The Big Bag of Air
Wednesday, December 15, 2021
Published irregularly, as conditions dictate.
Awaiting the Fed Announcement at 2 today. I expect it will be wrapped up like baklava, dripping with honey and the market will rally back to new all-time highs. Maybe I’m Pavlov’s dog here as with anyone else who has seen what is going on in these markets. Yes, I have sort term indications (alluded to yesterday) saying this market should be getting cracked here, and I really do expect things to fall apart any hour here, amid the complacency of December, but, hell-bent to catch the coming bear market, the coming drops that will comprise that, I try to keep my immediate hopes in check and prepare for an even longer battle. I don’t think there will be any other way to catch this when it descends. It is the only sure-fire way to be in there, is to be in it all the time until it happens, if you can.
Consider that 8.6 trillion has been created by the Fed since the ‘08 Financial Crisis, most of it in the past two years, in the forms of QE buying 80 bln of junk ETFs and 40 bln of mortgage backeds.
This was money created out of thin air
In addition, we are at about the 29 trillion level of total federal debt. When you issue debt with the indention of never retiring it, merely rolling it over, that is the same thing as creating money out of thin air.
Of this 29 trillion (which coming into 1980 was less than 1 trillion) those who own the debt can borrow against it up to 95% of the value. The money borrowed - at least most of it, is not resident on deposit, but ends up borrowed at…..the Fed Window, creating thus more, 75% or more, money out of thin air on this 29 trillion dollar debt.
So money creation, money added into the system, just on the federal expenditures level, is somewhere in the neighborhood of at least 60 trillion currently. This does not account for money created through the fractional banking system at the private level.
The stock market, in the aggregate, has a capitalization of about 56 trillion right now.
Of the money added into the system, a large portion of it - perhaps the lion’s share, has pushed up risk asset prices - stocks, private equity, real estate, crypto, and to a lesser extent, collectibles. It is, as everyone knows, an “everything bubble,” a giant bag of air.
Several days ago, I posted this chart, of the ten year, inflation-adjusted total return on the SP 500:
Historically, when this return is > about 12% average per year, you want to be moving out of stocks, and when < -7%, moving into stocks, particularly if you are executing a passive investment program.
Mean reversion is a rule.
When ten year average returns are above 10, 12%, there tends to be a prevalent delusion that somehow the rules have changed, that we are in a new dynamic, anew era, whether the “permanently higher plateau” notion of 1929, or the “post-covid, FOMO, TINA, you wouldn’t understand” mentality of the bulls today.
Mean reversion is a rule.
For long stretches of time, bond returns outpace stock total returns, and, with the past as a guide, we should very soon return to such an environment. Of any charts I can show, I think this is the most sobering:
The blue line is the inflation-adjusted, annual rolling ten-year total returns on the SP500 minus the real return of the ten-year return. Never in US history has it been so grotesquely excessive. As a general rule, when the difference exceeds 10%, historically, it has been the right time to be getting out of equities. We are currently over 18%.
Consider the Sovereign Wealth Funds, who own trillions of US equities, and are nearly 100% long. The public and private pension plans, the multitude of 401K and IRA accounts all lined up long vis-à-vis this chart, long a market that has been inflated to the point of being a big bag of air
No one wants to be out of risk assets now, no one seems to want to be in cash or near cash. But mean reversion is a rule.