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« Possible Endings for the Greek Drama | Main | A Question for Shiller Disciples: Why the interest in profit margins? »

May 20, 2012

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Scott Murray

Looking at the three indicators, it looks extremely bullish. If prices are significantly lower (thus risk is reduced as prices fall, naturally), the majority are bearish, recession is remote, and financial stress is minimal, what is there to be bearish about?

Judging by that chart, I would have voted bullish in the poll.

oldprof

Angel - -The SLFSI serves an important purpose. It helps to avoid a 2008 style situation. More importantly, it is an antidote to those who see black swans by the flock. It provides a measurable, market-based assessment of risk. It is not my opinion, nor yours, nor anyone else's. without such a discipline no one would ever invest in anything.

It does not reflect the possibility of things like terrorist attacks, although you can see the 9/11 effect in the pointer I provided.

Jeff

oldprof

David - I do not use a ten-year horizon, since I actively manage everything with regular reviews. Every stock I own is based upon an analysis of past earnings that is longer than ten years, includes more than one business cycle, and normalizes growth on that basis. I also compare stocks to other asset classes, and most importantly, the needs of each client.

Right now there are many stocks that qualify on this basis.

At various times in the past, stocks have been much less attractive by these criteria, especially in the 2000 era.

I also reduce exposure when risk is high -- my reason for carefully following the SLFSI and various recession indicators.

These are all cases where I have reduced stock exposure and would do so again.

Meanwhile, even Shiller himself does not use his method in the way everyone else does -- as some extreme market-timing tool. He owns stocks, and has all along.

I hope this is helpful.

Jeff

David

Jeff - I have a quick question. I read you quite frequently as my "divergent opinion." I generally tend to think the market as a whole is overvalued given astronomic profit margins, shiller p/e, etc. I don't really want to argue over that at present because I know we disagree - which is just fine. I need to find people who disagree with me as it's worth reading what they write. But here's my main question - is there anything that would make you bearish? I.e., specifically, what would make you pessimistic about long term (i.e. a decade out) returns?

Angel Martin


Hi Jeff, sorry i was not clear about my 911 reference, it was to an analogous event in financial markets, a catastrophe with no warning where the risk measured by the SLFSI would go from current levels to,say, 5 instantly with an accompanying crash like 1987 ...

In such a scenario i'm not sure how much help the St Louis index would be...

oldprof

Angel -- The SLFSI was tested for 9/11 and it remained around 1. If you click through on the link I show you will see the chart. I don't post it each week. http://research.stlouisfed.org/fred2/series/STLFSI

I did a major study of the SLFSI last year before implementing, and it is excellent for my purposes. It shows risk in a clear fashion, and helps to avoid the major downdrafts. If you wanted to go all out for investment returns, you would actually be BUYING at the high risk points.

I keep trying to explain that many of those commenting on my work are trying to trade, while I am trying to manage six different risk-adjusted programs.

You should feel free to play for tail moves and guess at such risks, but none of those who claim to be doing this have reported great returns.

I appreciate the suggestion. I looked at the paper, but I don't see the advantage, even in a back-tested sense.

Jeff

Octavio Richetta

Very thorough analysis and two great comments so far. Hopefully, I will not break the trend. You give enough ammunition for smart people to use your analysis as an additional piece of information in reaching their own conclusions.

In a harsh, not very well thought or expelled out, comment I called you a broken clock in one of your previous posts. I now realize i was clearly mistaken. I want to correct my statement here. The closest I can come to rephrasing my original comment is to say that you probably had enough evidence, perhaps of a qualitative nature, to have gone/go back to a more bearish instance sooner. However, I see that my observation now has the benefit of hindsight so we will have to see how it fares in the coming weeks. We all know that calling the markets in the short term is a looser's game; but if one still wants to give it a try, I must admit your approach is the best one I have seen out there in terms of its objectivity, and that may call for leaving the "art" side of forecasting outside the analysis.

In closing, I have a few thoughts on Europe. I believe that the current mess in Europe will one day be recognized not as a sovereign debt crisis but as the Big Euro bubble, the biggest bubble in European history, possibly world history, to date; adding to some of the greatest bubbles of all times such as the South Sea Co. Bubble and the Tulip bubble both made in Europe. I will explain.

The creation of the Eurozone, and more specifically the Euro, brought with it great unfounded expectations despite the concerns/warnings from many economists which were successfully ignored, as many rightfully predicted, until the first big crisis hit.

Even under the most optimistic outcome in Europe, "The Damage is Done" (any one out there remember the Foreigner song?). What I mean by this is that even if the Euro survives, even if Greece stays in, the "age of innocence" is over. Regardless of how positive the resolution of the European mess may be, the era of believing in the great synergistic European miracle is over. And this, I believe, even ignoring all the turbulence that may yet to come, is not yet priced in whatever steady state markets will come to once this mess is over. In other words, I believe one should be ready for lower, not higher, market prices sometime in the medium term future.

In closing I will mention a few words i have written many times at PragCap.com. I still believe the European Sovereign Debt crisis will be/is bigger than subprime, even correcting for all the CB action we have seen and the continued avoidance of Lehman moments. A lot of European "mirage" wealth has been and will continue to be destroyed leaving a big black hole behind.

At some future time, we will deal with China, another accident in the making. I hope your readers, are ready for some thoughtful bear arguments to balance the mainly rosy stuff they read in the MSM.


Angel Martin

Jeff, I agree with almost everything that you write on europe this week (for a change !)

What i don't agree with is relying on the St Louis index for warning when systematic risk gets excessive. The St Louis index is a summary measure of bond yields, credit spreads... etc. It is a co-incident indicator.

The St Louis index will give a timely warning if there is a gradual increase in systematic risk like there was in 2008. However, if there is a sudden financial crisis event similar to Sept 11, the index may well gap up from 0.2 to 5 instantly with no warning...

I don't have a good candidate for a replacement but i would probably start here
http://www.ecb.int/pub/pdf/scpwps/ecbwp1327.pdf

Keith Piccirillo

Your macro data reminded me of something that was said in the movie you allude to. Blondie and Tuco told the supine, whiskey drinking, dying civil war Captain "Expect good news". I don't think that news comes until this Fall.
I will be watching to see if the 50 day m.a. of $SPX on the weekly @ 1282 yields a bounce. The daily 200 day is close by @ 1278 and a close below that should cause the bridge to blow up.
Our administration will try to find a way to gradually rebuild the bridge in time for our elections. Big monied interests on the other side might like to see a half year of market decline.
In a relatively short time frame, the Euro could have a big reactionary move down, followed by a spike up following on any one of the last 3 you listed. It could even be a currency event.

http://surfingthenewnormal.files.wordpress.com/2011/06/a-currency-event-is-unavoidable.jpg

Merkel seems to be softening and may just cut a check and give their workers better wages.
We have 7 continents slowly walking forward on 7 different bridges of varying strength, and all are are crossed with great trepidation, always seeking a foothold.

http://news.google.com/newspapers?nid=1913&dat=19281211&id=ZXsgAAAAIBAJ&sjid=qWcFAAAAIBAJ&pg=795,5984880

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