The past couple of days have been a little odd, and they’ve left me less time to put pen to paper (keyboard to screen?) – what happens when the very things we anticipated start happening?
Let’s start with yields…For months we’ve been discussing the historic levels of the 10/30 spread:
It’s couldn’t get wider forever and as a value-guy at heart, I like finding these types of extensions and looking for reversions to the mean. We’re getting it, but there’s more to go.
What about on an absolute level? 10 year yields could go down to 2%, but the risk is definitely to the upside (for yields, downside for prices).
What about currencies? The USD index is finding some support, and I think it’s found a floor. There is a lot of speculative money that is short the USD (short USD/long equities was THE trade for the past few months).
Lastly, what about equities? Equities are overvalued on a fundamental basis. No matter what justification is used, bull markets do NOT start from these valuations. There could be rallies, and powerful ones at that, but we are looking at 10%-15% upside potential with 30-40% downside risk. That’s a bad trade and a recipe for permanent investment losses.
The arguments floating around that QE will push assets up are valid. I get them. The arguments that USD debasement will continue are valid. But they are flawed. The Fed believes these arguments and is basing their decisions on them. The idea is push asset prices higher to stimulate spending (the wealth effect) and get the economy going.
It will fail due to two gaping flaw: the market has already discounted the efforts and is valued based on those assumptions. In order to get prices higher, the Fed would need to surprise the market with ever increasing levels of QE. The second gaping hole is the assumption that prices will actually rise. Prices of real estate are poised for 20% more downside based on various valuation methods, or more in certain areas with excess inventory of up to 18 years worth of homes!! Prices of stocks are 30% overvalued based on the q-ratio, and at best fairly valued, so room for upside is limited. Prices of bonds are already extended and have no place to go but down. So you have the 3 main stores of wealth poised for declines. There is nothing the Fed can do to change that.
Last 5 posts by Yaron Sadan
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