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The calmest markets ever

This is the 2nd longest run in history


without a 3% pullback in the S&P
500. 232 days and counting

Down days appear to be a thing


of the past

SOURCE: Charlie Bilello, @charliebilello


Markets only go one way, right?

The last 4 years have been unusual


to say the least.

We have seen an abnormal period


as far as drawdowns are concerned.

2017 on course to break new


records.

SOURCE: TheAtlasInvestor.com, h/t @northmantrader


US expansion long in the tooth?

This is the 3rd longest US


economic recovery in history.

While the current expansion is


long, in magnitude the recovery
has been muted.

History suggests we are likely


closer to the end than the
beginning.

On its own it signals little in


terms of timing the next
recession.

SOURCE: NBER, KKR Global Macro & Asset Allocation


Will the calm continue?

Has risk been extinguished?

Investors need to ask what is driving this calm.

What is sending the markets to ever-higher levels?

Central banks have played a big part.


Central banks have been an increasing presence in the market

Central bank intervention in


aggregate is now greater than
at any time, including the midst
of the GFC.

If you thought the Fed were


reckless, the SNB and the BoJ
make them look like amateurs.

"Today's highly levered domestic and


global economies which have feasted on
the easy monetary policies of recent
years can likely not stand anywhere
close to the flat yield curves witnessed in
prior decades."
Bill Gross Janus Capital

SOURCE: Bloomberg
Central Bank largesse knows no bounds

While the Fed and the BoE have


moderated their asset
purchases

The ECB and the BoJ have


accelerated theirs.

As central banks remain pedal-to


the-metal, investors should ask
where the benefits of monetary
policy have most been felt.

SOURCE: Thomson Reuters


Valuations are at nosebleed levels

The Warren Buffett indicator points


to one of the most expensive
markets on record.

More than 100% equity to GDP


has been a warning signal for an
impending correction in the past.

This 8-year bull market has driven


markets to rich valuations

yet central banks suggest no


letting up in terms of stimulus.

Normal?

SOURCE: h/t Kyle Bass


The most expensive market ever

On some metrics markets


have NEVER been more
expensive.

I really think now, I look at this


market and you just say look at
some of these values and you have
to wonder,
Carl Icahn

SOURCE: Dr. John Hussman, h/t @ttmygh


Cyclically-adjusted valuations are elevated

Robert Shiller notes that the


current situation has similarities
to all of the 13 bear markets of
the last 100+ years.

This month, the CAPE ratio in the US


is just above 30. That is a high ratio.
Indeed, between 1881 and today,
the average CAPE ratio has stood at
just 16.8. Moreover, it has exceeded
30 only twice during that period: in
1929 and in 1997-2002.
Robert Shiller

SOURCE: Robert Shiller


Do relative calm and high valuations disguise what lies beneath the surface?

While markets appear calm and remain close to all time highs, there are some warning flags
that investors should consider:

$14tln and counting in central bank intervention is going to leave its mark on markets.

These are NOT normal times.

Investors should be on the look out for signs of excess risk taking.

Lets examine the evidence


Bond volatility is higher than equity volatility

One or both of these look mis-


priced.

The last time government bond


volatility was higher than equity
volatility was in 2008.

Things have been going up for too


long. When yields on corporate
bonds are lower than dividends on
stocks, that unnerves me. Lloyd
Blankfein CEO Goldman Sachs

SOURCE: The ECU Group, @ECUgroup


Everyone is betting that markets will remain calm

The market is convinced


volatility will remain low
indefinitely, or that there is a
greater fool.

Short VIX positions continue to


hit all time highs.

Pennies and steamrollers come


to mind.

"Just as portfolio insurance


caused the 1987 rout, the new
danger zone is the half-trillion
dollars in risk parity funds.
Paul Tudor Jones

SOURCE: Bloomberg
The chase for yield is extreme

Central bank intervention is so


prevalent that European junk
bonds have the same yield as
US Treasuries.

That means investors are pricing


in the same risk for European
high yield bonds as they do for
US Treasuries.

The first bubble is that bonds are at


ridiculous levels, so that the saver, the
small charity, has no place to put his
money except into stocks. I think that
situation is serious on that score. Nobody
seems to be concerned about that.
Julian Robertson Tiger Management

SOURCE: The Credit Strategist


Investors are being pushed further out on the risk curve

Low yields have forced investors to


buy riskier assets.

EM debt has seen some of the largest


inflows.

Are investors being adequately


compensated for taking additional
risk?

Aggressive investors are


engaging in willing risk-taking,
funding risky deals and creating
risky market conditions
- Howard Marks Oaktree Capital

SOURCE: Bloomberg
Distribution of credit rated corporate bonds

Junk has got junkier

Lending standards have been


relaxed and bond dispersion
quality has fallen.

SOURCE: BIS
Peak complacency

Inflows to passive investments


have been a one-way street.

Active management has


become taboo.

Why pay high fees if the market


only goes up?

Passive investing is in danger of


devouring capitalism. What may have
been a clever idea in its infancy has
grown into a blob which is destructive
to the growth-creating and consensus-
building prospects of free market
capitalism.
Paul Singer

SOURCE: Steve Bregman, Horizon Kinetics


With weak economic growth how can consumers maintain their life styles? Debt

Low interest rates have allowed


consumers to accumulate more and
more debt.

Student, auto, credit card and


mortgage loan creation is rampant.

Where are we in the credit cycle?

SOURCE: FRED
US government borrowing is insatiable

US federal government debt


continues to expand to new
records.

$20tn and counting

while interest rates stay


depressed.

Can the US government service


its debt if yields rise?

SOURCE: FRED
Consumer credit delinquencies

We are starting to see a pickup


in delinquencies.

Even small rate increases have


affected consumers ability to
repay debt.

This is normally a sign of being


late-cycle.

SOURCE: FRED
Is the market losing its foundation?

Corporate buybacks have been


one of the key pillars of support
for equity markets.

Corporates have been issuing


debt to buyback shares.

Is this support going away?

SOURCE: BofA Merrill Lynch


Market breadth looks very weak

Market breadth is poor.

Narrow participation in rallies


historically has been an ominous
indicator for market health.

SOURCE: Jesse Felder, @jessefelder


Unemployment moving from tailwind to headwind?

Employment looks like it cant


get any better.

Have we seen the cyclical low?

SOURCE: FRED, h/t GMI, @RaoulGMI


Employment numbers have been flattering

The low labour participation


rate paints a different picture to
the robust headline numbers.

Is a temporary worker really


worth as much to the economy
as a permanent worker?

SOURCE: FRED
Is the fed pulling the rug?

As the fed starts reducing its


balance sheet, does it matter for
markets?

It appears markets have moved


largely in lockstep with central
bank balance sheet expansion?

Can the fed really remove this


support without a major market
wobble?

SOURCE: MI2 Partners, @MI2Partners


Future returns look bleak

Historical evidence is
compelling.

Future expected returns, given


todays valuations, are very low.

Is now the time to be adding


risk?

SOURCE: GMO
Is the party ending?

No one can say for sure.

But with record high valuations and record low volatility, now is not the time to be
complacent. There is simply no margin of safety.

They dont ring a bell at the top, but will we look back and realise the clues were
there?

Some of the smartest, most successful investors are urging caution. Its time to assess
risk.
No hiding in bonds or equities?

Can you protect yourself from a


market correction in bonds or
equities?

Historically, throughout most of


the last 130 years, bonds and
stocks have moved in the same
direction.

If correlations were to revert to


the mean, both asset classes
may produce poor returns.

SOURCE: Artemis Capital


Beware of years ending in 7

For market historians, years


ending in 7 have not been kind.

1987, 1997, 2007 spring to


mind

SOURCE: Hedge Fund Telemetry, @TommyThornton


Dont take our word for it

It seems to me we are now socially and economically divided and burdened in ways that are broadly
analogous to 1937. Politics will probably play a greater role in affecting markets than we have experienced
before in our lifetimes, but in a way that is similar to that same year. Ray Dalio - Bridgewater

If youre waiting for the catalyst to show itself, youre going to be selling at a lower price. Investors should begin
moving toward the exits. Jeff Gundlach CEO Doubleline Capital

We are seeing signs of bubbles in more and more parts of the capital markets where we wouldnt have
expected them. John Cryan CEO DB
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