Wednesday, September 12, 2018

Bubbles For Fama

In this November 2016 paper, the authors - Robin Greenwood, Andrei Shleifer, & Yang You of Harvard University,
"[E]valuate Eugene Fama’s claim that stock prices do not exhibit price bubbles. Based on US industry returns 1926-2014 and international sector returns 1986-2014, we present four findings: (1) Fama is correct in that a sharp price increase of an industry portfolio does not, on average, predict unusually low returns going forward; (2) such sharp price increases do predict a substantially heightened probability of a crash; (3) attributes of the price run-up, including volatility, turnover, issuance, and the price path of the run-up can all help forecast an eventual crash; and (4) some of these characteristics can help investors earn superior returns by timing the bubble. Results hold similarly in US and international samples."
Download the complete paper here

Friday, March 23, 2018

2016 Leir Bubble Conference Proceedings

The severity of the 2008 crisis suggests that either the scope or nature of the regulations, or their implementation, failed. The US economy incurred the costs of regulations year in and year out for more than 50 years, and then, when a crisis occurred, several ad hoc initiatives were needed to forestall the implosion of asset values. Perhaps regulation reduced the cost of the crisis. Or perhaps the costs were larger because the regulation had led to a sense of security that proved unwarranted.

Various regulatory initiatives have been adopted to forestall the next crisis or reduce its severity, even though there does not appear to have been a systematic review of why regulation did not allay the 2008 crisis.

This leads to the primary questions addressed at the 2016 Leir Conference. What are the key issues and major trade-offs associated with the financial regulation initiatives prompted by the 2008 global financial crisis? Have the myriad of new regulations reduced the likelihood or severity of future crises?

Download the complete conference proceedings here.

Friday, February 2, 2018

Bracing Yourself for a Possible Near-Term Melt-Up

I think the attached analysis of whether we are in a bubble is worth close attention. Two points raised which I find particularly important are the concentration in a few large momentum stocks in a few industries, mostly technology and finance related. This reminds me of the auto sector bubble at the turn of the 20th Century where only auto stocks were involved. 

Secondly while there may not yet be euphoria from the Chicago Fed Forecasting Conference I can confirm that there is tremendous complacency and overoptimism along with willful blindness of anything economically negative such as the apparent weakness in the housing sector for both resale and new housing which the new tax law and higher interest rates can only have exacerbated. 

Indeed one critical question is what the non-deductibility of high property taxes for owners of those homes does to their cash flow coverage projections and whether all prime mortgages in those areas will remain prime.

Tuesday, October 31, 2017

2017 Leir Bubble Conference

All material related to the 2017 Leir Bubble Conference can be found at the permalink on the menu to the right or by clicking here: 2017 Bubble Conference.

Sunday, December 18, 2016

Global Credit Market Outlook: The Conditions Are Set For Heightened Volatility In 2017

The following market forecast from Diane Vazza, Managing Director and Head of Global Fixed Income Research, S & P Global Ratings, should be of interest to anyone visiting the Leir Center website. Best, Bill Rapp, Director

Global Credit Market Outlook: The Conditions Are Set For Heightened Volatility In 2017

As 2016 comes to an end, a look back at the year shows a very different picture than what most market participants and commentators expected heading in. Defying what most polls were showing in the lead-up to the elections, the U.K. voted to leave the EU in June, and Donald Trump defeated Hillary Clinton for the U.S. presidency. These unexpected outcomes produced increased volatility in the financial markets immediately afterwards. In the case of Brexit, the effect has thus far mostly been short-lived outside of currency markets. Regarding U.S. monetary policy, our economists expected the Federal Reserve to raise interest rates three to four times in 2016, but the year is nearly over, and we have yet to see a single increase. 

One thing that we mostly expected was the increase in corporate defaults in the U.S. oil and gas sector, though the full extent of the increase was underestimated. We expect market volatility across most asset classes to continue into next year. Most of this will likely be a continuation of the increased uncertainty from this year, rather than any certain downturn. The potential for financial disruptions is higher than we previously expected, especially in light of the multiple, unexpected outcomes in 2016.

Still, we believe these factors are unlikely to have any major, negative impact on most of our core measures of credit markets--issuance trends, default rates, rating actions, and borrowing costs--for the coming year.
2017 Credit Market Outlook Summary
Along with our baseline expectations, we also have optimistic and pessimistic scenarios, all of which are based on qualitative and quantitative inputs. Our projections are founded on several assumptions and perceived risks. In our view, geopolitical factors will have the greatest impact on global credit markets in 2017, as the Trump Administration's currently unclear economic and trade policies, as well as the eventual implementation of Brexit, create uncertainties.

These issues have a direct effect on the two largest economies (the U.S. and the EU), with ripple effects expected to be felt globally. Because of the relatively unexpected results of Brexit and the Trump victory, the future courses of these events could present a wider range of both upside and downside risks to all of the credit market measures presented
here. These possibilities are made more uncertain with upcoming elections in several European countries.

Thus far, the reduced debt issuance that we expected as a result of the Brexit vote in June has largely not occurred. On the one hand, this could be a reflection of market resilience amid a backdrop of numerous stimulus measures from the European Central Bank (ECB) and the Bank of England (BOE). On the other hand, it may reflect issuers coming to market ahead of expected volatility and interest rate increases once the formal process begins in 2017.

Our expectations for issuance growth in the coming year are largely driven by increased issuance out of China, particularly among non-financial corporations, financial institutions, public finance entities, and domestically focused Chinese securitization. We do not expect the government to restrain corporate borrowing over the next 18-24 months. Within Europe, we expect the ECB to extend its current series of monetary stimulus measures beyond the March deadline in an effort to further boost inflation, and to act as a counterweight to real or perceived financial fallout from the implementation of the Brexit process.

We expect the speculative-grade corporate default rate in the U.S. to peak around the second quarter of 2017 and to decline in the second half of the year as stress in the energy and natural resources sector will eventually subside. However, currently our sector analysts are anticipating no noticeable increase in the price of oil over the next 12 months, so we expect the energy and natural resources sector to continue to dominate global corporate defaults and downgrades.

In Europe, we expect the speculative-grade default rate to remain around its currently low level of 2%, based on the expectation for a decline in downgrades and healthy lending conditions that should be favorable for refinancing.

Given the intentions of the incoming Trump Administration thus far, one area that could benefit is U.S. infrastructure in both the public and private sectors. However, most of the injection of funding and projects, should it occur, is expected to happen later in the year, and the proposed manner of financing the investment could have a mitigating impact on debt markets.

U.S. voters approved a large number of bond measures on election day, but municipal bond yields spiked following the Trump election victory. Should this persist, the higher yields could contribute to our prediction for lower volume from the municipal market in 2017. In structured finance, we expect the implementation of new risk-retention rules in the U.S. and ongoing regulatory uncertainty in Europe to hamper volumes in 2017, although growth may continue in Asia. 

We therefore expect anemic overall global volume growth of 1%-6% year over year. Rating movement in U.S. public finance should continue its upward trajectory, but U.S. states and higher education could experience more downgrades than upgrades.

We expect defaults in U.S. public finance to remain rare, but a significant number of ratings in the 'CCC' and 'CC' categories in Puerto Rico indicates that the number of defaults in 2017 could be similar to the 12 defaults so far in 2016.

Rating movement in non-U.S. local and regional governments (LRGs) will likely continue downward in 2017. The 295 LRG ratings have 43 negative outlooks and 19 positive outlooks. Nearly one-third of the ratings with negative outlooks are the same as and capped at the related sovereign. If we lower the sovereign ratings, we would also likely
lower these LRG ratings.

Based on the current proportions of corporate ratings with positive and negative rating outlooks and CreditWatch, we anticipate rating actions in 2017 to lean net negative, with a baseline estimate for a global corporate downgrade rate of 11.8% and an upgrade rate of 8.1%. We expect global structured finance credit performance to remain benign in 2017. The 12-month-trailing average change in credit quality looks set to remain close to zero, indicating aggregate ratings stability. The default rate will likely remain somewhat elevated compared with the pre-2008 timeframe, but below its long-term average.

Diane Vazza
Managing Director and Head of Global Fixed Income Research
S & P Global Ratings

Saturday, June 25, 2016

Why The Bears Are Acting Rationally And The Bulls Are Not


Why The Bears Are Acting Rationally And The Bulls Are Not

William V. Rapp
Jun 24, 2016

The markets have essentially been moving sideways for over a year as the bulls and the bears seem to be equally convinced that world economic growth will continue or that it is in a period of economic stagnation comparable to the 1970s but without the inflation. Since there are plausible arguments on both sides the two groups appear to have roughly equal financial weight. 

US growth does appear to be moving forward and employment has continued to increase. Indeed the Fed felt confident enough last Fall to raise interest rates for the first time in roughly 7 years. On the other side energy and oil prices remain depressed and according to S&P defaults and issues highlighted for downgrades are now at the highest levels since 2009 with energy, commodities and financials especially vulnerable.

While the Brexit may or may not be related to these events it certainly adds uncertainty and complexity to the analytical brew. Thus the Fed and other central banks are likely to remain cautious in the months ahead at least through the US presidential elections. However even after these events begin to sort themselves out it would be wise to remain conservative because the bears were right all along even before Brexit and the current Presidential circus added their impacts to the global economic and financial market environments. 

This is because global growth for several years has been highly dependent on explosive Chinese growth and a continuation of this growth has been built into the micro and macro DCF models used by a wide range of global financial institutions and investors. Yet these assumptions are now clearly questionable as already identified at the 2014 Leir Bubble Conference and later confirmed at the 2015 Conference. However this view is now more widely accepted. Last year I attended an investor lunch hosted by a major global financial advisor where they forecast that Chinese growth would continue in the six to seven percent range. At this year’s lunch they had revised this forecast to three to four percent. The implications of this changed view are huge as analysts worldwide are forced to revise their DCF models downward.

Further at last year’s Leir Conference Professor Aliber forecast that like Japan after the 1989-90 crash China could experience a serious recession [actual negative growth] in the next three to five years and would then like Japan would have to recapitalize its banks. Whether a similar period of economic stagnation would follow is not clear but should be considered a possibility in any forecast. Thus as financial analysts continue to factor these considerations into their valuations including linkage effects to other countries’ economies, industries and companies in terms of the global economic multiplier we can expect that markets will continue to move sideways or down no matter how Brexit actually evolves.1


1 If China does not buy more iron ore from Brazil or Australia then they will not expand capacity and CAT or Komatsu will sell less mining equipment and will employ fewer people or may even reduce employment. Such reduction in demand has a downward global multiplier effect.