3 Things I Think I Think

1)  What an amazing year in the stock market.  Just how good has it been?  Well, the historical standard deviation of the S&P 500 index is about 19.5 going back to 1928.    This year the standard deviation is a little under 10.  That means we’re seeing half of the variance that we normally see in the market.  If you’ve had ANY overweight in stocks this year your risk adjusted returns likely look pretty good.

Even more amazing is the relative performance.  With gold and silver down about -30% this year the S&P 500 has outperformed a 50/50 gold silver portfolio by almost 60%.  And the long bond is almost as bad with a relative performance of -40%.  Unbelievable stuff.  We probably won’t see a year with this kind of divergence for a long long time.

2) Margin debt hit a new high in October.  I know, I know.  Margin debt doesn’t matter.  Hear me out.  I track margin debt because I think it’s a sign of potential growing imbalances.  It is a clear sign that more people are using debt for unproductive purposes.  And it’s also a clear sign of risk appetite.  I wouldn’t call this “bullish” or “bearish”, but it does give a pretty good idea of risk preferences and contrary to popular opinion, market risks actually tend to rise as prices rise, not as they fall.  When combined in a broader macro view this is just one of many indicators that can be used to gauge where we are in the cycle.



3)  Market practitioners and economists should collaborate more.  In a recent post at his website, Paul Krugman says “We don’t seem to need different economics as much as we need different economists.”   We don’t need new economists.  We need economists who are willing to try to really understand the real world of economics.  To me, this means we need more overlap between market practitioners and economists.

Economists who don’t understand banking, accounting, financial markets, etc are not going to have a good grasp on the modern macroeconomic landscape.  They just can’t.  The banking system, financial system and the economy are tied at the hip.  To understand one you have to understand the other.  It’s time for more overlap and collaboration between those who work in the trenches (the practitioners) and those who write the textbooks (the economists).  Otherwise, the economics profession is destined to remain dismal as the economists theorize about things that don’t actually apply to the real economy and young economists just regurgitate the same old myths that have been filling up textbooks for the last 50 years.


Got a comment or question about this post? Feel free to use the Ask Cullen section, leave a comment in the forum or send me a message on Twitter.
Cullen Roche

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services. He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance and Understanding the Modern Monetary System.

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  • SS

    We probably won’t see a year in the markets like this ever again. Incredible.

  • Suvy

    It’s funny Krugman made that comment and he doesn’t understand banking and completely dismisses balance sheets. I do agree with the comment though.

  • GreenAB

    margin debt as an indicator makes only sense when it´s viewed in relation to NYSE total market cap.

    can you plot a chart of this ratio? thanks a lot!

  • TheArmoTrader

    “Economists who don’t understand banking, accounting, financial markets, etc are not going to have a good grasp on the modern macroeconomic landscape.”

    Hmm……this description matches a blogger economist who heavily supports NGDP targeting. But I just can’t remember his name. Rhymed with one of the seasons of the year.

  • Matt

    Observation number 3:

    Spot on Cullen. I imagine we could count on one hand (at most) all of the Economists that have become wealthy using their own rational expectations theories versus anyone else using real-world economic observations.

  • JWG

    “Economists who don’t understand banking, accounting, financial markets, etc are not going to have a good grasp on the modern macroeconomic landscape.”

    Amen to that. Many academics and their followers have a disconcerting certainty about their positions and theories while knowing very little about how banking, finance, money, markets and business persons actually work in the real world. The number of variables and naked correlations in a market economy is so large that the only certainty is uncertainty. “Economics” is a social (soft) science and pretending it isn’t is a futile exercise. We are all just guessing.

  • RK

    I second this request. The amount of margin debt should be normalized as a percentage of market cap.

  • Andrew P

    Does that mean next year will be better, or worse? We know that bubbles always rise the fastest right before they pop, don’t we?

  • Andrew P
  • http://highgreely.com John Daschbach

    The fact that margin debt very closely correlates with the market tells us that there are groups who are employing a margin approach. There are regular funds (and certainly hedge funds) that employ this approach. Some are known as 80:20 or 70:30 funds. Depending on the fund type and prospectus it may be that there are funds that are required to maintain a relative margin level (which would track whatever basket of stocks they hold, not exactly the S&P500). My best guess is that high correlation is due to this type of activity, and the relative growth may be due to more people putting money into these type of funds and hedge funds.

    At the core Macroeconomics is like Thermodynamics. Real macro economists are interested in understanding economics like Thermodynamics (where the basic concepts of work, energy, temperature, pressure, chemical potential, etc.) are completely defined without any reference to restrictive definitions.

    Sometimes what you think of as macroeconomics is not at all macro, it’s semi-micro. It’s similar to the difference between scientists and engineers, which has proven to be a useful separation of skills for the most part. I don’t know what myths you are referring to but I don’t see a lot of myths in the classics of macro-economic thinking. The whole point of macroeconomics is to understand the economic system at a level that abstracts away the pithy details of the trenches.

    If you want a person who is considered by many as an economist, but has a good understanding of the trenches, I recommend Rgahuram Rajan. His undergrad degree is in Electrical Engineering, and his MIT PhD is in management (Banking specifically), not economics. Later, he was the Chief economist of the IMF for 3 years, and then a professor at the U of Chicago school of business. Now he is the head of the Indian Central Bank.

    In reading the academic papers of prominent Fed personalities, and other academic level Fed papers, I find there is a deep understanding of the trenches of financial activity, as well as the required solid understanding of differential and partial differential equations, Baysean statistics, Markov Chain Monte Carlo, and other analytical skills required in any discussion of macro economics.

  • Stoner

    You can say that every year, every day, … bla bla bla

  • InvestorX

    I recommend the Epsilon theory blog, the latest reading ties up some previous ideas:


    Some quotes:

    “Regimes do not stay in power by succeeding wildly; they stay in power by avoiding abject failure and by responding publicly to perceived threats. Once embraced, programmatic governmental guarantees never just go away on their own. Not only do they become institutionalized and thus acquire bureaucratic inertia and support, but more importantly they become part of what it means to be American, or French, or Chinese, or what have you. The threats that any regime responds to may change over the decades, but the programmatic responses to those threats accrete and remain over time.

    The perceived threat in the aftermath of the Great Recession is an inchoate fear of something that will make prices go down again. Worried that Congress might make some fiscal policy error? Worried about Obamacare? Worried about a Chinese hard landing? Worried that Europe might not get out of recession? Worried about the Middle East? Better keep QE going just to be safe. The future looms large today as a threat rather than as a promise, because the American regime (and by extension, the global regime) cannot withstand another nationwide decline in US home prices or a serious decline in the US stock market. Why not? Because the programmatic guarantees already made by the American regime (pensions, retirement insurance, medical insurance, poverty insurance, housing insurance, food insurance, banking insurance, etc.) cannot withstand a deflationary environment. It is politically untenable for asset prices to go down again, and so they won’t. If that comes at the cost of massively pulling forward demand for risk assets, of creating the mother of all crowding-out effects in Treasuries, of creating a $4 trillion balance sheet to fund an umbrella guarantee program, of lowering the structural growth potential of the country and the world … well, so be it. The goal of any regime, any organism, is to maximize its chances of survival. Deflation is the perceived existential threat of our age, and this is the dragon our Heroes will guarantee to slay.”

    ” I think Larry Summers is right– we are mired in a world of secular stagnation and a more or less permanent liquidity trap. The degree to which ZIRP and QE and bubble-promoting monetary policy creates that secular stagnation by delaying the deleveraging, loss assignment, and creative destruction that vibrant growth requires is ludicrously underappreciated in Summers’ speech, but as a statement of economic reality it’s pretty spot-on. I think Paul Krugman is right, too– in for a penny, in for a pound. Central bankers have come this far. Do you really think they’re going to back down now? I’m not saying that Krugman’s argument is “right” in terms of being intellectually honest or even very smart. I’m saying that I believe it is an accurate representation of the world as it is.
    Here’s the crucial part of what Summers and Krugman are saying: this is not a temporary gig. This isn’t going to just “get better” on its own over time. This really is, as Mohamed El-Erian of PIMCO would call it, the New Normal. And if you’re Jeremy Grantham or anyone for whom a stock has meaning as a fractional ownership stake in a real-world company rather than as a casino chip that gives you “market exposure” … well, that’s really bad news.”

  • Cowpoke

    “2) Margin debt hit a new high in October. I know, I know. Margin debt doesn’t matter.”

    Can anyone elaborate on why margin debt doesn’t matter?

    Doug Short has an interesting piece on “NYSE Margin Debt Hits Another Interim High”

    His summary:
    “As I pointed out above, the NYSE margin debt data is a several weeks old when it is published. Thus, even though it may in theory be a leading indicator, a major shift in margin debt isn’t immediately evident. Nevertheless, we see that the troughs in the monthly net credit balance preceded peaks in the monthly S&P 500 closes by six months in 2000 and four months in 2007. The most recent S&P 500 correction greater than 10% was the 19.39% selloff in 2011 from April 29th to October 3rd. Investor Credit hit a negative extreme in March 2011.

    There are too few peak/trough episodes in in this overlay series to take the latest credit-balance trough as a definitive warning for U.S. equities. But we’ll want to keep an eye on this metric in the months ahead.”

  • Android

    I also suggest collaboration with scientists, especially physicists and computer scientists. I believe an understanding of complex systems, such as the economy, will require input from many fields of endeavor.