Well. The Atlas known as the European civilisation is just shrugging under the burden imposed by politicians, bureacrats, lobbyists and other useless drones:
I prepared two New Year greetings cards, but can't decide which of the two I like most. Just look and pick your favourite one:
"Spain deflation alert. Minus 1.1% in December, far below expectations. Harbinger on EMU undershoot," Ambrose Evans-Pritchard wrote on Twitter.
The price inflation is not that important, however. The evolution of corporate credit in Spain tells the story of a prolonged credit deflation. A credit deflation episode is almost always associated with a credit crunch and an economic crisis. And that's the way it is.
Source: European Central Bank
Spain suffered from credit deflation of 12.9 per cent year-on-year in October 2014. This is no small issue.
George Osborne, the chancellor of the Exchequer, said this month that in 2015 Britain would repay part of the country’s debt from World War I, and that he wanted to pay off other bonds for debt incurred in the 18th and 19th centuries, the NYT reports.
If you happened to have owned the 2.5 per cent consol over the past year, you may enjoy a 28 per cent capital appreciation now:
Source: Hargreaves Landsdown
However, long term investors beware:
Of course, much of the original debt has been eroded by inflation. According to research for the British Parliament, prices rose by around 118 times from 1750 to 1998.
Thank you very much.
A vast majority of active portfolio managers underperformed the benchmark in 2014. Why? One of the main reasons of the underperfomance was the widespread belief that stocks were overvalued. Professor Robert Shiller's cyclically adjusted P/E was one of the most trusted valuation metrics.
In December 2013, Shiller's CAPE value was 24.9, more than fifty per cent above its long term average. Many portfolio managers believed the market was grossly expensive. "The market is steeply overvalued, leaving investors with the prospect of low, single-digit long-term expected returns," wrote William Hester, CFA one year ago. He was one of many to have believed it.
Source: Prof. Robert Shiller
Little wonder that most US money managers were underweight in stocks—and thus missed the 2014 bull market. Many hedge fund managers were short stocks and got hammered.
The problem has been in the metrics. Shiller's famous CAPE has a serious flaw. The CAPE is the valuation ratio that compares the S&P 500 Index to the 10-year average of inflation-adjusted earnings. The purpose of the 10-year averaging is to smooth out cyclical fluctuations of corporate earnings.
So far, so good. The problem is the inflation adjustment. Professor Shiller, as most other academics, knows no other measure of inflation but Consumer Price Index. However, the CPI has been significantly modified since the 1980's. It has been actually modified to the point of irrelevance. Moreover, a consumer price index is a wrong tool to adjust corporate earnings for inflation by definition.
Deflating profits by consumer prices is tantamount to dividing apples by oranges: simply wrong. Figures such as sales or profits must be discounted by very different inflation measures. Money supply—the original measure of inflation—comes to mind.
This is how Shiller's CAPE would look when the Money Zero Maturity aggregate is used instead of the CPI starting from 1980:
Source: Prof. Robert Shiller and The Devil's Dictionary's original calculations
The corrected CAPE would have been equal to 19.2 in December 2013. This was still above the long-term average (by almost a quarter) but less misguided than the original value of almost 25.
The most recent corrected CAPE (as of December 2014) equals 20.9, which appears neither too low nor too high. When expressed as earnings-to-price ratio it is equal to 4.78 per cent. Compared to the 30Y T-Bond yield to maturity of 2.82 per cent, the S&P 500 still looks like a buy.
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This is way beyond parody:
French statisticians are apparently more prudent than their British counterparts:
The Centre for Economics and Business Research (CEBR) said Britain's acceleration was also boosted by the inclusion of sex and drugs to UK growth. While the addition of prostitution and illegal drugs form part of new pan-European accounting standards, France has refused to comply with EU rules because it does not consider them to be "voluntary commercial activities".
Eric Dubois, a director at INSEE, France's statistics office, has described drug use as a "dependency" that does not involve "free will". He said prostitution was the result of "Mafia networks and trafficking illegal immigrants".
Source: The Telegraph
This is what my Devil's Dictionary of Economics & Finance writes on this topic:
Simon Kuznets, the originator of the idea of GDP, did not even want to include banking and advertising to GDP, since he believed these sectors were non-productive. What would he said now?
It was a bad, bad year for mutual fund managers when speaking about relative performance...
... while hedge fund managers have had a series of sub-par years:
Source: Ben Inker, GMO
Even some supposed stars failed badly:
The common denominator, in my opinion, is the widespread use of wrong equity valuation methods. While much of the active managers believed the stock market was overvalued, it wasn't. Measures such as P/E and Shiller's CAPE failed miserably. Consequently, dumb index trackers easily beat the 'smart money'.
Is there something better than CAPE? Yes, of course, it is. You'll learn about it in one of my posts in the near future.
In March 1999 when the Dow reached 10,000 it was a bubble:
Is it a bubble times 1.8 now? Well—no. In fact, there is 3.18 times more money in the US economy now compared to March of 1999:
I'm not saying that the Dow can't take a dive, but it's not valued as high as in 1999 measured by the price-to-money-supply ratio.
DISCLOSURE: I'm still long stocks.
DISCLAIMER: The above statement is no recommendation to buy or sell securities.
Getting rich by buying bonds was quite possible: if you had nerves of steel in 2008/2009 to buy extremely cheap high yield bonds!
Full disclosure: I didn't have the nerve myself. However, buying low credit risk long-term US Treasury bonds a couple of years ago would have paid handsomely, too.
Vanguard Long Term Bond Fund returned 8 per cent per annum on average during the most recent six years. How about the next six years? Forget it. With the perspective of rising interest rates, chasing past returns appears foolish.
The 30Y Treasury bond currently yields 2.84 per cent per annum to maturity. That's rather low by any standard. Should the yield revert to the mean, price of bonds would suffer. So would bond fund prices.
Getting rich by buying bonds is even more difficult than getting rich by buying equities. Of course, the bond yields could go further down. In such a case, bond prices would increase—think the Japanese scenario. However, good for the US economy, the Japanese scenario seems not to be followed by the US economy.
Disclaimer: In addition to the legal small print that nobody reads anyway, I would recommend everyone to think before making any investment decision. No, that's no joke or so.
Prediction is very difficult, especially about the future, as Niels Bohr reportedly said. A year ago, who would have expected the dramatic developments in Russia? Similarly, there were plenty of doomsayers that saw the US stock market melting down. They are yet to be vindicated.
Nobody, as far as I know, predicted the Russian stock market to lose almost half of its dollar value. Quiet a few equity fortunetellers saw the double-digit gains to come in the US. Well, yes, forecasting is difficult.
Even the backward explanation of what has really happened during the post-crisis period is not always easy:
With the benefit of hindsight, we can see the US stock market having outperformed Europe by a wide margin since the ending of the financial crisis—because it has never actually ended in most European countries. The British stock market has not been doing particularly well, however, despite Britain's economy having recovered handsomely. Why?
One explanation is that the British stock market has been dragged down by banks and the oil and gas industry. These industries form about 28 per cent of the FTSE 100 now. On the other hand, the US stock market is much more diversified and balanced.
Over the long-run time span of fifteen years, things look very different and much more dramatic:
Had you invested in Russia or China in December 1999, you would still be better off now compared to developed markets. However, would you feel comfortable with swings like that? I wouldn't. Give me the US stock market, or give me a savings account, to paraphrase the immortal Patrick Henry.
A white male with some professional experience in finance and investing.