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Duration of This Bull Market

Grant Williams has a fantastic presentation regarding overvaluation of the current market:

A World of Pure Imagination

A related presentation, but with a different focus, comes from Jim Rickards:

What I find interesting is that in these, and many other analyses, the bull market is defined as having started in 2009, making this one of the longest (and thus presumably most overwrought) bull markets in history.

That brings me to Josh Brown.

Back in 2016, he noted that a bull market starts once a new high is reached, not from the prior low, and also that a bull market is interrupted by a new bear market on a 20%+ drawdown.  From The Reformed Broker:

  • It’s become likely that we are in a secular bull market for stocks. We do not measure secular bull markets from the bear market low of the prior cycle. The 1982-2000 secular bull market is measured from the day in 1982 when stocks finally took out their 1966 high. It had been a 16 year secular bear market until closing above those highs, and stocks never looked back. We do not date that bull market from the lows of 1973-1974 that were the nadir of the prior bear. Nor should we use 2009 as our starting point for the current bull market. 2009 was merely the cycle low of the prior bear, not the starting point of the current bull.
  • The actual starting point of the current secular bull market is the spring of 2013, when we broke above the double-top record highs of 2000 and 2007. This means we’re only into the third year.
  • I also would like to asterisk the fall of 2011 because the S&P 500 dropped 21% briefly in the depths of that panic, which would restart the count anyway if you were using 2009. This is semantics but important if we’re serious about dating. A drop into 20%+ drawdown, even if it’s brief, means a bear market and the end of the previous bull, if we’re using the generally accepted 20% (which is also meaningless, but it is what it is).



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Size of Government vs. Growth

Charles Gave recently published a post showing a simple but important fact:  economic growth is inversely proportional to the size of the government.  This is shown in developed economies over varying conditions.  Published on John Mauldin’s website:

In the US, a similarly straight forward picture emerges, with the big increase in government spending that took place after 2009 being the main cause of the subsequent decline in the US’s structural growth rate.

By way of contrast, consider the reverse case of Canada, which in the mid-1990s slashed government spending to good effect. In two years Canadian government spending was cut from 31% of GDP to about 25%. The ensuing 18 months saw predictable howls of protest from economists that a depression must follow. In fact, not only was a recession avoided but Canada’s structural growth rate quickly picked up and in the next two decades a record uninterrupted economic expansion was achieved.

As an aside, I would ask readers to cite one case in the post-1971 fiat money era when a big rise in government spending did not lead to a structural slowdown. Alternatively, if they could cite an episode when cuts to public spending resulted in the growth rate falling. I am always willing to learn and change my mind!

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Fed Balance Sheet unwind

Michael Arone at SPDR Blog has added a bunch of global data to the info I posted previously regarding the Fed’s balance sheet.  He includes some information about current and future levels of required reinvestments (maturity dates) but really doesn’t touch on how equity markets might be impacted.

There are a bunch of cool charts (and one really, really dumb one, click on the link and you figure out which one).

Here’s a couple:




Importantly, he noted that the Chinese sale of treasuries was related to their desire to control the level of the yuan, not some general panic over US Treasuries, as that action is often portrayed.

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Electric cars: Not clear on the concept!

Whenever I see a headline like this:

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Bloomberg details the current cost of renewables vs. fossil fuels here.  For new installations, solar and wind are now both cheaper than any fossil fuel power plant.  What does that mean?  Well, it means that no one will build new fossil fuel power plants.  However, do not confuse this with “solar is cheaper now so everyone will switch.”

It’s still cheaper to increase production at existing power plants, even if that requires investment to improve environmental impacts.  It’s also cheaper to retrofit existing plants to run other types of fuels, like coal to natural gas, or coal to biomass.  Please note, China claims to be moving away from coal.

What we might hope for is to see the solar industry in the US benefit and grow, supplying emerging economies with energy.  Although China dominates all solar power markets, the US does have significant manufacturing.

What about oil and electric cars?  Bloomberg also posted this video comparing the recent oil glut and price drop to the amount of oil use expected to be eliminated as planned electric vehicle manufacturing gets into high gear.  This is from February 2016, but it’s pretty good:


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Fixed Income Dilemma

What are we to do about fixed income?  Current yields are low at all maturities, for all except the riskiest issues.  In addition, investors currently holding bonds or bond funds are looking at interest rates that can seemingly only rise, leading to losses in value.

Let’s start by examining why we hold bonds in the first place, and how they have been performing relative to those reasons.  Bond ETFs will be used as a proxy for bond performance.  Investment grade bonds are represented by AGG, which tracks the Barclays US Aggregate Bond Index (data at and  High yield bonds are represented by HYG, which tracks the Markit iBoxx USD High Yield Index (data at and

  1. Low risk.  A core justification for owning investment grade bonds is that they rarely lose value, and when they do, it’s not much.  3 year standard deviation is 2.64%, compared to 6.01% for HYG, and 10.8% for SPY.
  2. Diversification.  The equity beta for AGG vs. the S&P500 is -.03 as of 9/30/2016.  This tells us that AGG is a very good diversifier to stocks.  From a portfolio construction standpoint, this is not to be taken lightly.  On the other hand, HYG has a beta of .40.  Still a diversifier, but as one would expect, more positively correlated with equities.
  3. Income.  Those who are retired, and many advisors, see bonds or fixed income assets as a way to earn money from savings without touching the money that was saved (spend earnings instead of principal).  Since money is fungible, this is really just a behavioral bias (mental accounting).  However, since all of our clients are humans who exhibit these biases, if it makes a client feel terrible to sell 2% of assets that have appreciated 2%, but feel good to take the income from an asset that has 0% return but 2% yield, then that might be a valid reason to use bonds for income.  AGG has been yielding about 2% YTD, and HYG about 3.5%(!).
  4. Regulations.  This is not a small consideration.  New fiduciary rules impact portfolio management, and portfolio managers will need to document extensive research to back up deviations from “standard” portfolios, which might by default include substantial allocations to fixed income for certain types of clients.

What about going forward?  Will these assumptions still hold, given global negative interest rates (see Eric Robbins’ article in this issue) and the historic bond bull market in US Treasuries?  I’m going to focus just on the first item on the list.

Low risk.  Is it possible for bond values to remain elevated, with depressed yields, for any mid- to long-term time frame?  The driving force behind this dynamic since the great recession has been QE.  According to the Fed’s website, approximately $45B of their $4T balance sheet will mature in the next quarter.  Also from the Fed, new mortgages are being issued at a rate of about $100B per quarter, and according to SIFMA, new US Treasury issues have totaled an average of $165B per quarter.  So in order for the Fed to maintain their current balance sheet, they alone are currently consuming nearly 20% of all new Treasury and mortgage debt issued in the US.  Foreign governments are also engaged in QE.  According to the US Treasury, their holdings of US debt have remained fairly constant over the last year at around $6T.  These holdings also mature, so there is implied demand for new issues from foreign buyers as well.

Jeff Gundlach feels that, based on presidential election political rhetoric, a new round of fiscal stimulus is forthcoming, which will overwhelm these buyers and result, along with Fed interest rate changes, in increasing rates (September 8 presentation, available from DoubleLine).  He recommends moving to lower duration securities and cash, right now.  I would add the observation that government spending comes from Congress, not the White House, so it is the congressional makeup that will determine fiscal policy action, or lack thereof.  Fidelity does not share Gundlach’s view (update from Fidelity website).  Bill Irving believes that “yields will remain at historically low levels for some time.”

Another consideration is that we are, historically, past due for a recession.  This typically results not only in large losses in equities, but a flight to quality, supporting  bond prices.  The bottom line:  Rates are not likely to remain at current lows forever.  However, federally backed debt, which comprises 70% of AGG (including agency and implicit government-backed debt), may continue to hold value in the short or even mid term.  If you look at a graph of the Federal funds rate, you will notice that while interest rates drop in huge increments, they only increase in small increments, over time.  These interest rate changes have previously been implemented slowly enough for the average investor to adjust asset allocation before major impairment to asset values can occur.

Corporate debt, according to both Irving and Gundlach, is now trading at historically normal spreads.  John Hussman provides a lot of data showing that today’s equity market is highly overvalued.  These data points together suggest that corporate debt may not be adequately compensating for credit risk.  Instead, corporate bonds have been bought beyond reasonable levels in the quest for yield (adding credit risk).  That strategy may be a greater risk to overall portfolio value than interest rate risk.  In fact, if high yield bonds have been added to a portfolio including US equity, the risk is now even larger since there is positive correlation between those asset classes.  Gundlach suggests emerging market debt in place of high yield domestic corporate bonds.  Foreign bonds add currency risk, but that can be hedged (for a price).

Another option is to make use of actively traded long/short bond funds or SMAs.  Although the exposure will always be to bonds, this is not an asset class that acts like a bond, but instead is an alternative.

So, what to do?  Assess the timeline of your portfolio, and compare it to basic bond management theory.  Can you match duration to reduce interest rate risk?  Can you use a barbell strategy to reduce interest rate risk and still meet your return requirements?  If this doesn’t work, what kind of risk are you willing to take?  Are you willing to live with interest rate risk, at least in high quality US issues?  Are you willing to take credit risk as well as adding to your overall portfolio risk by adding high yield, preferred stock, or foreign bonds?  Does it make sense to reduce your bond exposure and invest in another asset class?  As you look at these trade offs, be sure to determine your criteria for further review and action.   Set a specific interest rate cutoff (and/or whatever other data points you deem valuable), and determine what actions you will take when it is reached.  Set a specific review date, and determine what data you will review at that time.  And last, but far from least, be sure to record your process for compliance.

Disclosure:  Long AGG, SPY



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Elon Musk Master Plan, Part Deux

Read the whole thing, here:

And here’s the best part:

What really matters to accelerate a sustainable future is being able to scale up production volume as quickly as possible. That is why Tesla engineering has transitioned to focus heavily on designing the machine that makes the machine — turning the factory itself into a product. A first principles physics analysis of automotive production suggests that somewhere between a 5 to 10 fold improvement is achievable by version 3 on a roughly 2 year iteration cycle. The first Model 3 factory machine should be thought of as version 0.5, with version 1.0 probably in 2018.

In addition to consumer vehicles, there are two other types of electric vehicle needed: heavy-duty trucks and high passenger-density urban transport. Both are in the early stages of development at Tesla and should be ready for unveiling next year. We believe the Tesla Semi will deliver a substantial reduction in the cost of cargo transport, while increasing safety and making it really fun to operate.

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