Are we in a Bubble?

A developing consensus view is that the US sharemarket is overvalued, certainly by measures such as the Shiller PE (Price to earnings ratio).  Future low returns can be expected based on this measure.

Of course there is some debate about whether this is a bubble. Time will tell.

An earlier Post did touch on this. Another Post put the recent level of sharemarket volatility into a historical context.


Furthermore, the consensus view is that although overvalued the risk of a US recession is low. Generally a recession is needed to trigger a large drop in the value of sharemarkets.

None of the following forward indicators are flashing the risk of a recession: Leading Economic Indicators, ISM Manufacturing New Orders, Initial Unemployment Insurance claims, Durable Goods Order, shape of the yield curve (e.g. are longer dated interest rates lower than short dated interest rates, which is often a precursor to recession) and level of High Yield Credit Spreads.

The consensus view is that the US economy will continue to expand in 2018, now into its third longest period of economic expansion. Over time capacity constraints within the economy will grow further (e.g. falling unemployment) and the US Central Bank, US Federal Reserve (Fed), will continue to raise interest rates as the threat of or higher inflation emerge.

This will result in a “classical” ending to the economic cycle where higher interest rates will result in a slowing of economic activity, resulting in a pick-up in unemployment, followed closely by recession, say late 2019 early 2020. Unfortunately the recession will be felt more heavily on Wall Street (e.g. large share price declines) than Main Street.

This article outlines a paper written by James Montier of GMO. He outlines 4 different types of bubbles:

  1. Fad or mania e.g. dot-com bubble, Roaring 20s, and US Housing market
  2. Intrinsic Bubble e.g. Financials prior to the GFC had inflated earnings
  3. Near Rational bubble – the greater fool market, cynical, and they can keep going as long as the music is playing.
  4. Information Bubble


Montier argues we are in a cynical bubble (3 above), noting many professional investors acknowledge the US market is expensive yet remain fully invested even overweight, based on a BofA Merrill Lynch survey.

He agrees with Jeremy Grantham, many of the psychological hallmarks of a Fad and Mania are absent. Grantham has raised the prospect the US sharemarket may be entering a two year “melt-up” period as the next phase of the current “bubble”.

Time will indeed tell.  Nevertheless, the cynical bubble appears consistent with the consensus view above.


Mortimer’s article also has some great quotes from John Maynard Keynes, a great investor in his own right.


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Investment Mistakes to avoid

In an earlier post we talked about the short volatility (VIX) products that had added to the recent global equity market volatility.


The experience of these products prompted a good article from Barry Ritholtz, Five Rules to Help Avoid Investing Disaster.

The Inverse Volatility Products will enter history along-side CDO’s. It is likely that 95% of the wealth invested in these Products will be wiped out when they are finally wound up/terminated.  Well worth following developments here.


I am somewhat bewildered from an investment strategy perspective why these exposures would end up in Portfolios at this time. It is a prime example of chasing historical returns. It is always a good idea to be guided by value.  The cost of buying volatility protection was very low. Therefore there was no value shorting market volatility, as these Products did. It is also a good idea to have a counter-cyclical bias in your investment approach: when markets are at historical extremes, i.e. historically low volatility, it is a good idea to reduce the exposure to that market extreme. Markets revert from extremes toward averages – often violently as we have recently witnessed.

This is basis of portfolio risk management and consistent with focusing on managing risk rather than trying to time markets and chase historical returns. I think most of the funds management industry was working out how to go long volatility given the over-brought nature of the global equity markets in January, not short it!  Some form of market correction was widely anticipated, the timing was just unknown.


Anyway, ………… the rules outlined to avoid making investment mistakes:

  1. Avoid new products – if they are a good investment no need to hurry – e.g. the Buffet rule in relations to Initial Public Offerings (IPOs)
  2. Learn from history – markets are volatile never get complacent – Hubris before the fall
  3. Never buy anything you don’t understand – another Buffet rule
  4. I would say get good investment advice i.e. wholesale products vs retail product comments, in fact considerable value can be added to client portfolios in this area and costs reduced by accessing appropriate investment strategies not readily available
  5. Greater returns always comes with greater risk – this is a fundamental axiom of investing, never forget it.  If it is too good to be true, it probably is.  There are never “easy” sustainable returns in investing.


Happy investing.


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History of Sharemarket corrections – An Anatomy of equity market corrections

There has been lots written placing the current US stockmarket correction into a historical context.

The analysis of this blog draws on recent analysis undertaken by Goldman Sachs.

As you know, 2018 started out as the strongest start for global sharemarkets in over 30 years. The S&P 500 was up over 7% at one stage during January 2018.

The US equities bull market has been going since March 2009. This is amongst the longest period in history without the US sharemarket entering a bear market. The US sharemarket is up over 300% since 2009.

A bear market is usually considered to have occurred when sharemarkets fall by more than 20% in value.

A sharemarket correction is a fall in value of between 10% and 20%.

Volatility was at historically low levels over 2017. The US sharemarket, as at the end of January 2015, was up for 15 consecutive months and endured the longest period since 1929 without falling in value of more than 5%.

The fall in early February ended 499 trading days of the market not incurring a fall in value of more than 10%, which is amongst the longest stretch in history.

Records have been set and then broken!


With regards to bear markets and corrections, Goldman Sachs had some interesting analysis.


There have been 22 corrections since 1945 of over 10%, and many more of less than 10%. The average correction is 13% over 4 months and takes 4 months to recover.

Bear Markets

There have been 14 bear markets, the average fall in value is 30% over 13 months and take 22 months to recover.


My own thoughts

Generally a bear market (i.e. 20% or more fall in value) does not occur without a recession (a recession is often defined as two consecutive quarters of negative economic growth).

The key forward looking indicators, such as an inverted yield curve, significant widening of high yield credit spreads, rising unemployment, and falling future manufacturing orders are not signalling a recession is on the horizon in the US.

Therefore, if you are playing the odds, the current correction might have further to run but it is unlikely to turn into a bear market.


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Equity Market declines in Perspective

Far from Unprecedented: Nine Selloffs Like this, and Nine Rebounds.

The Bloomberg article has much prettier graphs than I can do, but I can provide the view from a wonderful ski field in New Zealand, in the spirit of the Winter Olympics, Treble Cone near Wanaka.



So, since the beginning of the bull equity market run in 2009 there have been nine significant declines in global equities. On each occasion global equity markets have come back.

The nine episodes are outlined in the Table below. They make for interesting reading and are distant memories.

Now of course we maybe only partway through the decline of the current “correction” and it could be different this time i.e. no bounce


Market movements are in relation to the US S&P 500 Index.

Date Level of Decline Trigger
January 2016 -11% of three weeks Concerns over economic slowdown and mounting Chinese debt
August 2015 -11% over six sessions China’s shock devaluation of the Yuan
October 2014 -5.0% over week Spread of Ebola virus, concern over end of US Quantitative Easing and tensions in the Middle East
January 2014 -3.6% over the month Emerging markets equities and currencies sold down
October – November 2012 -7.2% US Election uncertainty between Obama and Romney
March – June 2012 ~-10.0% US Federal Reserve indicating it will likely hold back on further monetary Policy easing e.g. Quantitative Easing
July – August 2011 -17% US Credit downgrade and weaker than expected jobs report, Greece
January 2010 -8% Market correction uncertainty as to global growth outlook, particularly Europe
April – July 2010 -16% Similar reasons and the infamous flash crash
January 2018 -10.1% Rising longer dated interest rates, inflation concerns, Fed tightening, negative feedback loop of short volatility Products


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Global Equity Markets Meltdown – Don’t Panic Sell

Worried About Your Retirement Investments? Don’t Panic Sell was published prior to the big drop in the markets on Tuesday.

Nevertheless its messages are still very relevant given further market weakness over the last week.

I like how the article starts with the behaviour economics aspect of market volatility. Unfortunately we feel the pain of losses much more than the pleasure of market gains.  The 24 hour cycle of news headlines does not make the feeling of portfolio loses any better!

As the article highlights, equity markets are back to levels they were at a couple of months ago. Unless you have a portfolio of 100% equities (which is unwise in most circumstances – particularly if you are saving for a house deposit) your portfolio loses are unlikely to be as great as those posted by the equity market indices. The benefits of diversification.

Diversification does work. Having said this, the recent daily market activity has witnessed loses in both fixed interest (bonds) and equities on the same day. This is where allocations outside of equities and fixed interest such as alternative strategies adds another layer of true portfolio diversification.

The article makes the very valid point of having an Investment Policy Statement (IPS). This is a critical and important document. At times like this it is worth referencing this document, accessing appropriateness of goals, objectives, and long term strategic asset (risk) allocations. Of course this exercise should be undertaken formally and frequently (yearly) irrespective of market conditions. The continued focus should be on what needs to be done to reach longer term investment objectives. Outcomes should be measured against these objectives not market indices.


Rebalancing Policy

An essential component to adding value over time and increasing the chances of meeting investment objectives is to have a well-articulated and documented Rebalancing Policy. This assists in managing the risks that build up within portfolios over time, such that market movements like the recent one do not have an outsized impact relative to expectations and risk tolerance levels.


There are lots of other points to consider in the article, namely don’t try and time markets.


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Equity Markets Keep Falling

The equity market volatility from last week continued into this week.

The Dow Jones has experienced its worst week in two years. US equity markets reached “correction” territory (a decline of 10% from the peaks in January).

Concerns over higher longer term interest rates and a more aggressive Federal Reserve Fed Funds Rate tightening path than expected are the backdrop to the recent downturn in markets.

It also appears that the short VIX (volatility) products significantly added to market volatility. A good explanation of how these inverse volatility products impacted on market volatility can be found at $XIV Volpocalypse – A Sea of Disinformation and Misunderstanding

The US inflation number on February 14th has taken on heightened importance and will be the focus of markets this week i.e. a likely source of volatility

What has changed? Not much.

As expected prior to the “market melt-down” volatility was expected to pick up from historical lows and that interest rates would rise over coming months. Albeit the volatility has occurred more abruptly and violently than anticipated (as it often does).

US longer dated interest rates have reached 4 year highs but remain near historically low levels.

The global economy is characterised by synchronised economic growth. It is expected that all 45 of the larger economies monitored by the OECD will experience growth in 2017 and 2018. It has been a while since this has occurred. In the US unemployment remains at near historical lows and financial conditions remain supportive of ongoing economic activity. US equity markets are still up over 10% for the last 12 months.

It is a good idea to go back to what was being said prior to a large market event.

The comments by Mohamed El-Erain, the chief economic advisor at Allianz, at the Inside ETFs conference 23 January 2018 are a good reference point for the current market situation.

El-Erain told the conference we are not in an asset bubble but that we should expect a higher level of market volatility in 2018. Mohamed El-Erain: We’re Not in a Bubble

His comments focussed on the fact that the US Federal Reserve (Fed) would continue to normalise monetary Policy in 2018 e.g. lift interest rates over the year to more normal levels while also reducing the size of the Fed’s Balance Sheet.

El-Erain noted 3 key risks for 2018:

  1. Geopolitics e.g. Korea and the Middle East
  2. What happens if the four major Central Banks try to normalise monetary at the same time i.e. Fed, China, Japan, and Europe
  3. A market accident e.g. a liquidity event in say an ETF given an over promise to deliver

The last risk is very insightful given the events of the inverse volatility products over the last 10 days. I am quite sure El-Erain did not expect that risk to materialise so quickly!


So if things change, you change your mind, to badly paraphrase Keynes. Not sure that things have changed that much but maybe a realisation interest rates are actually heading higher and the very low level of market volatility experienced cannot last for ever. The US equity market is still trading on high valuations.

Whatever you do don’t panic. The Topic of my next post.


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Value of Investment Advice and Technology

I thought this was a well written and balanced article about the role of technology within the Financial Advice Industry.

The Uber moment has not really arrived in the financial services industry, particularly not in New Zealand (we have had a few cheap cabs join the ranks!).

The appropriate use of technology and mass customisation of investment solutions is the Uber moment in financial services industry.

The customisation of investment solutions involves a Goal Based investment approach, based on the principles of Liability Driven Investing.

A winning outcome will be the combination of smart technology and smart customised investment solutions.


Please see my Disclosure Statement


Global sharemarkets fall sharply – what to do?

The run of sharemarket records has been broken.

After reaching all-time highs and experiencing the longest period in history without a decline in value of more than 5%, US equity markets have fallen the most since 2011, the most in 6 ½ years.

The sell-off comes after: a record start to the year, +5.6% (the market has retraced all of January’s gains), a strong US employment report on Friday, including a larger than expected pick-up in wage growth, and rising US Treasury yields over the previous days.

Combined the fear of greater than expected increases in interest rates by the US Federal Reserve (Fed)), high market valuations, and an over brought market (technicals) sentiment has turned quickly, leading to the sharp fall in the market over recent days. More may be likely – who really knows?

Nevertheless, a pull-back in the market has been long overdue and the underlying fundamentals remain good e.g. global synchronised growth

What to do in times like this? Listen to your investment advisor, ensure you have a truly diversified portfolio, and take a longer term approach.

This article is timely given the recent market volatility.

It highlights Goal-Based Investing and 4 other trends to look out for in 2018.

I hope the people that are advising you are across these topics, in particular:

  • Goal Based investing – this is key focus on this Blog site. This is fundamental.  The focus on how much growth assets one should have, a return and benchmark focus, and target date type funds may not deliver desired outcomes to meet retirement needs;
  • Responsible Investing. A responsible investing and ESG framework / policy is important for sustainable investment outcomes;
  • Uncertainty – well that has certainly risen over the last couple of days! Nevertheless, it was in the background given the very low level of interest rates and the high valuation of equities, the US in particular. The article points to the increasing allocations to alternatives as a means to truly diversify portfolios and make them more robust in the face of market uncertainty and volatility.
  • It is likely that ETFs could play an important role in meeting investment objectives


Bitcoin has lost its shine!



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