Guest Post: "Mean Reversion In Equities Is Coming" -- by Olivier Garret, CEO of Hard Assets Alliance

7
Fri, May 18, 2018 - 5:49pm

Our friends at Hard Assets Alliance offer another timely and insightful piece for your consideration.

Guest Post: "Mean Reversion In Equities Is Coming"

by Olivier Garret, CEO of Hard Assets Alliance

At the Strategic Investment Conference 2018, David Rosenberg of Gluskin Sheff warned investors of the coming mean reversion in the stock market, which can push down equity prices by 20% or more.

Rosenberg also admitted that this is one of the strangest rallies of all time. That’s because all asset classes went up, even the ones that are inversely correlated:

Whether it was bank stocks, emerging market bonds, Ant stocks, the CRB, oil—every single market, even global bonds. Barkley's Bond Index globally generated a 7.5% return. The least-risky asset class in a risk-on year generated an equity-like return of 7.5%.

He thinks that a breaking point is a year away and so investors should start taking precautions.

Smart Money Is Pulling Back

The beginning of this year started off great for investors. The S&P 500 hit record highs at around 2,750, and stocks had their best January since 1987.

As if it was not enough, Rosenberg pointed out, Wall Street now raised their target to 3,000. The media extrapolating record returns only added to the rise in investors’ unreasonable expectations.

However, increasingly more hedge fund managers and billionaire investors who timed the previous crashes are backing out.

One of them is Sam Zell, a billionaire real estate investor, whom David Rosenberg admits is a “hero” of his. Sam Zell predicted the 2008 financial crisis—eight months early, though. But essentially, he was right. Today, his view is that valuations are at record highs and easy money has been made.

Then we have Howard Marks, a billionaire American investor who is the co-founder and co-chairman of Oaktree Capital Management. He seconds Sam Zell’s view that valuations are unreasonably high.

“And I don't always try to seek out corroborating evidence. But there are some serious people out there saying some very serious things about the longevity of the cycle,” said Rosenberg.

Data Suggests That Equities Are Poised for a Major Correction

Later, David Rosenberg shifted from quoting high-profile investors to showing actual data, which paints the same ominous picture.

For starters, David Rosenberg pointed out that only 9% of the time in history have US stocks been so expensive.

Then he showed a table with GDP growth figures in the last nine bull rallies. This table reveals a dire trend where each subsequent bull rally in the last 70 years generated less GDP growth. Essentially, that means we are paying more for less growth.

“Historically, you get a 17% growth rate in a bull market with nominal GDP at 7 and real GDP almost at 4. This time around, we did it with three six nominal [3.6% nominal GDP], and two one real [2.1% real GDP]. We basically had a typical bull market in the context of economic growth that was barely half of what it normally was.”

According to David Rosenberg’s calculations, the S&P 500 should be at least 1,000 points lower than it is today based on economic growth. In spite of this, equity valuations sit at record highs.

Another historically accurate indicator that predicts the end of bull cycles is household net worth’s share of personal disposable income.

As you can see in the chart below, the last two peaks in this ratio almost perfectly coincided with the dot-com crash and the 2008 financial crisis.

Now the ratio is at the highest level since 1975, which is another sign that reversion is near.

Even the Fed Thinks Mean Reversion Is Coming

As another strong indicator that recession is around the corner, Rosenberg quoted The Federal Reserve Bank of San Francisco. He pointed out that, having access to tons of research, they themselves admit that equity valuations are so stretched that there will be no returns in the next decade:

Current valuation ratios for households and businesses are high relative to historical benchmarks… we find that the current price-to-earnings ratio predicts approximately zero growth in real equity prices over the next ten years.

Basically, the Fed is giving investors an explicit warning that the market will mean revert.

But when we revert, we don’t stop at the mean, warns Rosenberg. He gave an example of how mean reversion in the household net worth/GDP ratio would create a snowball effect.

According to his calculations, if the household net worth/GDP ratio reverted to the mean, savings rates would go from 2% to 6%. As a result, GDP would go down 3%, which would have nasty consequences for the economy and, in turn, stocks.

Monetary Regime Change

Stretched valuations are not the only problem for the stock market. Rosenberg thinks that new Fed Chair Jerome Powell marks the end of low interest rates, which will also add pressure to equities.

Even the biggest Fed doves admit that low rates created a heightened risk of asset bubbles and unstable asset inflation. And so, Rosenberg thinks, Powell will be more hawkish than people think.

“He's [Jerome Powell] talked about risk-taking in the past, he's talked about frothy financial conditions. He was adamantly against the prolonged period of zero percent interest rates. He was profoundly opposed to the repeated rounds of QE, and now he's in charge. So, for people to think he's only going to go three times this year, I think he'll go four. He may go more, depending on the circumstances.”

Rosenberg also thinks that Powell will not cut interest rates, even if we get a 20% sell-off. That’s how determined Powell is to normalize interest rates, according to him.

In other words, we are in the middle of the Fed tightening cycle. As history shows, a tightening cycle is almost always followed by a recession.

Bottom line: All signs point to a recession, which, Rosenberg predicts, is a year away. As such, he suggests de-risking your portfolio. That means raising cash and investing in asset classes that are not correlated to the stock market.

A Time-Tested Hedge That Withstood Most Stock Crashes

Finding assets uncorrelated to the stock market is not easy. Generally, bonds do well, but they are reaching historical highs. Plus, they are threatened by rising interest rates and excessive US debt.

Dividends can cushion a fall in equity prices, but only to an extent.

That leaves us with gold, a time-tested hedge against recessions that is largely uncorrelated to stocks and many other asset classes.

This means when the markets tumble, gold tends to rise. Here’s proof:

There have been seven recessions since 1965. In five of the seven previous recessions, the gold price rose.

This makes sense when you think about the nature of investing in gold. Gold is called a fear trade, meaning that when investors worry about instability in the market, they tend to buy gold, such as liquid sovereign gold coins or gold bars.

Not only that, gold’s correlation to stocks drops during a recession.

Look at the chart below to see what happens to gold’s correlation to other asset classes when the economy tumbles:

(A “1” correlation means assets always move in the same direction; “0” means they move together 50% of the time; and “-1” means they never move together.)

Gold already has a negative correlation to the S&P during periods of growth. In an economic collapse, the correlation grows even more negative.

That makes it a perfect hedge against the bubbly stock market that we have today.

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About the Author

Founder
turd [at] tfmetalsreport [dot] com ()

  7 Comments

silver66
May 18, 2018 - 6:08pm

First

While on vacation

6 hour time shift messes up sleep patterns

mrs silver66 won't be happy, but she was able to fall asleep

silver66

NW VIEW
May 18, 2018 - 6:53pm

School shootings?

Will they ever end? Or, is this just the beginning? What did we think the outcome would be when we allowed the infiltration of liberal thought, to invade the classroom? Did we believe that the students of the 1950's would be the same as the students of today? The slow process of destroying the family life, the invasion of the demonic of Hollywood (right into our living rooms), P.C. in the schools and teachings, and now we have a BROKEN SYSTEM. They actually believe that removing all the guns will take us back to 1950. THEY DO NOT REALIZE WHAT THAT HAS BEEN TAKEN BY THE ENEMY!

THE SORROWS OF TODAY WILL BE MULTIPLIED BY THE COMING EVENTS. There will be angers and frustrations. Politicians will pound their fists , make speeches, and none will come to the truth. Our detoured educational system has been infiltrated by a dark agenda and those who see it are outcasts. jmo Jim

Fred Hayek
May 19, 2018 - 9:35am

I'm shocked at what I just saw

I turned on the tv and surfed past a few channels and saw a face I recognized. Wait! Was that . . ?

It was Chris Martenson of Peak Prosperity. I looked down and saw to my surprise that the channel was CNBC. Okay, it was a sort of infomercial for some outfit called Lear Capital urging people to convert some of their 401K and IRA money into a precious metals IRA. Along with Chris, there was Nomi Prins and some guy named Lance Roberts.

Okay, it was just an infomercial. Right now CNBC is running one for Total Gym by Chuck Norris. But still, it's a pleasant surprise to see Chris and anything speaking positively of precious metals on that channel.

J Siefert
May 19, 2018 - 12:43pm

Micro-satellite to inspect if Americans did land on Moon

Micro-satellite to inspect if Americans did land on Moon
J Siefert
May 20, 2018 - 6:44am

Sunday Lesson from Doug

Doug's done a whole bunch of good YouTubes in the last few days .. he's on a run. lol

Here's one I liked... (Not quite sure if this is appropriate for Pentecost (Pfingsten in German) ??? )

Who Needs God? I don't believe in that God either. Andy Stanley
AngryCitizen
May 20, 2018 - 7:21pm

Re:J -- Wow, So Many False Premises

I don't know where to begin. No wonder you can't see God clearly.

Please go to Primary sources, instead of what someone else thinks "Christians" believe, if you want to attempt a credible argument. This is trash.

Thanks for the Guest Post w/ HAA, Craig. Good info.

agjames
May 20, 2018 - 10:11pm

Sunday school lesson

I think Jesus is referencing Doug in Luke 24:25 then he said unto them, O fools, and slow of heart to believe all that the prophets have spoken. The Bible says you have to believe it for it Effectually work in you. First Thessalonians 2: 13 for this cause also thank we God without ceasing,because, when ye received the word of God which ye heard of us ye received it not as the word of men but as it is in truth, the word of God, which effectually worketh also in you that believe

Doug seems to think he can judge the word of God but in reality it is discerning the thoughts and intents of his heart, Hebrews 4:12 for the word of God is quick,and powerful,and sharper than any twoedged sword,piercing even to the dividing asunder of soul and spirit, and of the joints and marrow,and is a discerner of the thoughts and intents of the heart. 13 neither is there any creature that has not manifest in his sight: but all things are naked and opened unto the eyes of him with whom we have to do. Romans 1:22 professing themselves to be wise they,became fools.Doug will fall after the same example of unbelief Hebrews 4:11

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