed in the aforementioned August 22 blog post.  Much of the potential for rising interest rates will be due to the “bursting” of the bond bubble.

Many observers have dismissed the threat of rising interest rates, often for the reason that they believe a rising interest rate environment will be accompanied by a stronger economy; thus, by their reasoning, although there will be some sort of economic “drag” caused by rising interest rates, the “drag” will be largely, if not completely, offset by the concomitant strengthening economy.

For a variety of reasons, I do not believe this line of reasoning to be accurate.  As I stated in the aforementioned August 22, 2013 post:

Although there are various areas which benefit from increased interest rates, from an “all-things-considered” basis rising interest rates have many problematic aspects for our current-era economy. While 10-Year Treasury Yields were above 5% as recently as 2007 – with no seeming adverse economic impact – I believe that the economy will have difficulties “absorbing” higher yields far before that 5%+ rate on the 10-Year Treasury is again reached.

Also, I do not believe that one should discount the adversity such a rising interest rate environment will have on the financial system, as well as (exceedingly) problematical aspects such a rising rate environment will have on various U.S. debt-funding and QE-related operations, such as that discussed in the June 26 post, “Potential Losses In The Federal Reserve’s Portfolio.”

As well, my analyses continue to indicate that another financial-system “crash” of tremendous magnitude will occur.  In this “crash” I expect that 10-Year Treasuries will not be the “safe haven” many believe them to be.

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The Special Note summarizes my overall thoughts about our economic situation

SPX at 1808.37 as this post is written