Author Archive for Lance Roberts

5 Things Things Bulls Should Consider

By Lance Roberts, STA Wealth

This past week I wrote two articles discussing Shiller’s CAPE ratio (see here and here) and why valuations are still an important metric when it comes to making long term investments.  However, during the research process of writing that article I could not help but notice the extreme amount of optimism about the financial markets. Despite weak economic data and geopolitical intrigue the complacency and “bullishness” are at extreme levels.

My Californian money manager friend sent me the following note yesterday from Wolf Richter:

“And so we have a series of geniuses: Greenspan who said that the very concept of a national housing bubble in the US was impossible just as the national housing bubble was inflating to monstrous proportions; Bernanke who said that the consequences of sub-prime lending were ‘contained’ just as the consequences of subprime lending were eating up the banks from the inside out; and Yellen who now told us that complacency is nothing to worry about.

So we sally deeper into the Yellen era, which is the same as the Bernanke era, in that the Fed – and other central banks, for that matter – is the only thing worth looking at. Central banks rule. Practically nothing else matters. Metrics and ratios are just for decoration. Markets as a means of price discovery no longer exist.”

Wolf is correct, the markets have now come to believe that the Federal Reserve is the omnipotent controller of the financial markets.  Such beliefs have always ended badly. This is why I discussed one of the biggest traps that investors fall into during times like these“Confirmation Bias:”

“As human beings, we hate being told that we are wrong, so we tend to seek out sources that tell us we are ‘right.'”

 This week’s “Things To Ponder” is dedicated to things that “market bulls” should consider to keep from falling prey to the psychological biases that lead to poor investment returns over time.

1) Who Is Selling Stocks? by Sigmund via

“According to Reuters, 1st quarter share weighted earnings amounted to $258.8 billion. So companies in the S&P 500 spent 93% of their earnings on buybacks and dividends. It’s been all the rage in this cycle to look at “shareholder yield” which is a combination of buybacks and dividends, something I find too clever by half considering the past track record of management led buybacks. But if you think that is a useful metric, you have to ask yourself, is a 93% payout ratio sustainable? I guess we do have the answer to one question though. We know why capital spending has been so punk.”

2) BuyBacks Grow 50% YoY – Near Pre-Recession Highs via FactSet

Aggregate share buybacks for the S&P 500 grew 50% in Q1 to $154.2 billion, and amounted to the third largest quarterly total since 2005. The biggest contributor to the Q1 total was Apple’s record $18.6 billion in repurchases, but IBM also had an uncharacteristically active quarter with $8.3 billion in buybacks. In addition, five of the top ten companies by dollar-value buybacks in Q1 are traditionally not big spenders, and each spent more money on buybacks in Q1 than in any quarter in at least ten years.”


“But the increase in buybacks has outpaced cash inflows for the highest growth sectors. The Materials sector spent 195.5% of adjusted free cash flows on share repurchases in the trailing twelve months ending Q1. This compares to a median of 82.9%. In addition, the Information Technology and Industrials sectors are also significantly above their median (83.7% versus 68.7%, and 104.6% versus 79.4%).”

3) Volatility Is Disconnected From Fundamentals by JP Morgan via ZeroHedge

To further understand the current low volatility levels and compare it to the 2004-2007 time period, we looked at levels of market activity and structural drivers of volatility. Firstly, there is much less trading activity now as compared to the 2004-2007 time period. [The data] shows a nearly 50% decline of equity share volumes since 2007. Volume and volatility are highly correlated. Volatility and volumes are linked by a positive feedback loop (lower volumes lead to lower volatility and vice versa).

In summary, we see the current market environment as different from 2004-2007. Volatility appears to be too low and disconnected from fundamentals.However, the low yield environment and support from central banks is currently keeping volatility low not just in equities but across asset classes.

Additionally, equity volatility has been held down by low trading activity and option hedging pressure. As we will discuss below, some of the option-related pressure on volatility will abate after the June expiry, which could result in higher realized volatility.


READ ALSO:  It’s Not The VIX That’s Vexing The Market by Michael Kahn via Barron’s

“I won’t debate whether indicators measuring investor sentiment are different from those measuring professional sentiment. But from what I see in many sentiment gauges, the weight of the evidence leans toward the market being too sanguine for its own good right now.

Jason Goepfert, who runs the Website, offered a third view, saying that the low levels of volatility expectations across asset classes have forced traders to make bolder bets.

It is the same concept. Traders and investors are taking risks without worrying about the consequences. That should be a warning for everyone.”

4) Food Stamp Usage Is Cratering by Cullen Roche via Pragmatic Capitalist

The rate of participation in the food stamps program has now declined on a year over year basis for six straight months. And the cost of benefits has declined at a near double-digit pace for each of the last 5 months.  After reaching peak participation of 47.6 million last August the number of participants has declined to 46.1 million.

This might seem like good news, but it’s more likely a sign of a late cycle recovery trend.  You see, food stamps are a countercyclical event.  They’re part of what economists refer to as ‘automatic stabilizers’.  That is, when corporations fire employees they often sign up for government benefits so they can try to make ends meet while they look for work.  And those benefits are most in demand when the economy is at its worst.  So programs like food stamps ‘automatically’ kick into high gear when the economy goes into recession.  You can see this clearly in the following chart:”



“The fact that this trend is now sharply improving means that the economy is on the mend.  But it also means that the economy is late in the cycle of expansion.  And so what looks like a positive trend could actually be a sign of something negative developing.”

5) Does The Fed Really Know What Time It Is? by Vince Foster via MinyanVille

“Fed officials keep talking about when they will raise rates, and media focus is on whether it will be sooner than the market expects. More significant questions are not being discussed.

JPMorgan CFO Marianne Lake outlined the exit process the bank was preparing for, raising some risk management hurdles…

‘In terms of sequencing, what we expect is that the Fed will seize asset purchases by the end of this year. The likely next step would be to drain liquidity from the systems, potentially as much as $1 trillion or so using the reverse repo facility with non-banks. This is likely to happen over a short period of time, maybe a quarter or two and probably in the second or maybe in the second-half of 2015. After which the Fed funds rate will start to raise and lastly reinvestment in order to shrink the remaining balance sheet, but over time.

The second important assumption we’re making is that as rates continue to normalize over time, we’re all likely to also see a migration of stickier high quality retail deposits in favor of more attractive rates in money funds. We think ultimately those deposits will likely find their way back to bank balance sheet in the form of wholesale deposits, which of course is very important particularly in light of regulatory liquidity standards, when notably, if you take a retail deposit that has a low outflow assumptions and ultimately replaced with a wholesale deposit that has a high outflow assumption, it could substantially reduce your liquidity…”

Think about that last bit for a minute.  The Federal Reserve will drain liquidity from the system at the same time they begin to raise the overnight lending rateswhile looking for rates “normalize” at higher levels.  Considering that the markets have been primarily advancing on the back of continued flows of liquidity from the Federal Reserve combined with artificially suppressed interest rates; what do you think the impact on the financial markets will be?  The chart below shows the history of the Fed’s ability to control the economy.



 “Success breeds complacency. Complacency breeds failure. Only the paranoid survive.”  –  Andy Grove

Shiller’s CAPE – Is It Really Just B.S.?

By Lance Roberts, CEO, STA Wealth

In late stage bull market cycles, the inevitable bashing of long term valuation metrics comes to full fruition. In the late 90’s if you were buying shares of Berkshire Hathaway stock it was mocked as “driving Dad’s old Pontiac.”  In 2007, valuation metrics were being dismissed because the markets were flush with liquidity and interest rates were low.  Today, we once again see repeated arguments as to why “this time is different.”

There has been an ongoing debate about Dr. Robert Shiller’s Cyclically Adjusted Price Earnings (CAPE) ratio and its current validity. Critics argue that the earnings component of CAPE is just too low, changes to accounting rules have suppressed earnings, and the financial crisis changed everything.  The latest was by Wade Slome:

“If something sounds like BS, looks like BS, and smells like BS, there’s a good chance you’re probably eyeball-deep in BS. In the investment world, I encounter a lot of very intelligent analysis, but at the same time I also continually step into piles of investment BS. One of those piles of BS I repeatedly step into is the CAPE ratio (Cyclically Adjusted Price-to-Earnings) created by Robert Shiller.”

Let’s break down Wade’s arguments against Dr. Shiller’s CAPE P/E individually.

Shiller’s Ratio Is Useless?

Wade states:

“The short answer…not very. For example, if investors followed the implicit recommendation of the CAPE for the periods when Shiller’s model showed stocks as expensive they would have missed a more than quintupling (+469% ex-dividends) in the S&P 500 index. Over a shorter timeframe (2009 – 2014) the S&P 500 is up +114% ex-dividends (+190% since March 2009).”

Wade’s analysis is correct.  However, the problem is that valuation models are not, and were never meant to be, “market timing indicators.”  The vast majority of analysts assume that if a measure of valuation (P/E, P/S, P/B, etc.) reaches some specific level it means that:

  1. The market is about to crash, and;
  2. Investors should be in 100% cash.

This is incorrect. Valuation measures are simply just that – a measure of current valuation. If you “overpay” for something today, the future net return will be lower than if you had paid a discount for it.  Think about housing prices for a moment as shown in the chart below.


There are two things to take away from the chart above in relation to valuation models.  The first is that if a home was purchased at any time (and not sold) when the average 12-month price was above the long term linear trend, the forward annualized returns were significantly worse than if the home was purchased below that trend. Secondly, if a home was purchased near the peak in valuations, forward returns are likely to be extremely low, if not negative, for a very long time.

This is the same with the financial markets. When investors “pay” too much for an investment, future returns will suffer. “Buy cheap and sell dear” is not just some Wall Street slogan printed on a coffee mug, but a reality of virtually all of the great investors in our time in some form or another.

Cliff Asness discussed this issue in particular stating:

“Ten-year forward average returns fall nearly monotonically as starting Shiller P/E’s increase. Also, as starting Shiller P/E’s go up, worst cases get worse and best cases get weaker.

If today’s Shiller P/E is 22.2, and your long-term plan calls for a 10% nominal (or with today’s inflation about 7-8% real) return on the stock market, you are basically rooting for the absolute best case in history to play out again, and rooting for something drastically above the average case from these valuations.”


Asness continues:

“It [Shiller’s CAPE] has very limited use for market timing (certainly on its own) and there is still great variability around its predictions over even decades. But, if you don’t lower your expectations when Shiller P/E’s are high without a good reason — and in my view the critics have not provided a good reason this time around — I think you are making a mistake.”

While, Wade is correct that investors who got out of the market using Shiller’s P/E ratio would have missed the run in the markets from 2009 to present, those same individuals most likely sold at the bottom of the market in 2008 and only recently began to return as shown by net equity inflows below. In other words, they missed the “run” anyway. As I discussed yesterday, investor psychology has more to do with long term investment outcomes than just about anything else.


Peaches for $.25 Post-Bubble?

Wade’s second argument is also important which discusses the price of peaches falling to $.25 per pound where he concludes:

“This complete neglect of current market prices in the calculation of CAPE makes absolutely no sense, but this same dynamic of ignoring current pricing reality is happening today in the stock market. Effectively what’s occurring is the higher P/E ratios experienced over the last 10 years are distorting the Shiller CAPE ratio, thereby masking the true current value of stocks. In other words the current CAPE of 26x vastly exaggerates the pricey-ness of the actual S&P 500 P/E ratio of 16x for 2014 and 14x for 2015.”

Let’s break that statement down into its two basic arguments:  1) Higher P/E ratios over the last 10 years are distorting CAPE, and: 2) the problem with forward P/E ratios.

First, it is true that P/E’s have been higher over the last decade due to the aberration in prices versus earnings leading up to the 2000 peak.  However, as shown in the chart below, the “reversion” process of that excessive overvaluation is still underway.


Clff Asness directly addressed this concern:

“Some outright hucksters still use the trick of comparing current P/E’s based on ‘forecast’ ‘operating’ earnings with historical average P/E’s based on total trailing earnings. In addition, some critics say you can’t compare today to the past because accounting standards have changed, and the long-term past contains things like World Wars and Depressions. While I don’t buy it, this argument applies equally to the one-year P/E which many are still somehow willing to use. Also it’s ironic that the chief argument of the critics, their big gun that I address exhaustively above [from the earlier post], is that the last 10 years are just too disastrous to be meaningful (recall they are actually mildly above average).”

Secondly, I specifically addressed this issue of forward P/E’s recently in “The Problem With Forward P/E’s:”

“As a reminder, it is important to remember that when discussing valuations, particularly regarding historic over/under valuation, it is ALWAYS based on trailing REPORTED earnings.  This is what is actually sitting on the bottom line of corporate income statements versus operating earnings, which is “what I would have earned if XYZ hadn’t happened.”  

Beginning in the late 90’s, as the Wall Street casino opened its doors to the mass retail public, use of forward operating earning estimates to justify extremely overvalued markets came into vogue.  However, the problem with forward operating earning estimates is that they are historically wrong by an average of 33%.”

The consistent error rate in forward earnings projections makes using such data dangerous when making long term investments. This is why trailing reported earnings is the only “honest” way to approach valuing financial markets. Importantly, long term investors should be abundantly aware of what the future expected returns will be when buying into overvalued markets. Bill Hester recently wrote a very good note in this regard in response to critics of Shiller’s CAPE ratio and future annualized returns:

“More recently the ratio has undergone an attack from some widely-followed analysts, questioning its validity and offering up attempts to adjust the ratio. This may be a reaction to its new-found notoriety, but more likely it’s because the CAPE is suggesting that US stocks are significantly overvalued.  All of the adjustments analysts have made so far imply that stocks are less overvalued than the traditional CAPE would suggest.”

We feel no particular obligation defend the CAPE ratio. It has a strong long-term relationship to subsequent 10-year market returns. And it’s only one of numerous valuation indicators that we use in our work – many which are considerably more reliable. All of these valuation indicators – particularly when record-high profit margins are accounted for – are sending the same message: The market is steeply overvalued, leaving investors with the prospect of low, single-digit long-term expected returns. But we decided to come to the aid of the CAPE ratio in this case because a few errors have slipped into the debate, and it’s important for investors who have previously relied on this ratio to understand these errors so they can judge the valuation metric fairly.  Importantly, the primary error that is being made is not even the fault of those making the arguments against the CAPE ratio. The fault lies at the feet of a misleading data series.


As clearly stated thoughout this missive, fundamental valuation metrics are not, and were never meant to be, market timing indicators. This was a point made by Dr. Robert Shiller himself in an interview with Henry Blodgett:

“John Campbell, who’s now a professor at Harvard, and I presented our findings first to the Federal Reserve Board in 1996, and we had a regression, showing how the P/E ratio predicts returns. And we had scatter diagrams, showing 10-year subsequent returns against the CAPE, what we call the cyclically adjusted price earnings ratio. And that had a pretty good fit. So I think the bottom line that we were giving – and maybe we didn’t stress or emphasize it enough – was that it’s continual. It’s not a timing mechanism, it doesn’t tell you – and I had the same mistake in my mind, to some extent — wait until it goes all the way down to a P/E of 7, or something.”

Currently, there is clear evidence that future expectations should be significantly lower than the long term historical averages. Does the current valuation levels mean that you should be all in cash? No. However, it does suggest that a more cautious stance to equity allocations and increased risk management will likely offset much of the next“reversion” when it occurs.

While I disagree with Wade’s assessment, it does not mean that I do not value his opinion. My job is to protect investment capital from major market reversions and meet investment returns anchored to retirement planning projections. Not paying attention to rising investment risks, or adjusting for lower expected future returns, are detrimental to both of those objectives.

Tomorrow, I will introduce a modified version of the Shiller CAPE ratio that is currently flashing a very important warning sign that you should be paying attention too.

Yield Spreads & Market Reversions

By Lance Roberts. STA Wealth

Over the last few days, I have been discussing the very wide deviations in price from long term moving averages and other signs of bullish excess.  As of late, even the“bullishly biased” mainstream media has begun to at least question the eerie calm that has overcome the financial markets as volume and volatility have all but disappeared.

I found it very interesting that several market commentators all made similar statements when asked about the “market calm.” 

“Where else are investors going to go to get yield.”

The “chase for yield” was the desired result by the Federal Reserve when they dropped rates to record lows and announced, in 2010, that supporting asset prices to boost consumer confidence had become a “third mandate.” However, they may have gotten more than they bargained for as several Fed officials have now voiced concerns over potential financial instability.  To wit:

Fed’s Kocherlakota Urges 5 More Years Of Low Interest Rates via Reuters

Kocherlakota acknowledged that keeping rates low for so long can lead to conditions that signal financial instability, including high asset prices, volatile returns on assets, and frantic levels of merger activity as businesses and individuals strive to take advantage of low interest rates.

But that is a risk, he suggested, the Fed should be willing to take.

Fed’s Williams Says Central Banks Need To Realize Investor’s Aren’t Rational via The Wall Street Journal

“In a world of rational expectations, asset prices adjust and that’s it, but if one allows for limited information, the resulting bull market may cause investors to get ‘carried away’ over time and confuse what is a one-time, perhaps transitory, shift in fundamentals for a new paradigm of rising asset prices.

This “exuberance” can be clearly seen in bond yields. In normal times, the interest rate paid on a loan is driven by the potential for a default on repayment of the principal. For example, a person with a credit score of 500 is going to pay a substantially higher interest rate on a loan than an individual with a 700+ credit score. The “risk” of a potential repayment default is offset to some degree by a higher interest rate.  If a loan of $100,000 is made with an interest rate of 10% for 30 years, the principal is recouped after the first 10 years.  The real risk is that the loan defaults within the first 1/3 of its term.

Currently, investors are assigning only 1/2% difference in interest rates between loaning money to a highly credit worthy borrower and one that is only marginally so.  This is shown in the chart below which is the spread between AAA and BAA rated bonds from 1919-present.


There have been precious few times in history that the spread between interest rates have been so low. Importantly, extremely low yield spreads are not a precursor to an extended economic recovery but rather a sign of a mature economic cycle.

The Federal Reserve officials have very good reason to be concerned about the potential for “financial instability” as extremely low thin yield spreads have also been indicative of both minor and major financial market corrections and crashes.


I have zoomed into the chart above to show just 1960-present in order to provide a bit more clarity.


What investors need to be watching for is a “widening” of the spread between yields. The decline in the yield spread shows the rise of investor “complacency.” However, the“lack of fear” is a late-cycle development and not one seen at the beginning of economic upswings. Importantly, when the yield spread begins to rise, it tends to do so rapidly leading to a reversion in asset prices.

Currently, the ongoing “chase for yield” has led investors to take on much more “credit risk” in portfolios than they most likely realize. When “fear” is introduced into the financial markets, the subsequent “instability” will lead to far greater losses than most individuals are prepared for.

The chart below is a comparison between “junk bond” yields, the least credit worth borrowers, versus the S&P 500.



Currently, loans are being made to the highest risk borrowers at an effective interest rate of just 5% as compared to the “risk free” rate of 2.6% for a 10-year Government bond.

We have seen this exuberance before.  In 1999, the old valuation metrics no longer mattered as it was “clicks per page.”  In 2007, there was NO concern over subprime mortgages as the housing boom fostered a new era of financial stability.  Today, it is the Federal Reserve “put” which is unanimously believed to be the backstop to any potential shock that may occur.

I always have to qualify these missives by stating that my portfolios are still biased to the long side of the markets. When I discuss rising risks in the markets, which is what leads to catastrophic and irreversible destruction of capital, it is always assumed that I am sitting in cash.  This is not the case. I must remain invested while markets are rising or suffer career risk, however knowing when to “fold’em” is what makes the difference to long term investment returns.

However, having qualified my position, it is important to understand that it is not the DECLINE in interest rates and yield spread that is important, but it is the REVERSAL that must be watched for.  I point out these issues of risk only to make you aware of them as the always bullishly biased media tends to ignore “risks” until it is far too late to matter. It is likely that it will be no different this time.

“Once more unto the breach, dear friends, once more” – William Shakespeare

Is This The Mania Phase of the Bull Market?

By Lance Roberts, STA Wealth

During the course of the past two months, I have been regularly discussing the market consolidation that began in early February.  (Here for latest and archives) In that weekly analysis, I posted the following chart which showed the two most probable outcomes of the current consolidation process.



The breakout above 1900 yesterday brings into focus the potential for a continuation of the current bull market cycle.  However, with the market very overbought in both the short and intermediate term, it is unclear how far the advance will go considering the drag from reduced liquidity inflows by the Federal Reserve.  This concern is not unfounded as we have seen this particular set up (overbought conditions with reduced liquidity) previously in 2011 as QE 2 came to its conclusion.


I am NOT suggesting that the current market cycle will exactly replicate the 2011 experience as there have been enough market period chart comparisons as of late. However, what I am suggesting is that a similar “set up” had a negative consequence and the current market cycle should not be taken for granted. Markets don’t repeat, but they do rhyme quite often.

With the current bull market now stretching into its sixth year; it seems appropriate to review the three very distinct phases of historical bull market cycles.

Phase 1) “What bull market? The fall is right around the corner”

Following a massive, mean reverting, correction – markets tend to bottom and begin an initial recovery. Most individuals have been crushed by the previous market decline and only recently “panicked sold” into cash.

There are many signs during the initial phase that a new bullish uptrend has started.  Money flows from defensive names in order to chase higher yield, market breadth is improving, and volatility declines substantially.

However, despite those indications, many individuals do not believe that the rally is real.  They use the rally to sell into cash and angrily leave the markets or continue to stay in cash expecting another failure.

Note: The fastest price appreciation in the market happens during the first and third stages of the bull market.

2) Acceptance stage

During the second phase individuals gradually warm up to the idea that the markets have indeed bottomed the psychology changes to one of acceptance.  At this point, the market is generally considered “innocent until proven guilty.“

The overall psychology remains very cautionary during this second phase.  Investors react very negatively any short term market correction believing the bull market just ended.  They continue to remain underweight equities and overweight defensive positions and cash.

During the second phase stocks continue to climb higher and market corrections are short-lived.  It is between second and third phases that a deeper market pullback occurs.  This pullback tests the resilience of the rally, shakes weak hands out of the market, and allows for new bases to be formed.  This deeper pullback is used as a buying opportunity by institutions, which missed the initial stages of the rally, and their buying continues to push the markets to new highs.

3) Everything will go up forever

During the first phase, most individuals remain skeptical of a market that has just gone through a high-correlation, mean-reverting correction.  It is at this point that most investors are unwilling to see the positive change in market dynamics.

In phase two, however, investors gradually turn bullish for the simple reason that prices have been steadily rising for some time. Analysts and strategists are also turning universally “bullish” in an attempt to manage their career risk and attract investor dollars.

In the final phase of the bull market, market participants become ecstatic.  This euphoria is driven by continually rising prices and a belief that the markets have become a “no risk opportunity.”  Fundamental arguments are generally dismissed as “this time is different.”  The media chastises anyone who contradicts the bullish view, bad news is ignored, and everything seems easy. The future looks “rosy” and complacency takes over proper due diligence.  During the third phase, there is a near complete rotation out of “safety” and into “risk.”  Previously cautious investors dump conservative advice, and holdings, for last year’s hot “hand”  and picks.

The chart below shows these three phases of the bull market over the past three market cycles.


Note:  I have highlighted with blue vertical lines the deviation between current prices and the linear trend of the index. The current extreme price divergence is not indefinitely sustainable.

While the current bull market remains “bulletproof” at the moment to geopolitical events, technical deterioration, overbought conditions and extremely complacent conditions; it is worth remembering what was being said during the third phase of the previous two bull markets:

  • Low inflation supports higher valuations
  • Valuation based on forward estimates shows stocks are cheap.
  • Low interest rates suggest that stocks can go higher.
  • Nothing can stop this market from going higher.
  • There is no risk of a recession on the horizon.
  • Markets always climb a wall of worry.
  • “This time is different than last time.”
  • This market is not anything like (name your previous correction year.)

Well, you get the idea.

Are we in the third phase of a bull market?  Most who read this article will immediately say “no.”  But isn’t that what was always believed during the “mania” phase of every previous bull market cycle?


Survey Explains Why Investors Remain “Side Lined”

By Lance Roberts. STA Wealth

Each quarter I run a survey of investor attitudes, allocations and economic expectations to get a sense of actual “investor” behavior. In the financial markets it is easy to become“detached” from reality and assume that “everyone” is acting in a similar manner. The survey shows that this is far from being the case. What was not surprising was the makeup of survey participants.

I have often stated that the average investor has about 15 years to save for retirement. This is due to ability much more than desire. During the younger years of life there is little ability to save as wage scales tend to be lower as marriage, family and debt consume most of their income. As shown by the survey the majority of individuals are between the ages of 46-65. Furthermore, as would be expected, the majority of investors surveyed also have higher levels of education which tends to lead to higher incomes later in life.


Of course, when it comes to “saving for retirement” the most important question is whether an individual is saving enough? The survey shows that roughly half of those surveyed “think” they are saving enough for retirement with on 15% feeling as though they have more than enough.


However, much of the current “confidence” in savings has been the result of a surging stock market over the last few years. It is highly likely that when the next mean reverting event occurs that confidence will shift rather markedly.

The reason I suggest that will be the case is because of “where” the majority of investors are receiving their investment advice. As shown in the chart below the majority of investment “advice” is coming from newsletters and the internet.


This too is not surprising given the surge in the markets which tends to make individuals believe that they are “smarter than the average bear.” Success breeds overconfidence in the markets which has a long history of poor outcomes.

One interesting sidenote is that television only made up 2% of the vote which confirms the plunge in ratings that CNBC has experienced in recent years.

Not So Forgetfull

It has often been stated by the media and Wall Street analysts that the current “bull market” cycle is “the most hated in history.” The survey shows that this may indeed be the case as two nasty bear markets over the last 13 years have left an indelible stain on individuals memories and retirement accounts.

When asked what is most important to them the survey showed that, by a wide margin, the majority are more focused on loss avoidance rather than chasing stock market returns.


That mentality is reflected in their asset allocation models with the roughly on 44% invested in stocks and 48% in bonds and cash.


While the media and Wall Street chants that the markets have hit new nominal highs, the reality is far different for individuals who panic sold near the last market bottom and are only now wading back into the markets again. The loss of capital, due to both declines and inflation, combined with the loss of “available time” to save for retirement has crippled investor psychology on many levels.

The problem is that investors today have “seen this film” before and are fairly confident in how it ends.  When asked about stocks the vast majority believe that stocks are current overvalued.


Conversely, most investors see bonds as part of their long term investment strategy to protect capital and create income.


It is interesting that most mainstream analysis is confused as to why individuals remain cautious despite the surge in asset prices. However, in addition to the massive beatings that investors took over the last decade, much of their caution is likely rooted in the massive divergence between Main Street and Wall Street.

“It’s The Economy, Stupid”

Following the very weak economic performance in the first quarter of the year, most economists blamed the weakness on “cold weather.” However, since we often experience “cold weather” during the winter, it is likely that the economic drag was more deeply rooted in consumer outlooks.  When asked about their outlook for the second quarter of this year the response was decidedly negative with over 80% expecting the economy to perform the same or worse.


What has not been lost on individuals is that the Federal Reserve’s monetary interventions have done little to improve the quality of their lives but have vastly benefitted Wall Street.  This is why despite wanting her to focus on improving economic growth, they also want her to continue tapering the current Q.E. program.

Not Surprised

If you have been paying attention at all, what is happening in the world outside of “Wall Street” leaves little surprise in these survey results. For most, the recovery of wealth over the last few years has certainly made many individuals feel more secure about their current financial position. However, they also realize that they have only recovered most of what they lost and are unwilling, and many unable, to live through such an event again.

With the majority of individuals surveyed facing retirement in the very near future, the need to conserve principal has overtaken the desire to accumulate wealth.

As I have continually reminded you, the “real economy” is far different from the“statistical economy” as reported in government data. While the costs of living continue to increase incomes have remained stagnant. With 1-3 Americans on some sort of government assistance, and nearly as many sitting outside the labor force, it is really on a handful of individuals that are actually invested in the financial markets to begin with.

As I stated recently in “Expect Low Returns:”

“Despite the media’s commentary that “if an investor had ‘bought’ the bottom of the market…” the reality is that few, if any, actually did.  The biggest drag on investor performance over time is allowing ‘emotions’ to dictate investment decisions.  This is shown in the 2013 Dalbar Investor Study which showed ‘psychological factors’ accounted for between 45-55% of underperformance.  From the study:

‘Analysis of investor fund flows compared to market performance further supports the argument that investors are unsuccessful at timing the market. Market upswings rarely coincide with mutual fund inflows while market downturns do not coincide with mutual fund outflows.’

In other words, investors consistently bought the ‘tops’ and sold the ‘bottoms.’  The other two primary reasons of underperformance from the study related to a lack of capital to invest.  This is also not surprising given the current economic environment.”

While many dismiss the impact of the “baby boomer” generation moving into retirement, the reality is likely to be far different. If the current survey is representative of that particular group, the drag on the financial markets and economy over the next decade could be quite substantial.

Historical Market Comparisons Are Meaningless

By Lance Roberts, STA Wealth

As Chief Strategist for STA Wealth Management I start each and every day by consuming copious amounts of a heavily caffeinated beverage and a data feed from a litany of web and blog sites. Over the last couple of days in particular, they have been numerous articles on whether the market is currently in a bubble.   Here are a few as an example that I just grabbed from

Is This a Bubble Market? There’s One Way to Tell

Is Financial Media Warding Off Stock ‘Bubble’?

The Upside of Speculative Market ‘Bubbles’

Yellen: Bubbles? What Bubbles?

Well, you get the idea. First of all, bubbles only occur when no one is looking for them. Bubbles form when greed runs rampant and there is a mass hypnotic state that the current ride will never end. The shear fact that multitudes of articles are being written about “market bubbles” is a sign that we are likely not there, yet. (Read: Too Much Bubble Talk)

However, as a shot of caffeine hits my brain, I read with interest a recent piece on Bloomberg entitled 5 Reasons We’re Not In a 2000 Bubble Redux.” which I have summarized for you:

1) Volume of IPO’s is less than half of the first quarter of 2000

2) First-day returns of IPO’s are just 1/5th of the first 1st quarter of 2000.

3) Speculative companies carried a 43% higher valuation to dividend paying companies in 2000 versus just 26% today.

4) Cash derived from equity issuance was 20% in 2000 versus just 11% today.

5) Share turnover in 2000 was an annualized 89% rate versus 58% today.

While these are certainly some interesting arguments, the comparison between now and the turn of the century peak is virtually meaningless. Why? Because no two major market peaks (speculative bubble or otherwise) have ever been the same. Let me explain.

In late October of 2007, I gave a seminar to about 300 investors discussing why I believed that we were rapidly approaching the end of the bull market and that 2008 would likely be bad, really bad. Part of that discussion focused on market bubbles and what caused them.  The following two slides are from that presentation:

001-Is-This-Time-Different 001-All-Bubbles-Revolved-Around-Something


Every major market peak, and subsequent devastating mean reverting correction, has ever been the result of the exact ingredients seen previously. Only the ignorance of its existence has been a common theme.

As I discussed yesterday, the reason that investors ALWAYS fail to recognize the major turning points in the markets is because they allow emotional “greed” to keep them looking backward rather than forward.

Of course, the media foster’s much of this “willful” blindness by dismissing, and chastising, opposing views generally until it is too late for their acknowledgement to be of any real use.

The next chart shows every major bubble and bust in the U.S. financial markets since 1871 (Source: Robert Shiller)



At the peak of each one of these markets, there was no one claiming that a crash was imminent. It was always the contrary with market pundits waging war against those nagging naysayers of the bullish mantra. Yet, in the end, it was something that was unexpected, unknown or simply dismissed that yanked the proverbial rug from beneath investors.

What will spark the next mean reverting event? No one knows for sure but the catalysts are present from:

  • Excess leverage,
  • IPO’s of negligible companies,
  • Companies using cheap debt to complete stock buybacks and pay dividends, or
  • High levels of investor complacency.

Either individually, or in combination, these issues are all inert. Much like pouring gasoline on a pile of wood, the fire will not start without a proper catalyst. What we do know is that an event WILL occur, it is only a function of “when.” 

The discussion of why “this time is not like the last time” is largely irrelevant. Whatever gains that investors garner in the between now and the next correction by chasing the“bullish thesis” will be wiped away in a swift and brutal downdraft. Of course, this is the sad history of individual investors in the financial markets as they are always “told to buy” but never “when to sell.”

For now, the “bullish case” remains alive and well. The media will go on berating those heretics who dare to point out the risks that prevail. However, the one simple truth is“this time is indeed different.”  When the crash ultimately comes the reasons will be different than they were in the past – only the outcome will remain same.

No One Will Ring The Bell At The Top

By Lance Roberts, STA Wealth

The market has had a rough start of the year flipping between positive and negative year-to-date returns. However, despite all of the recent turmoil from an emerging markets scare, concerns over how soon the Fed will start to hike interest rates and signs of deterioration in the underlying technical foundations of the market, investors remain extremely optimistic about their investments. It is, of course, at these times that investors should start to become more cautious about the risk they undertake. Unfortunately, the“greed factor,” combined with the ever bullish Wall Street “buy and hold so I can charge you a fee” advice, often deafens the voice of common sense.

One of my favorite quotes of all time is from Howard Marks who stated:

“Resisting – and thereby achieving success as a contrarian – isn’t easy. Things combine to make it difficult; including natural herd tendencies and the pain imposed by being out of step, since momentum invariably makes pro-cyclical actions look correct for a while. (That’s why it’s essential to remember that ‘being too far ahead of your time is indistinguishable from being wrong.’)

Given the uncertain nature of the future, and thus the difficulty of being confident your position is the right one – especially as price moves against you – it’s challenging to be a lonely contrarian.”

That quote is truest at extremes as markets can remain “irrational” far longer than would otherwise seem logical. This is particularly the case when, despite clear signs of overvaluation and excess, central banks worldwide are dumping liquidity into economies in a desperate attempt to “resolve a debt bubble with more debt.”

It is interesting that when you ask most people if they would bet heavily on a “pair of deuces” in a game of poker, they will quickly tell you “no.” When asked why, they clearly understand that the “risk to reward” ratio is clearly not in their favor. However, when it comes to the investing the greater the risk of loss, the more they want to invest. It is a curious thing particularly when considering that the bets in poker are miniscule as compared to an individual’s “life savings” in the investment game.

However, that is where we clearly find ourselves today. There was never a clearer sign of excessive bullish optimism than what is currently found within the levels of margin debt. Even as the markets sold off sharply in February, investors sharply levered up portfolios and increasing overall portfolio risk.

MarginDebt-NetCredit-040814-2Even professional investors, who are supposed to be the “smart money,” are currently at the highest levels of bullishness seen since 1990.  (The chart below is the 4-month moving average of the net-difference between bullish and bearish sentiment.)


Franklin Roosevelt, during his first inaugural address, made one of his most famous statements:

“So, first of all, let me assert my firm belief that the only thing we have to fear is fear itself…”

However, when it comes to the stock market it is the “lack of fear” that we should be most fearful of.  Throughout human history, the emotions of “fear” and “greed” have influenced market dynamics.  From soaring bull markets to crashing bear markets, tulip bubbles to the South Sea, railroads to technology; the emotions of greed, fear, panic, hope and despair have remained a constant driver of investor behavior.  The chart below, which I have discussed previously, shows the investor psychology cycle overlaid against the S&P 500 and the 3-month average of net equity fund inflows by investors. The longer that an advance occurs in the market, the more complacent that investors tend to become.

Investor-Psychology-Cycle-040814Complacency is like a “warm blanket on a freezing day.”  No matter how badly you want something, you are likely to defer action because it will require leaving the “cozy comfort” the blanket affords you. When it comes to the markets, that complacency can be detrimental to your long term financial health. The chart below shows the 6-month average of the volatility index (VIX) which represents the level of “fear” by investors of a potential market correction.


The current levels of investor complacency are more usually associated with late stage bull markets rather than the beginning of new ones. Of course, if you think about it, this only makes sense if you refer back to the investor psychology chart above.

The point here is simple. The combined levels of bullish optimism, lack of concern about a possible market correction (don’t worry the Fed has the markets back), and rising levels of leverage in markets provide the “ingredients” for a more severe market correction. However,  it is important to understand that these ingredients by themselves are inert. It is because they are inert that they are quickly dismissed under the guise that“this time is different.”

Like a thermite reaction, when these relatively inert ingredients are ignited by a catalyst they will burn extremely hot. Unfortunately, there is no way to know exactly what that catalyst will be or when it will occur. The problem for individuals is that they are trapped by the combustion an unable to extract themselves in time.

I recently wrote an article entitled “OMG! Not Another Comparison Chart” because there have been too many of these types of charts lately. The reason I make that distinction is that the next chart is NOT a comparison for the purposes of stating this market is like a previous one. Rather, it is an analysis of what a market topping pattern looks like.


As you can see, during the initial phases of a topping process complacency as shown by the 3-month volatility index at the bottom remains low. As the markets rise, investor confidence builds leading to a “willful” blindness of the inherent risks. This confidence remains during the topping process which can take months to complete. With individuals focused on the extremely short term market movements (the tree) they miss the fact that the forest is on fire around them. However, as shown, by the time investors realize the markets have broken it is generally too late.

As Seth Klarman recently wrote:

“The survivors pledged to themselves that they would forever be more careful, less greedy, less short-term oriented.

But here we are again, mired in a euphoric environment in which some securities have risen in price beyond all reason, where leverage is returning to rainy markets and asset classes, and where caution seems radical and risk-taking the prudent course. Not surprisingly, lessons learned in 2008 were only learned temporarily. These are the inevitable cycles of greed and fear, of peaks and troughs.

Can we say when it will end? No. Can we say that it will end? Yes. And when it ends and the trend reverses, here is what we can say for sure. Few will be ready. Few will be prepared.”

It is in that statement that we find the unfortunate truth. Individuals are once again told that this time will be different. Anyone who dares speak against the clergy of bullishness is immediately chastised for heresy. Yet, in the end, no one will ring the bell at the top and ask everyone to please exit the building in an orderly fashion. Rather, it will be a “Constanza moment as the adults (professionals) trample the children (retail) to flee the building in a moment of panic.

It is only then that anyone will ask the question of “why?”  Why didn’t anyone warn me? Why did this happen? Why didn’t we see it coming? Why didn’t someone do something about it?




The Problem With Forward P/E’s

By Lance Roberts, STA Wealth

In a recent note by Jeff Saut at Raymond James, he noted that valuations are cheap based on forward earnings estimates.  He is what he says:

“That said, valuations are not particularly onerous with the P/E ratio for the S&P 500 (SPX/1841.13) currently trading around 15.2x this year’s bottom-up estimate of roughly $121 per share. Moreover, if next year’s estimates are anywhere near the mark of $137, the SPX is being valued at a mere 13.4x earnings.”

As a reminder, it is important to remember that when discussing valuations, particularly regarding historic over/under valuation, it is ALWAYS based on trailing REPORTED earnings.  This is what is actually sitting on the bottom line of corporate income statements versus operating earnings, which is “what I would have earned if XYZ hadn’t happened.” 

Beginning in the late 90’s, as the Wall Street casino opened its doors to the mass retail public, use of forward operating earning estimates to justify extremely overvalued markets came into vogue.  However, the problem with forward operating earning estimates is that they are historically wrong by an average of 33%.  The chart below, courtesy of Ed Yardeni, shows this clearly.



Let me give you a real time example of what I mean.  At the beginning of the year, the value of the S&P 500 was roughly 1850, which is about where at the end of last week.  In January, forward operating earnings for 2014 was expected to be $121.45 per share.  This gave the S&P 500 a P/FE (forward earnings) ratio of 15.23x.

Already forward operating earnings estimates have been reduced to $120.34 for 2014.  If we use the same price level as in January – the P/FE ratio has already climbed 15.37x.

Let’s take this exercise one step further and consider the historical overstatement average of 33%.  However, let’s be generous and assume that estimates are only overstated by just 15%.  Currently, S&P is estimating that earnings for the broad market index will be, as stated above, $120.34 per share in 2014 but will rise by 14% in 2015 to $137.36 per share.  If we reduce both of these numbers by just 15% to account for overly optimistic assumptions, then the undervaluation story becomes much less evident.  Assuming that the price of the market remains constant the current P/FE ratios rise to 18.08x for 2014 and 15.84x for 2015.

Of course, it is all just fun with numbers and, as I stated yesterday, this there are only three types of lies:

“Lies, Damned Lies and Statistics.”

With the continued changes to accounting rules, repeal of FASB rule 157, and the ongoing torturing of income statements by corporations over the last 25 years in particular, the truth between real and artificial earnings per share has grown ever wider.  As I stated recently in“50% Profit Growth:”

“The sustainability of corporate profits is dependent on two primary factors; sustained revenue growth and cost controls.  From each dollar of sales is subtracted the operating costs of the business to achieve net profitability.  The chart below shows the percentage change of sales, what happens at the top line of the income statement, as compared to actual earnings (reported and operating) growth.”


“Since 2000, each dollar of gross sales has been increased into more than $1 in operating and reported profits through financial engineering and cost suppression.  The next chart shows that the surge in corporate profitability in recent years is a result of a consistent reduction of both employment and wage growth.  This has been achieved by increases in productivity, technology and offshoring of labor.  However, it is important to note that benefits from such actions are finite.”

This is why trailing reported earnings is the only “honest” way to approach valuing the markets.  Bill Hester recently wrote a very good note in this regard in response to critics of Shiller’s CAPE (cyclically-adjusted price/earnings) ratio which smoothes trailing reported earnings.

“More recently the ratio has undergone an attack from some widely-followed analysts, questioning its validity and offering up attempts to adjust the ratio.This may be a reaction to its new-found notoriety, but more likely it’s because the CAPE is suggesting that US stocks are significantly overvalued.  All of the adjustments analysts have made so far imply that stocks are less overvalued than the traditional CAPE would suggest.”

We feel no particular obligation defend the CAPE ratio. It has a strong long-term relationship to subsequent 10-year market returns. And it’s only one of numerous valuation indicators that we use in our work – many which are considerably more reliable. All of these valuation indicators – particularly when record-high profit margins are accounted for – are sending the same message: The market is steeply overvalued, leaving investors with the prospect of low, single-digit long-term expected returns. But we decided to come to the aid of the CAPE ratio in this case because a few errors have slipped into the debate, and it’s important for investors who have previously relied on this ratio to understand these errors so they can judge the valuation metric fairly.  Importantly, the primary error that is being made is not even the fault of those making the arguments against the CAPE ratio. The fault lies at the feet of a misleading data series.


If I want to justify selling you an overvalued mutual fund or equity, then I certainly would try to find ways to discount measures which suggest investments made at current levels will likely have low to negative future returns.  However, as a money manager for individuals in retirement, my bigger concern is protecting investment capital first.  (Note: that statement does not mean that I am currently in cash, we are fully invested at the current time.  However, we are not naive about the risks to our holdings.)

The following chart shows Tobin’s “Q” ratio and Robert Shillers “Cyclically Adjusted P/E (CAPE)” ratio versus the S&P 500. James Tobin of Yale University, Nobel laureate in economics, hypothesized that the combined market value of all the companies on the stock market should be about equal to their replacement costs. The Q ratio is calculated as the market value of a company divided by the replacement value of the firm’s assets.  Currently, the CAPE is at 25.41x, and the Q-ratio is at 1.01.


Both of these measures are currently at levels that suggest that forward stock market returns are likely to be in the low to single digits over the next decade.  However, it is always at the point of peak valuations where the search for creative justification begins. Unfortunately, it has never “been different this time.”

Lastly, with corporate profits at record levels relative to economic growth, it is likely that the current robust expectations for continued double digit margin expansions will likely turn out to be somewhat disappointing.



As we know repeatedly from history, extrapolated projections rarely happen.  Therefore, when analysts value the market as if current profits are representative of an indefinite future, they have likely insured investors will receive a very rude awakening at some point in the future.

There is mounting evidence, from valuations being paid in M&A deals, junk bond yields, margin debt and price extensions from long term means, “exuberance” is once again returning to the financial markets.  Again, as I stated previously, my firm remains fully invested in the markets at the current time.  I write this article, not from a position of being“bearish” as all such commentary tends to be classified, but from a position of being aware of the “risk” that could potentially damage long term returns to my clients.  It is always interesting that, following two major bear markets, investors have forgotten that it was these very same analysts that had them buying into the market peaks previously.