Friday, August 8, 2014

This is NOT Nuts, Where is the Crash?

The secret of making money in the market is to bet against it and then be right as well. As a far-fetched corollary, we can also say when everyone is worried about a market crash, that is perhaps not the best time to actually position for a crash. Even if they are central bankers warning of over-valuation of certain stocks or warning of outright market crash. Central bankers have not shown particular excellence and consistency in timing the markets. Keywords charts for "asset bubbles" and especially "market crash" bursting through the roofs here!

So here we take a look at the global market valuation. We have all range of valuations, from downright moribund Russian stocks to upbeat Mexico. And these excludes much of emerging and frontier markets. As good as a time to stay invested for long term, as any other time. And look for value.

And the markets seem to understand. We have hardly seen any great shift in momentum in equity flow. We have seen recent outflows in emerging market debt, high yield and developed markets equities. And also some increased flows in to US and core Europe bond funds. But before you listen to financial analysts and talking heads, there are very little evidence of flight to safety here. On longer term, what we are seeing is NOT rotation, rather a reflation, i.e. money continues to flow in to both bonds and equities. This is corroborated by central banks flows of funds accounts, as well as other higher frequency flow data. The amount of recent outflows from US equities is dwarfed by the amount pumped in since the financial crisis.

There are reason to believe these latest rounds flows in to bonds has little to do with safe heaven demand. The unforeseen consequences of changes in regulatory landscape (BASEL 3, SOLVENCY 2, all leading to higher bonds demands) and austerity and stress on balanced budget (leading to lower supply) may be the major driver. Clearly yield chasing has been significant as well, but there is some amount of caution out there - see the recent outflows of high yields. The real dangers are the developed economies getting in to the next recession following a natural business cycles from a much lower peak than past recoveries, and a China problem. But none of these present an extreme tail scenario to me. And if your expectation is a total Chinese melt-down, then heaven save us! So unless we see a central bank induced shock therapy gone wrong, a crash may never come anytime soon. At least not when everyone is looking for it! 

And even if it does arrive, probably it will be safer to stay in equities than in fixed income

And, oh, if someone tells you the evidence of irrational exuberance in the equity market is the insane levels of margin debt on NYSE and/or the cheapening of put skew, just sigh and shake your heads.

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