Hosted by Erik Townsend and starring Jeffrey Snider, Mark Yusko and Luke Gromen
December 24, 2017
Erik: MacroVoices episode 95 was pre-recorded back in late November, 2017, to air on December 24, 2017. I’m Erik Townsend; happy holidays, everyone. We’re not going to have a market wrap or postgame segment for the balance of 2017. We’ll return to our usual format on January 4th, 2018. Instead, today’s entire show will be entirely dedicated to Part 1 of our Year-end special, featuring Morgan Creek founder Mark Yusko, Alhambra Investments’ CIO Jeffrey Snider, and Forrest for the Trees’ founder Luke Gromen. I think you’re really going to enjoy this 5-part series, which in my opinion is the only level headed, serious discussion you’ll find anywhere about how and why the U.S. Dollar will gradually lose its position of prominence and hegemony over the global financial system, just as the British Pound Sterling fell from that position of prominence in the early 20th century. This series was originally conceived as a 2-hour special, and the planned topic was simply a debate between the secular dollar bull vs. secular dollar bear arguments, with Jeff Snider and myself slated to represent the dollar bull argument, and Mark Yusko and Luke Gromen slated to argue the dollar bear case. Now let’s dive in to what were originally intended to be opening arguments. Keep in mind that as we were recording this first part, we still thought we were setting up a dollar bear vs. dollar bull debate. I’ll be back after these initial arguments to explain why we re-framed the rest of the series after realizing we were all in violent agreement that the Dollar’s age of hegemony over the global financial system is ending.
Joining me next on the program are Jeffrey Snider, CIO at Alhambra Partners, Luke Gromen, founder of Forest for the Trees, and Mark Yusko, founder and fund manager for Morgan Creek. I’d like to thank you guys for the time and energy you’ve put into this project. It really means a lot to us and our listeners. So thanks for joining us.
Erik: Joining me now is Professor Steve Keen. Steve, you are very distinguished in the fact that you’re one of very, very few people in finance who not only predicted the 2008 financial crisis – but can prove it, because you wrote about the fact that it would happen, why it would happen, and how it would happen, before it happened.
So you do have a book out this year, which is titled Can We Avoid Another Financial Crisis. The short answer is no, we cannot. The longer answer, in 140 pages, is a bargain at only $9 for the eBook version of that. We’ve got a link in our Research Roundup email to the Wiley Publications website where you can order that.
But give us the background. What was the principle cause of the last financial crisis in 2008?
Steve: Fundamentally, that we borrowed too much private debt and became dependent on the rise in that debt as a major source of aggregate demand for both goods and services. And also asset markets. And when that debt stopped rising, that meant total demand actually fell. So it’s quite simple in that sense.
A financial crisis is caused by becoming too dependent on credit and credit then ceasing. And when it ceases, because credit is such a large part of demand a huge slab of demand disappears very rapidly. And that, first of all, affects finance markets. Because finance markets, of course, have more volatile prices than goods and services markets. And that collapse in prices means people then stop borrowing money. When they stop borrowing money demand falls and you have a crunch.
Joining me now is JDI Research founder Juliette Declercq. Juliette is perhaps best known for her fantastic macro charts. In the past we’ve been very restricted in our ability to share these charts with our listeners, because Juliette’s institutional client base expects exclusive access. But we have an early Christmas present for you this week: Juliette put together a fantastic book of charts and graphs you won’t see anywhere else, and sent them to her institutional subscribers first to assure they keep the leg up on the market they’re paying for. This means we can now share them with MacroVoices listeners. Registered users will find the download link in your Research Roundup e-mail. If you’re not yet registered just go to MacroVoices.com and look for registration and download instructions on our home page.
Erik: Just to set the scene, how have you looked at the macro landscape in the US in 2017?
Juliette: That’s a very good question because one thing I would like to reiterate before I delve into my 2018 outlook in broad lines … is that the low US growth potential is not going away however loud Trump will be in stating the contrary … Let’s start on Chart 1 in my 2018 chart pack.
Erik: Joining me next is Marin Katusa, founder of Katusa Research and a very well-known natural resource investor.
Marin, I want to start with not just the oil market but particularly Saudi Arabia.
I absolutely do not profess to be an expert on Saudi Arabia and their culture and politics and so forth. But what little I thought I knew about that country is I thought they were a very conservative culture that tended to place a lot of value on things like age and experience, you know, older age, wisdom.
You would think in a culture like that that if there was going to be a procession of power according to bloodlines it would probably go to the king’s eldest son.
And the other impression I’ve had of Saudi Arabia is they try to keep their business in house, you know, almost like what happens in the royal family stays in the royal family.
And all of a sudden, holy cow, we have Mohammad bin Salman, who’s the youngest son of the king. Not only has he been named the heir apparent to the throne, but he is basically really showing his teeth and has arrested a number of other very senior ranking princes – including Al-Waleed bin Talal who is estimated to be worth about 15 billion dollars.
Some people have called him the Warren Buffett of the Middle East. This guy is no schmuck, he’s a really serious guy. And there’s actually reports that Bin Salman has tied these guys up and literally humiliated them with beatings and all sorts of things. I don’t know if any of those reports are actually true – some of them are from dubious sources – but, holy cow.
What’s going on in Saudi Arabia? And what’s brought this about? And where’s it headed?
Erik: Joining me next on the program is Francesco Filia from Fasanara Capital in London. Francesco, I’m really excited to get you on the program, because, as an engineer, I think in terms of things like feedback loops, and I know that you look at finance and some terminology that’s very familiar to me.
You’ve sent us a wonderful slide deck that I strongly encourage our listeners to refer to. Registered users, you’ll find the download link in your Research Roundup email. If you’re not yet registered, just go to macrovoices.com and look for the red button above Francesco’s picture that says Looking for the Download. And you’ll get instructions to get registered and get the download.
Let’s go ahead and jump right into your presentation. Why don’t we start with Page 3 here? You’re talking about an equity bubble, very much something that’s near and dear to my heart. And, just so you know, we’ve tried to position – we had a guest last week who was saying don’t worry about the bubble, don’t worry about valuations. We wanted to bring you in to give the contrasting view.
So tell us about the equity bubble and what you see on the horizon.
Francesco: Thank you, Erik. I think the equity bubble is quite uncontroversial, is quite unambiguous. There are a lot of different valuation metrics for those that care to look into them. They’ve been valid for over a hundred years of modern financial markets. And this time is no different in that respect.
There are the usual metrics that the valuation guys are looking at, like financial assets to disposable income that shows that this market is way more expensive than at any point in history including the big dot com bubble and the Lehman moment in 2007-2008.
But there are other metrics like the Buffett Indicator (market cap on GDP), the median debt on total assets, the corporate debt to GDP, the price on sales, the price to book, enterprise value on sales, enterprise value on EBITDA – there are a number of different metrics. They all convene that this is a market bubble that has not been seen before in history.
The only one metric that makes it a little bit less acceptable and tolerable is the comparison to bonds, which, unfortunately, are themselves into a bubble. And so they don’t provide much help in this respect. We will go through that in a moment.
But we at Fasanara, we developed our own indicator just to try to add something to what was available already. And we started with one of the most famous of all the indicators in this respect, which is the Shiller adjusted PE ratio, or the CAPE ratio. This is the most famous of them. Professor Shiller got a Nobel Prize in 2013 for it. And for his studies on market inefficiencies and for the ability to infer future expected returns from valuation metrics such as the Shiller PE.
And, based on the Shiller PE, what it does is simply to compare current prices to not spot earnings of foreign earnings, but a more reliable measure of the average of the last ten years and adjusted for inflation. So the average of the last ten years of real earnings. And on the basis of this index, we find out that the market is as expensive and just a little bit less expensive than it was in 1929 during the Great Depression, the peak of the market before the biggest collapse in equity prices ever seen, and the year 2000. So just slightly cheaper than the year 2000.
From that point onward – you know, that index itself has got a few critics. They say, yes, but wait a minute. Because of the great financial crisis in 2007-2008, what you have, you have the distorting effect of those low earnings. So if you do the average, the average is impacted by those low earnings.
So what other people like John Hussman very famously came out with – what they do is they adjusted this PE ratio for peak earnings instead of average earnings. To diffuse the most common criticism of the Shiller adjusted ratio. On the basis of the Hussman ratio (if you want to call it that), the market has never been so expensive except in the year 2000. So on the basis of the Hussman ratio, the market is more expensive than 1929 but is not as expensive as in the year 2000 (as yet).
Then Hussman also looks at the adjusted ratio for profit margins and finds out that this market is yet more expensive than the year 2000. But, on the basis of his indicator based on peak earnings, you could still argue that this market is not as expensive as in the year 2000.
What we do is an evolution of the Hussman PE ratio (which is taken from the Shiller ratio) which is to compare – kind of putting all in the basket. So we put the peak earnings as opposed to average earnings, and for peak earnings we really mean the peak. We take the two top quarters over the last 40 quarters. So we cannot really be seen as being any more generous to the current markets, we take the two peak quarters of the last 40 quarters. And then what we do is we compare these peak earnings to potential growth, or trend growth.
Because the point here is that what you pay in terms of stocks, should compare, not just to the past or the earnings of proposition, but also to the overall economy generally. Because if the overall economy has a lower potential growth you should be expecting to be able to pay less in terms of multiples than otherwise. The overall economy has a big correlation to earnings and to profit margins, so you should expect the potential growth rate of the economy to be quite relevant when it comes to PE multiples.