Investors remain locked in discussion about the same issues they were mulling before the holidays. The rollout of the vaccine—however frustratingly slow in some countries—means that the light at the end of the tunnel for the economy is probably not an oncoming train. That’s great news, but the counterpoint is that markets have long since priced-in such an outcome, leaving investors vulnerable to the famous adage that if they’re buying the rumour, they’re also likely to sell the fact. In that vein, I am happy to double down on my comments at the end of last year that you should now be looking to stash away profits rather than putting new money to work. On that occasion I showed two charts to warn about incoming multiple contraction in equities, proxied by valuations on the S&P 500, and my in-house valuation score, which is also headed for the basement. The first chart on the next page shows that the six-month stock-to-bond return ratio in the U.S. remains pinned close to cyclical highs, also hinting that equities are about to give up some of their recent gains, with bonds rallying in appreciation. The second chart shows what happened the last time stock-to-bond returns were this stretched. It occurred in the run-up to the Flash Crash in 2010, before the swoon in the summer of 2011, ahead of the drawdown in May 2012, not to mention during the Taper Tantrum in 2013. Based on this albeit short sample, investors should brace for volatility in H1.
Read MoreIt’s been quite a year. I am inclined to say that next year can’t be worse, but that would probably jinx it. Also, for owners of financial assets, 2020 has been a great year, even if the economy, and event the fabrics of society, have been stretched to a breaking point. The main question for 2021 is whether this imbalance can continue? I’ll continue to investigate that question on the blog in the new year. I also hope to be able to do some more videos and podcasts.
Apart from that, all that is left for me is to wish all my readers a Merry Christmas and a happy New Year. I am very grateful for the attention you afford this little corner of the internet. I know time is a scarce resource, and the content I share is guided by that consideration. I also wish a Merry Christmas and a Happy New Year to my fellow narrative-warriors and collaborators on Twitter.
Read MoreFinancial journalists have had to resort to clichés in the past few weeks to describe the reality that they’re being paid to report on. At the start of December, Financial Times’ Robin Wigglesworth invoked the “everything rally” to describe a market "too hot to handle”, while Bloomberg’s Marcus Ashworth and Mark Gilbert have gone for the idea that markets will “defy gravity”, again, in 2021. The industry’s most widely watched investor survey— the BofA's GMFS—chimes in with the observation that "asset allocators are underweight cash first time since May’13; triggering FMS Cash Rule “sell signal,” a sentiment supported by the opening line in ASR’s recent study; “this is the most bullish result we have seen in the six year running our asset allocation survey.” The bull market in equities is paved with the irrelevance of such skeptical analysis, but sometimes the truth is in fact staring you in the face. This market is flirting with danger, and will soon suffer a significant correction. The more pertinent question, however, is whether I, or anyone else, have the tools or wherewithal to pick a tradable top, and following from that, whether a correction will mark the beginning of a more sustained downturn in equities, and other financial asset prices? As far as the first question is concerned, luck is a thing, but trying to pick even relatively obvious intermediate tops in this market isn’t easy. As a friend on the buy-side likes to remind me; “my put options are melting like butter in the microwave.” In terms of a more dramatic shift in the trend and narrative, we won’t be able to perceive it when it happens, but I don’t think such a shift is imminent.
Read MoreThe chancellor of the Exchequer had sobering news for the UK public last month when he unveiled that the Treasury is on track to borrow almost 20% of GDP this year to plug the hole in the economy created by the virus, a move that will see the public debt-to-GDP ratio zoom past 100%. In a world governed by the rules of the now-defunct work by Rogoff and Reinhart—famously discredited by a spreadsheet error—these numbers would send chills down the spine of economists and public policymakers, but we’ve moved from on then, significantly. We now understand that the government does not operate under a budget constraint, and that it can, in fact, create as much (sovereign) money it wants to buy as much debt that it wishes to issue—via primary market purchases by the central bank—to finance whatever level of spending and investment—ostensibly to generate jobs for every able man and woman—that it wants. I treated these issues in a long-form essay on fiscal policy, but the elevator pitch is simple enough. Under the auspice of MMT, governments have the ability and duty to create jobs for everyone and to prevent financial and economic distress and harm. It must do so because the economic costs and constraints hitherto associated with such a policy strategy are figments of Neo-Classical economists’ imagination.
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