34 Charts: This Time Is Different
“This time is different” — I might include that in the title of everything I publish from now on.
I’ll never be wrong, which is an appealing proposition. A man can dream. And funny thing: A dream is the subject at hand.
In October, I asked whether the market could have its cake and eat it too. The hope was for persistent low interest rates and consistently appreciating securities.
Somebody seems to have remembered cake doesn’t work that way.
According to some, this buying opportunity is brought to you by the letter “C”: China, commodities, and the now questionably healthy consumer. Reaching towards risk feels sensible. It’s been nearly 10 years since it wasn’t.
But today, growth, like certainty, is hard to come by. We hear the word “recession” again. There have been more Google searches for the phrase “sell stocks” this month than at any time since October 2008. And January is not over.
To some strategists, the writing is on the wall. I wrote recently that anyone who says they know exactly what will happen is wrong, cheating, or both. I still think that. So before getting into what I see, I want to tell you what to do: your homework. Now is the time to distinguish yourself as an investor. So as you read through everything below, remember: I’ll be disappointed if you wind up agreeing with everything I say.
Let’s get started.
— Mamta Badkar (@mamtabadkar) January 19, 2016
Fifteen straight quarters of year-over-year revenue declines from a company that once set the world on fire. Things haven’t actually been that bad for IBM since they disbanded their corporate orchestra in 2001.
It outperformed the NASDAQ until revenue growth reversed and it transmogrified from a tech company into an object lesson.
I’m not saying that to be mean. Without question, IBM is still changing the world. They make incredible things. But they are far from the company they used to be. In 2000, books published in the English language mentioned IBM roughly twice as often as Intel, Cisco, and Microsoft combined. Today, “IBM” is googled less than any of them.
Is it prudent to bank on a rebound? Think it over as you keep reading.
— zerohedge (@zerohedge) January 15, 2016
Because IBM is not alone. Investors focused on the Shanghai Composite could be forgiven for the assumption that the bull market we’ve experienced has brought us to broad-based new highs. Consider the experience of a wide range of companies instead, and it’s transparently not so simple.
Facebook, Amazon, Netflix, and Google (FANG) are the poster children for an era in which winners win by a lot and dominate the headlines. Bulls on these companies call them monopolies. Others call them near-monopolies.
Meanwhile, looking at the median daily price change of stocks is not an uplifting exercise. Companies in aggregate are mired in a multi-decade stagnation.
Reminder: "The market is down" and "the market is cheap" are not equivalent statements. pic.twitter.com/KDwdPR477B
— William Ortel (@willortel) January 20, 2016
You wouldn’t think that from their valuations though. Shares of the FANG monopolies and 496 other companies fancied by the index committee at Standard & Poor’s change hands for a princely 1.6 times their last 12 months’ revenue.
A similarly rare “profit recession” occurred in the mid-1980s on the back of dollar strength + collapsing oil prices pic.twitter.com/BryOD1L7eZ
— Urban Carmel (@ukarlewitz) January 15, 2016
And when sales aren’t reliably translating into earnings, it becomes more difficult to rationally pay up for them.
If the sales were expected to grow substantially, it would of course make sense to some degree. But I have to wonder: to what degree? I would happily pay two-times sales for Netflix, but the price as of this writing is six to seven times. Ditto Google. Amazon is a relative bargain at less than three-times sales.
And at 17-times sales, one is left wondering how soon investors think Facebook will be a $26-trillion dollar company.
either someone found alpha's magic formula or a big imbalance is accumulating that'll end in sharpe mean-reversion pic.twitter.com/W8pwpFXUVn
— Guillermo 🙁 (@groditi) January 15, 2016
Or maybe something else is at work? Guillermo’s chart shows the returns of four different factor-based exchange-traded funds (ETFs). Starting from the red line at the bottom: Value, Size, Quality, and Momentum.
And he makes a heck of a point: It would be strange for this to persist for any length of time.
Especially in such an unusual context.
Mentions of "deflation" during earnings calls… pic.twitter.com/cNDJc8Wdfl
— Yield Curve (@TenYearNote) January 20, 2016
And when we have a pretty big distraction looming on the horizon. It was true last year and it’s true now: Deflation is a thing.
Being “a thing” means that it’s more than just a topic of conversation during exchanges between managements and the analysts who love them. It means that the US Consumer Price Index (CPI) was up just 0.7% in the 12 months ended December 2015.
— Real Time Economics (@WSJecon) January 17, 2016
And since the whole reason it was positive at all is consistent growth in rents, you have to wonder if deflation is already here.
— Andrew Levin (@andrewtlevin) January 18, 2016
And whether deflation will bring a recession along with it. As Andrew Levin points out in the linked note, there has not been an instance since 1970 when the industrial sector shrank as quickly without the economy following it downward, often into recession.
— Matthew B (@boes_) January 15, 2016
Though not cause for alarm on its own, the mood of most consumers is far from buoyant. This has come up a lot here in the United States amid the ongoing presidential race, which is likely to feature at least some degree of populism on both sides of the political spectrum — perhaps even more than most expect.
Over the summer, I bet a friend a nice dinner that Hillary Clinton will lose the Democratic nomination, and though it’s still a long shot, I look a lot less crazy now.
A good rule for when investment people invoke politics is to stop listening. So I won’t blame you for rolling your eyes. I only bring it up to highlight something that I don’t think is so well understood in the global investment community: American optimism is being tested. What’s especially sad is that negative readings on this particular measure used to be quickly reverting statistical aberrations. Not any more.
You can kind of see why. Just shy of 46 million Americans are on food stamps. This is not a sign of broad prosperity.
Weak US retail sales will make recession drumbeat grow louder. But remember falling goods prices big part of weaknes pic.twitter.com/RNJcWr7QRE
— Johnny Bo Jakobsen (@jbjakobsen) January 15, 2016
Neither is falling goods prices something to brush off. To me, this chart screams “declining pricing power.” Remember: Investing is not about correctly forecasting economic data. It’s about figuring out the degree to which reality is reflected in an asset’s price. Whether it indicates a capital “R” Recession or just a lowercase really bad time for anyone in the business of selling things to consumers, this chart does not contain good news.
— Martin Enlund (@enlundm) January 17, 2016
Though it’s important to keep one quarter’s GDP print in context. Martin Enlund makes a great point: 2015 won’t look terrible on an annual basis even if the fourth quarter figures wind up at the low end of recent GDPNow forecasts.
Amazingly not every "analysis" on Twitter is accurate: here is the real Atlanta Fed vs Actual GDP pic.twitter.com/dsFMgst42z
— zerohedge (@zerohedge) January 17, 2016
And GDPNow — the favorite forecasting model of economic hipsters — isn’t infallible. We could very well get a great GDP print in the fourth quarter, and it wouldn’t be out of line with the tool’s recent history.
IMF China Growth Downgrades:
They Just Keep Coming pic.twitter.com/JrT0w87kJQ
— ian bremmer (@ianbremmer) January 19, 2016
But there is the little matter of what happens next. Let’s consider the case of China, currently the world’s largest exporter of volatility. We polled CFA Institute Financial NewsBrief readers, and 53% of them think the IMF’s 6.3% annual GDP growth forecast is too high. History shows they are likely to be correct.
Ian Bremmer also knows a thing or two about the world, so his skepticism about these forecasts should be taken seriously.
Chart (GS): China's heavy dependence on investment – pic.twitter.com/Jse3lt0A6N
— (((The Daily Shot))) (@SoberLook) January 21, 2016
Especially since China hasn’t quite managed to wean itself off its dependence on investment for continued growth.
— (((The Daily Shot))) (@SoberLook) January 20, 2016
And things might still soften from here. The linked article makes two critical points: First, these are export orders, not exports. That means that this series will materialize in actual trade flows in two to three months’ time.
Second, a lot of exports from Taiwan are sent to Chinese factories owned by Taiwanese companies to then be exported again. That means the share of GDP coming from investment in China might rise simply because exports fall. This is not a positive development.
Shenzhen property prices pic.twitter.com/KVxMSsaRkO
— Callum Thomas (@Callum_Thomas) January 18, 2016
But this is. Kind of. Shenzhen is the city directly adjacent to Hong Kong on the Chinese mainland, and it’s also the home of a booming technology sector. This has created a sense of promise in the city. In November, the Financial Times reported that residents in Shenzhen could look forward to strong wage growth, in contrast to stagnating pay packets across the border in Hong Kong.
The existence of growth is a good thing, but the intensity of change in the value of a square foot should make you wonder how scarce growth really is. And what happens if that growth dissipates?
And zoom out for a second. If you assume CFA Institute Financial NewsBrief readers are right that 2016 GDP growth in China will come in below 6%, strip out the nearly 50% of growth that comes from investment and then consider how rapidly prices are changing in the economic zones where there is organic growth. It’s hard to walk away thinking that the aggregate will perform well.
EM vs DM business confidence. Growing divergence pic.twitter.com/EyfYBD7CC1
— Eurofaultlines (@Eurofaultlines) January 16, 2016
And that’s not just a China thing.
— Saltyman (@SaltyMain) January 23, 2016
The decline in sentiment has been accompanied by a commensurate sucking sound in investment flows.
— Jim Roberts (@nycjim) January 17, 2016
Oil certainly has a lot to do with it in some cases.
Financial stress rising for energy assets, EM energy has ways to go to catch up pic.twitter.com/Ey110TIOED
— Eurofaultlines (@Eurofaultlines) January 16, 2016
But the preponderance of petro pain has so far hit the United States.
— (((The Daily Shot))) (@SoberLook) January 17, 2016
You can see why.
Oil = undervalued pic.twitter.com/BWtxRyKW0j
— Callum Thomas (@Callum_Thomas) January 19, 2016
Yet the “oil is undervalued” argument persists. Don’t get me wrong: This is a fantastic chart. Isn’t it remarkable how tidily the investment community’s perceptions of value for oil center on $80 a barrel?
In real, inflation-adjusted terms, oil prices were at about $20 a barrel, or below, for most of the past 150yrs pic.twitter.com/wkvMzwLcP9
— Ed Conway (@EdConwaySky) January 17, 2016
It’s a bit surprising how infrequently oil has traded at $80 on an inflation-adjusted basis over the last 150 years though. Clearly, things have changed since the sepia-toned days when the first North American commercial oil well was drilled in Oil Springs, Canada. But within the last 20 years, oil has traded across nearly its entire historical price range.
Don’t forget what happened after the last sharp decline to the $28 range. Prices did not snap back quickly.
On energy Bks and what's to come. Dollar value of filings in '15 far exceeds '09. pic.twitter.com/yAZEFtcFWx
— modest proposal (@modestproposal1) January 18, 2016
So it’s no surprise that energy-related defaults have spiked so much.
Less than 1% of debt maturing in 2016 pic.twitter.com/1OZfDtzTto
— credit markets (@swaptions) January 16, 2016
Until you realize that defaults weren’t the result of imminent debt payments. And then you realize that the energy companies that haven’t defaulted still need to service all that debt.
This is pretty damn unprecedented (and yes HY price not spread market blah blah) pic.twitter.com/KAx1f5l1Tm
— Eric Burroughs 📈 (@ericbeebo) January 17, 2016
So good credit analysts have a lot to look forward to. But the art of investing will be as important as the science this year. These are strange times.
So a month after the Fed "raised" rates, rates are actually lower & the yield curve is just as steep… pic.twitter.com/lR73vP8qU7
— Bluegrass Capital (@BluegrassCap) January 15, 2016
It’s not clear if short-term interest rates are that effective a tool right now.
— Adam Samson (@adamsamson) January 15, 2016
Though it is clear there aren’t many people who think rates are headed up anytime soon.
Free-Market Capitalism, ladies and gentlemen. pic.twitter.com/D1ovLjEAZt
— Rudolf E. Havenstein (@RudyHavenstein) January 25, 2016
And plenty of people are looking for a savior.
— Joe Weisenthal (@TheStalwart) January 16, 2016
For those who aren’t yet familiar with unterest rates, it may be tempting to also feel that there’s not much room for central banks to accommodate further. Here’s a quick primer on what that shadow rate actually is and why it’s useful. But in brief, the shadow rate is a calculation that allows you to keep using other economic models when headline rates are trapped at the zero bound. To a policymaker, this is quite a useful thing.
But the conclusion of the paper introducing the shadow rate is as interesting as the rate itself: “Our estimates imply that the efforts by the Federal Reserve to stimulate the economy since July 2009 succeeded in making the unemployment rate in December 2013 0.13% lower than it otherwise would have been.”
Granted, to the people who otherwise wouldn’t have had jobs, this is a great thing. But you have to wonder . . .
— Pedro da Costa (@pdacosta) January 16, 2016
Is the emperor wearing any clothes?
If I could hear the thoughts of every other investor who works in Midtown Manhattan, I imagine they’d be saying something along the lines of “the Fed is distorting asset prices.”
The US Federal Reserve is not useless. I was around in 2008, working in the auction-rate preferred market. It was dominated by Lehman Brothers. I know what it’s like when liquidity disappears. I’m sharply skeptical of any argument that the world would have been better off without a liquidity provider of last resort at the peak of the crisis.
But this time is different. The problem now is not liquidity. It’s that growth is accruing to a collection of businesses that can serve the entire world with a a tiny village of employees. I’m not sure what the formal cutoff is for what constitutes a village, but I still mean that literally. Netflix had 2,450 full- and part-time employees as of 31 December 2014. Its service is available almost everywhere on earth.
This isn’t necessarily a bad thing. On the contrary, by the time you’re reading this, I might already own their stock.
Interesting empirical data. Computer volumes for top platform as a function of time. pic.twitter.com/zqWuK1DmuO
— Horace Dediu (@asymco) January 18, 2016
Because “scale begets scale” is an iron law in technology, at least within a product cycle.
But what happens to the infrastructure that’s been built out to serve customers the old way?
For instance, what happens to the auto business when self-driving cars are widely adopted? How big will the auto parts industry be? Will it have millions of customers or a handful? How many autos will have to be manufactured as car utilization rates climb from around 4% to something closer to 100%? Since (for now) it owns the button you press to summon the car, Uber will be having a nice time. AutoZone? Not so sure. The companies that sell through them? That’s even less certain.
I am not predicting the end of history. Monopolies end. Progress is not immediate. Remember IBM? Ever glanced at what people thought 2010 would look like?
But I wouldn’t poke around in the public equity markets for what will replace today’s monopolies. And it’s doubtful there are 500 companies that are worth 1.6 times sales as the economy flirts with recession and pricing power evaporates. And deflation is a thing. And the rapid growth of valuations relative to realized growth contains risk. And what’s happening in emerging markets is about more than just oil. And the returns society as a whole received from an unprecedented expansion of the Fed’s balance sheet were not that great towards the latter part of the intervention. And now we’ve got at least one Japan hanging around that needs to be unwound.
And against that backdrop, every risk on earth is being repriced. We can still be friends if you don’t agree with me though.
I saved this Tweet to cheer you up pic.twitter.com/IyHIuTmtGU
— StockCats (@StockCats) January 17, 2016
Because I believe this too. But I’m 27 years old now, so I have a pretty good idea of how long 20–25 years is. And the pace of innovation has quickened immensely since the first top on this chart in 1929 and, indeed, since the most recent one in 2000. It’s not going to slow.
So really I believe a version of this: That by the time I’m 50, I’ll have lived through an era of now-unfathomable, unprecedented prosperity. But just as this recent bout of volatility was in some ways brought to us by the letter “C,” we’ll have to wait and see what gets us there. And patiently, because it’s a long road.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.
Image credit: ©iStockphoto.com/FrankRamspott