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Flight To Imbecility
"Just because every fiber of society and government wants bond and housing price inflation
to continue without consequence does not mean that this will happen."
- Michael J. Burry
In a crisis, investors fly to safety; all of a sudden, their attention shifts from return ON investment to return OF investment. Bond buyers, typically headed down the yield curve, will give up the gray skies of high-yielding debt in favor of the more reliable weather offered by Treasuries. 'We'll at least get our money back,' they tell themselves. Whatever else may happen, the U.S. government will pay...
...even if it has to print the money.
Stock buyers, meanwhile, fly to quality by moving from growth and momentum stocks towards those that offer value and yield. Thus out of harm's way, they prepare to wait out the crisis...cashing dividend checks.
But what about today's investor? He looks around him and sees no menace, neither from the highest debt levels in history, nor from the trillions in derivatives, nor from rising unemployment, nor from falling profits, nor from high stock prices, nor from the largest deficits in history - both in government and trade. What should he do?
Get another pair of eyes, is our answer.
Instead, he has boarded a cheap flight to mediocrity...and taken the entire market with him.
In the bond market, investors have favored junk over quality. "C-rated paper in aggregate has outperformed B-rated paper by more than 3000 basis points since the market low on October 10, 2002," writes Dr. Michael J. Burry of Scion Capital (courtesy of Marc Faber).
And in the stock market, the most speculative tech stocks have been the best performers - by far - so far this year.
"Just as the lowest-rated of junk bonds led the bond rally during the first half of the year," Burry continues, "the best stocks in terms of performance were the worst in terms of quality."
There is the smart money and the dumb money. In normal times, they are like Republicans and Democrats, not so different from one another that you can tell them apart. A stock trading at 10 times earnings, for example, may be too expensive. Or it may be too cheap. Only time will tell.
Worse, for long periods of time, the dumb money actually looks smart. Nothing raises the I.Q. of an investor faster than seeing his shares go up; until a crisis changes attitudes, even the dumbest investors think they are geniuses.
As investors reach for higher-yielding bonds, for example, they drive the junk up in price. Stock market investors, meanwhile, rushing to buy shares of bad companies, push up prices...making both the companies and themselves look like winners.
But at extremes, the smart money and the dumb money part company. We read in yesterday's news that insiders, usually the smart money, sold $44 of stock for every $1 they bought. Insiders are generally net sellers. But this ratio is the highest ever. The smart money is taking advantage of this opportunity to get out.
Looking back on the bubble years - 1997-2000 - we see who was who. The smart money sold stocks. The dumb money bought them. Smarter money sold stocks it didn't own. But the real geniuses created the stocks investors wanted to buy.
Not all the money lost in the initial phase of the bear market, 2000-2003, disappeared. Many companies - notably Amazon.com - took advantage of investors' fearlessness to create and sell stocks. Investors offered money with no strings attached. The companies needed neither collateral assets, profits, dividends, nor even a reasonable business plan. Effectively, the money was free. Amazon and other companies raised billions of dollars this way...which gave them a cushion of cash, on which many fat derrières rest even now.
On the other side, the dumb money bought Amazon at the peak. Dumber money borrowed to buy the shares. And the dumbest money of all was in the hands of corporate managers, who borrowed money to buy back their own inflated shares! The object of the game was to run up your share price, issue millions of shares, and sell them to yokels without a clue. But these corporate finance wizards completely misunderstood what they were doing. Instead of taking advantage of the dumb money, they bought the dumb money's shares back - at higher prices. In this case, the money was not merely dumb, but so severely retarded that you would be doing it a favor by holding a pillow over its head.
Where then is the dumb money now...and how can we take advantage of it?
We don't know; we're just asking. But in the stock market, it seems obvious; buyers of Krispy Kreme, financial stocks, or builders are probably cruisin' for a bruisin'. The stocks are expensive. As a general principle, the smart money buys cheap and sells dear; the dumb money does the opposite.
But how about people who are lending money at the lowest yields in 40 years? Are they not providing capital at astonishingly low rates? Shouldn't we borrow it...before lenders look around and notice a possible crisis or two? Foreign lenders, for example, won't they soon realize that they have little to gain from a bond paying 5%...if the dollar goes down 10%?
And there is the spectacle of people mortgaging their houses for more than they are worth; what do we make of that? Who is the greater fool...the borrower, or the lender? It is hard to say; both seem to be headed towards a disaster.
Theoretically, the lender is the expert; the borrower is the rube. But, in their flight to mediocrity, mortgage lenders have reached further and further for yield - going after more and more marginal credit risks. Haven't they created a situation in which both sides could be losers?
The lender stands to lose from a boost in inflation rates. Inflation would collapse the value of a fixed-rate mortgage.
But inflation is no sure thing. The homeowner stands to lose, too. Jobs are disappearing. Pay levels are stagnating. Deflation would make it harder for him to make his mortgage payments. And if his house fell in value, maybe he wouldn't want to.
An adjustable rate mechanism would protect the lender from inflation...but then again, not if the borrower can't pay.
In a real crisis, over-stretched homeowners couldn't continue servicing their mortgages. Already going bankrupt at the highest rates in recent history, millions more could go down if a genuine recession were to begin. Most likely, Fannie Mae, Freddie Mac and other mortgage lenders would soon be insolvent, too.
What about gold? Who is the chump? The buyer or the seller? We don't know, of course, but trading the Dow stocks for 26 ounces of it seems almost like a giveaway; you get 26 times more for your money than you would have 23 years ago. Back then, the dumbest thing you could do was to trade the Dow for a single ounce of gold. Over the next 20 years, the Dow went up 1,100%, while the gold price got cut in half. Of course, that was a period of crisis - when investors took flight for quality. The Dow may have been cheap, they reasoned, but gold was sure.
They were wrong. And now they probably are wrong again - but in the opposite direction. Now there are crises waiting for them everywhere, but they don't see them. Instead of flying to quality...they scoot off towards mediocrity, and imbecility. They take up the worst deals on Wall Street, and leave gold untouched.
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Flight To Imbecility
"Just because every fiber of society and government wants bond and housing price inflation
to continue without consequence does not mean that this will happen."
- Michael J. Burry
In a crisis, investors fly to safety; all of a sudden, their attention shifts from return ON investment to return OF investment. Bond buyers, typically headed down the yield curve, will give up the gray skies of high-yielding debt in favor of the more reliable weather offered by Treasuries. 'We'll at least get our money back,' they tell themselves. Whatever else may happen, the U.S. government will pay...
...even if it has to print the money.
Stock buyers, meanwhile, fly to quality by moving from growth and momentum stocks towards those that offer value and yield. Thus out of harm's way, they prepare to wait out the crisis...cashing dividend checks.
But what about today's investor? He looks around him and sees no menace, neither from the highest debt levels in history, nor from the trillions in derivatives, nor from rising unemployment, nor from falling profits, nor from high stock prices, nor from the largest deficits in history - both in government and trade. What should he do?
Get another pair of eyes, is our answer.
Instead, he has boarded a cheap flight to mediocrity...and taken the entire market with him.
In the bond market, investors have favored junk over quality. "C-rated paper in aggregate has outperformed B-rated paper by more than 3000 basis points since the market low on October 10, 2002," writes Dr. Michael J. Burry of Scion Capital (courtesy of Marc Faber).
And in the stock market, the most speculative tech stocks have been the best performers - by far - so far this year.
"Just as the lowest-rated of junk bonds led the bond rally during the first half of the year," Burry continues, "the best stocks in terms of performance were the worst in terms of quality."
There is the smart money and the dumb money. In normal times, they are like Republicans and Democrats, not so different from one another that you can tell them apart. A stock trading at 10 times earnings, for example, may be too expensive. Or it may be too cheap. Only time will tell.
Worse, for long periods of time, the dumb money actually looks smart. Nothing raises the I.Q. of an investor faster than seeing his shares go up; until a crisis changes attitudes, even the dumbest investors think they are geniuses.
As investors reach for higher-yielding bonds, for example, they drive the junk up in price. Stock market investors, meanwhile, rushing to buy shares of bad companies, push up prices...making both the companies and themselves look like winners.
But at extremes, the smart money and the dumb money part company. We read in yesterday's news that insiders, usually the smart money, sold $44 of stock for every $1 they bought. Insiders are generally net sellers. But this ratio is the highest ever. The smart money is taking advantage of this opportunity to get out.
Looking back on the bubble years - 1997-2000 - we see who was who. The smart money sold stocks. The dumb money bought them. Smarter money sold stocks it didn't own. But the real geniuses created the stocks investors wanted to buy.
Not all the money lost in the initial phase of the bear market, 2000-2003, disappeared. Many companies - notably Amazon.com - took advantage of investors' fearlessness to create and sell stocks. Investors offered money with no strings attached. The companies needed neither collateral assets, profits, dividends, nor even a reasonable business plan. Effectively, the money was free. Amazon and other companies raised billions of dollars this way...which gave them a cushion of cash, on which many fat derrières rest even now.
On the other side, the dumb money bought Amazon at the peak. Dumber money borrowed to buy the shares. And the dumbest money of all was in the hands of corporate managers, who borrowed money to buy back their own inflated shares! The object of the game was to run up your share price, issue millions of shares, and sell them to yokels without a clue. But these corporate finance wizards completely misunderstood what they were doing. Instead of taking advantage of the dumb money, they bought the dumb money's shares back - at higher prices. In this case, the money was not merely dumb, but so severely retarded that you would be doing it a favor by holding a pillow over its head.
Where then is the dumb money now...and how can we take advantage of it?
We don't know; we're just asking. But in the stock market, it seems obvious; buyers of Krispy Kreme, financial stocks, or builders are probably cruisin' for a bruisin'. The stocks are expensive. As a general principle, the smart money buys cheap and sells dear; the dumb money does the opposite.
But how about people who are lending money at the lowest yields in 40 years? Are they not providing capital at astonishingly low rates? Shouldn't we borrow it...before lenders look around and notice a possible crisis or two? Foreign lenders, for example, won't they soon realize that they have little to gain from a bond paying 5%...if the dollar goes down 10%?
And there is the spectacle of people mortgaging their houses for more than they are worth; what do we make of that? Who is the greater fool...the borrower, or the lender? It is hard to say; both seem to be headed towards a disaster.
Theoretically, the lender is the expert; the borrower is the rube. But, in their flight to mediocrity, mortgage lenders have reached further and further for yield - going after more and more marginal credit risks. Haven't they created a situation in which both sides could be losers?
The lender stands to lose from a boost in inflation rates. Inflation would collapse the value of a fixed-rate mortgage.
But inflation is no sure thing. The homeowner stands to lose, too. Jobs are disappearing. Pay levels are stagnating. Deflation would make it harder for him to make his mortgage payments. And if his house fell in value, maybe he wouldn't want to.
An adjustable rate mechanism would protect the lender from inflation...but then again, not if the borrower can't pay.
In a real crisis, over-stretched homeowners couldn't continue servicing their mortgages. Already going bankrupt at the highest rates in recent history, millions more could go down if a genuine recession were to begin. Most likely, Fannie Mae, Freddie Mac and other mortgage lenders would soon be insolvent, too.
What about gold? Who is the chump? The buyer or the seller? We don't know, of course, but trading the Dow stocks for 26 ounces of it seems almost like a giveaway; you get 26 times more for your money than you would have 23 years ago. Back then, the dumbest thing you could do was to trade the Dow for a single ounce of gold. Over the next 20 years, the Dow went up 1,100%, while the gold price got cut in half. Of course, that was a period of crisis - when investors took flight for quality. The Dow may have been cheap, they reasoned, but gold was sure.
They were wrong. And now they probably are wrong again - but in the opposite direction. Now there are crises waiting for them everywhere, but they don't see them. Instead of flying to quality...they scoot off towards mediocrity, and imbecility. They take up the worst deals on Wall Street, and leave gold untouched.
