An impeached American President is acquited without trial
A historic, bitterly partisan fight in Washington came to an end yesterday as the Senate voted to acquit President Donald Trump on charges he abused his power and obstructed Congress, making him the third U.S. leader in history to escape removal from office.
Trump became the third U.S. president to escape removal from office after being impeached by the House in December. Utah Senator Mitt Romney was the only Republican on Wednesday to break with his party and find Trump guilty of seeking a political favor from the Ukrainian government. He voted to clear the president of the obstruction charge.
The Republican-led Senate voted 52-48 to find Trump not guilty of abusing his power and 53-47 to find him not guilty of obstructing Congress.
In a saga where whistle-blowers, facts, and testimonies all incriminated the serving US President, forcing the Democrats to initiate impeachment proceedings, the Republican-led Senate not only refused to remove him from office but actually refused to allow his closest aides to testify during the trial.
Seen from abroad, the whole process raises doubts about America’s system, Rule of Law and Government moral standards.
A US president that was elected with 2 million fewer votes than his opponent in 2016 clearly uses his position as the most powerful leader of the world to better his chances of elections in the next contest and is cleared of wrongdoing by his own political party after the same political party prevents crucial witnesses from testifying in front of the highest body of representatives of the people.
Has this happened in any other country, commentators would have probably considered that country to be a “Banana Republic” where the Rule of Law and the independence of justice are variable concepts that are superseded by political considerations.
In a nutshell, the outcome of the entire impeachment process is that a US President has evidently committed a “crime” but that a US President can do anything for as long as his political allies want to protect him!
No surprise then that the Chinese consider that their system is superior to the American democratic system !
A politically-motivated FED is fueling asset bubbles!
On two occasions in the past eight months, global bond yields went to multi-decade record lows, yield curves have inverted and real bond yields have been negative across the entire yield curve.
As many analysts have highlighted, the unprecedented extraordinary monetary policies engineered by the world central banks since 2008 have triggered asset bubbles almost everywhere and the last FED “preventive” cut unleashed a melt-up in US equities that is now taking mania proportions.
Since the beginning of the year, the assassination of Iranian general Qassim Suleymani, which brought the world very close to a global war, and the erupting of the most uncontrollable virus ever known have barely dented investors psychology and buy-the-dips mentality despite extreme valuations.
The culprit: abnormally low-interest rates that are seen as being there to stay and make equities the only possible investment around.
And the risks on monetary policies have become assymetrical :
The belief is that the Federal Reserve — and many other central banks — are backed in a position where the only way they can move for the rest of this year is toward even easier conditions. In other words, it is definitely safe to go back into even overvalued equities whatever happens.
Why is it so safe?
In part, the ongoing risks created by the virus outbreak bind the hands of any central bank that might have been tempted to try tightening financial conditions.
Secondly, the US Fed has boxed itself in. It is now making clear that its 2% inflation target is “symmetrical”, and not a tight upper limit, making it all the harder to justify raising rates.
With an election coming in November, and the Fed wanting to avoid the politically contentious step of raising rates during a campaign, investors are working on the assumption that the risks, unlike the Fed’s inflation target, are asymmetric.
Rates might go down, but there is no way they will rise. And so, the S&P 500 and the Nasdaq are back at new record highs.
When the markets turn though and stocks lose 60 to 80 % of their value, investors and commentators will be entitled to ask why the FED had deliberately fueled what was clearly a highly toxic asset bubble.
This will lead to an in-depth questioning of the FED’s processes and models and their reluctance to including asset prices in the inflation indexes.
Price stability is at the heart of the Fed’s mandate.
Asset price instability is probably the most damaging factor of all and the main responsibility of any Central Bank should be to AVOID financial crises.
US Investors seem to have gone mad!
In the past few weeks, and even more so since the erupting of the Wuhan Coronavirus, equity investors seem to have lost all sense of risk, fundamentals or even common sense.
The Tesla Mania
In another sign of the mania that US equities have gone into, Tesla shares had a crazy week with the stock rising from 600 to almost 1000 in three days as investors have gone mad about a company that sells 370’000 vehicles per annum but is worth almost as much as Toyota motors corp that sells 10.7 million cars a year.
US$ 50 Billion worth of TESLA shares changed hands last week against leaving analysts and strategists completely dumbfounded.
This is just another indication that investors in US equities have lost complete sense of reason and are driven by an overwhelming Fear of Missing Out. These sharp moves find no fundamental justification and it is difficult to see how investors who have bought Tesla shares at 900 will recoup their investment in the near future.
No Cash left
Few investors seem to be holding cash anymore, and it is hard to blame them. With rates near historic lows, bond yields at record lows and a stock market that can’t even suffer a 3% pullback for a day, even when the world is hit by the biggest pandemic of the past few decades, there is little to justify a heavy cash balance.
Cash holdings among mutual fund managers had one of its largest plunges ever, dropping to only 2.5% of assets, by far a record low.
Retail investors aren’t holding much cash, neither are Rydex fund timers, other individual investors, or pension funds. The chart below depicts the average cash holdings of all the different groups of investors.
Across a broad swath of investor types, the average cash balance just fell below 7% of total portfolio value. That’s the 2nd-lowest in 40 years, next to a couple of weeks in January 2018, just before the indexes peaked.
This has significant implications as on one hand, it testifies the extreme level of optimism prevailing amongst investors and on the other hand, there is little ammunition left to push equities much higher.
No more expected returns ahead
At the end of January 2020, Hussman Strategic advisors’ proprietary model of likely 12-year nominal total returns for a conventional passive investment portfolio (60% S&P 500, 30% Treasury bonds, 10% Treasury bills) fell to just 0.04% annually, below even the previous record of 0.34% set in August 1929.
This extreme reflects the combination of record equity market valuations and depressed interest rates that hampers all hopes of positive returns in the future.
This is a combination that joins insult with injury, creating weak prospects for the future returns of passive, diversified buy-and-hold strategies, across the board.
The more glorious this bubble of everything becomes, the more dismal future investment returns become in foresight. The higher the price investors pay for a set of future cash flows, the lower the return they will enjoy over time. Investment is not independent of price.
As we have argued many times when analyzing the intrinsic value of the leading stocks of this bull market, whatever US investors are doing right now, it is not “investment.”
And whatever CEO’s have been doing when buying back their shares at current valuations, it is not proper management of their shareholder’s money and they may ultimately face lawsuits in the future.
The chart below shows Hussman’s estimate of 12-year total returns on a conventional passive investment mix (blue) along with actual subsequent returns. They use a 12-year horizon because that is the point where the “autocorrelation” of reliable valuation measures typically hits zero, meaning that overvaluation or undervaluation at one point becomes uncorrelated with later valuations.
So “mean reversion” is most likely on a 12-year horizon.
Valuation extremes like 1929 and 2000, along with lesser extremes like 2007, have generally been followed by profound market losses (and associated spikes in expected future returns) over a much shorter time frame.
At the peak of every valuation bubble, recent returns have invariably been greater than one might have projected several years earlier because the advance to hyper valuation produces temporary returns that are later erased.
That is why actual returns were higher during the 12-year period from 1988-2000 than one would have projected in 1988, and it is why actual returns have been higher during the recent 12-year period than one would have projected 12 years ago.
The problem, as investors should recall from the 2000-2002 and 2007-2009 collapses, is that the extra returns from those “errors” are invariably erased.
Still, it is useful to understand how far below-average the returns of the S&P 500 are likely to be in the coming years even if valuations don’t normalize at all, and instead remain at their present extremes forever.
The U.S. economy is presently running at a structural real GDP growth rate of only about 1.6%, reflecting the combination of demographic labor force growth and trend productivity. That’s the real economic growth that we would observe if the rate of unemployment was simply held constant at current lows indefinitely.
Add 2% inflation, and you’re up to 3.6% nominal growth (which is also the nominal growth rate of S&P 500 revenues over the past two decades).
Add a 2% dividend yield, and we can estimate – assuming that market valuations remain at current extremes forever – the S&P 500 would achieve total returns averaging 5.6% annually. Even one episode of significant risk-aversion and that requirement will be violated.
Investors may not like the idea that record extremes in future market valuations will be requiredin order for the S&P 500 to produce even 5.6% annual returns, but see, that’s exactly how the S&P 500 has produced a similar total return since March 2000.
Specifically, at the end of 2019, the price/revenue ratio of the S&P 500 pushed to the same extreme we observed in March 2000. Meanwhile, S&P 500 revenues have grown at an average annual rate of 3.6% since 2000 (a figure that includes all the benefits of stock repurchases during the past two decades), while the S&P 500 dividend yield has averaged 2%.
In the last two weeks, yet another valuation indicator has reached a historical extreme.
the S&P 500 price/revenue ratio clawed its way to the steepest extreme in U.S. history.
The chart below shows the current price/revenue extreme for the S&P 500.
Having done so, investors now require market valuations to maintain a “permanently high plateau” at this level in order for continued growth in GDP, revenues, and dividends to collectively produce S&P 500 total returns of even 5.6% annually.
Given the current 10-year Treasury bond yield of about 1.6%, and the 3-month Treasury bill yield of about 1.5%, the maintenance of current valuation extremes, a decade from today, would still produce likely returns on a passive investment portfolio (60% stocks, 30% bonds, 10% T-bills) of just 4% annually.
More likely, assuming that market valuations simply touch their run-of-the-mill historical norms in the future, passive investors should be braced for zero or negative total returns both in the S&P 500 and in a conventional 60/30/10 asset mix over the coming 10-12 year horizon.
Allow market valuations to slip at all, and likely S&P 500 total returns will slip as well. Annualize the slip in valuations over whatever holding period you’re considering, and you’ll get a reasonable estimate of the impact on likely market returns.
So if market valuations, which are presently about triple their historical norms on the most reliable measures, simply move to double their historical norms a decade from today, the implied 10-year annual total return for the S&P 500 would be roughly (1.036)*(2/3)^(1/10)-1+.02 = 1.48% annually.
Simply touching the historical norm – not even reaching historically undervalued levels – would imply a 10-year annual total return for the S&P 500 of roughly (1.036)*(1/3)^(1/10)-1+.02 = -5.18% annually.
Whatever they’re doing, it’s not “investment.”
As Graham and Dodd argued, “It is unsound to think always of investment character as inhering in an issue per se. The price is an essential element, so that a stock may have investment merit at one price level but not another. This is exactly what we have been arguing all along on the extreme valuations of the FAANGs + Microsoft
Amidst an “everything bubble” that has touched every asset class, investors should not imagine that there is some appropriate investment that promises a satisfactory return in such broad extremes.
Even international stocks tend to lose significant value when U.S. stocks decline, regardless of their valuations. Yes, there may be niches that could be useful for diversification, but the primary “alternative” that investors have here are cash, patience, and hedged investment exposure.
Inflation won’t bail investors out
Investors should not imagine that inflation would improve the situation. Historically, the first casualty of inflation is market valuations.
With the most reliable measures of market valuation presently between 2.7 and 3.2 times their historical norms, the CPI would have to roughly triple before the beneficial effects of inflation on nominal growth would outweigh the negative effects of inflation on market valuations. Until that happens, higher inflation will only make matters worse for investors.
The fact is that cash – short-term interest-bearing liquidity – has clearly outperformed the stock market during periods of rising inflation. Indeed, when the rate of inflation is rising, higher rates of inflation are typically associated with poorer stock market performance until market valuations are driven to historically depressed levels (after which the effect of inflation on nominal growth finally dominates).
Valuation extremes
The following charts show two of the most reliable market valuation measures over time. Both are better-correlated with actual subsequent stock market returns across history than numerous alternatives, including price/forward-earnings, the Shiller cyclically-adjusted P/E (CAPE), and the Fed Model.
The first chart below shows the ratio of nonfinancial market capitalization to corporate gross value-added, including estimated foreign revenues. I introduced this valuation measure in 2015, and it remains the measure that we find best correlated with actual subsequent market returns across history. In recent weeks, this measure has moved to extremes implying negative estimated total returns for the S&P 500 on both 10-year and 12-year horizons.
The Hussman proprietory Margin-Adjusted P/E (MAPE) is nearly as reliable as MarketCap/GVA and spans a much longer history to the early-1900’s. This measure has moved to extremes that eclipse both peaks observed in 1929 and 2000.
Across history, and even in recent cycles, market valuations have remained extremely informative about long-term market returns on a 10-12 year horizon, as well as potential market losses over the completion of a given market cycle.
At the same time, however, market returns over shorter segments of the market cycle are driven by the psychology of investors – specifically, their inclination toward speculation or risk-aversion.
Presently, we observe the combination of hyper valuation and negative market internals, which I view as a “trap door” situation. In other words, the recent rally since October has the hallmarks of a massive Bull Trap where investors forget about valuations and justify their buying by everlasting low interest rates and high valuations.
Faced with hypervalued extremes on historically reliable valuation measures, the first refuge of speculators is always to justify valuations on the argument that “this time is different.”
As J.K. Galbraith wrote in The Great Crash, recounting the 1929 market collapse:
“The market will not go on a speculative rampage without some rationalization. But during any future boom some newly rediscovered virtuosity of the free enterprise system will be cited. It will be pointed out that people are justified in paying the present prices – indeed, almost any price – to have an equity position in the system.”
Two of the most common appeals to “this time it’s different” relate to interest rates and profit margins.
First, while low interest rates may very well encourage rich stock valuations, those rich stock valuations have the function of reducing likely future returns on stocks. For any given amount of future cash, if one can observe the price being paid today, one can directly calculate the implied rate of return embedded in that price. No further “adjustment” for interest rates is required.
A second, equally important point is that if interest rates are low because growth rates are also low, no valuation premium is “justified” by the low interest rates at all. Stocks will produce a competitively low return by virtue of the depressed growth rate. Elevating valuations in that situation only adds insult to injury.
What we are most concerned about is that US investors seem to believe that valuations do not matter, that the Fed is omnipotent and that stocks are now the ONLY possible “investment,” regardless of their price.
All these elements, the hyperbolic nature of the leaders of the markets, the irrational moves in the share prices of companies like TESLA, the huge concentration in very few stocks and the very small amount of cash left ALL combine to tell us that the current HYPERVALUED state of the market will be followed by significant market losses.
We expect the SP500 to lose 67 % of its value from now till the end of 2021 and the Nasdaq to lose probably more like 80 % of its value.
As it happened, the Nasdaq 100 lost an implausibly precise 83% of its value from March 2000 to October 2002 while valuations were actually less extreme than today.
The leading superpower of the world uses its might to annihilate the rights of an entire Nation
The publishing of Jared Kushner’s peace plan for the Middle East revealed that the one-sidedness of the current US Administration in the Isreali-Palestinian conflict goes well beyond anything commentators and specialists imagined.
Non-content of having unilaterally given Israel sovereignty over the occupied Syrian Golan and having legitimized the illegal colonies that have been condemned unanimously in international law, the Middle East plan proposed last week creates a non-viable nation and annihilates all the rights of the Palestinians to auto-determination and sovereignty.
The official chart of the proposed “Independent Palestiani State” tells the full story.
The plan has been elaborated without consultation of the Palestinians and the real worry is that it could technically be implemented unilaterally by Israel without any recourse or possibility to correct things in the future.
Granted, the Palestinian people have missed numerous opportunities to reach a peace agreement in the past but they were not the only party refusing to make concessions.
The Palestinian dream of a viable Palestinian Nation is quickly fading away, as are the principles of International Law it seems.
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