The author of that post suggests that the CAPE is useless for comparisons since FAS 157 changed accounting for fair value. A review of other posts recently made by the author indicate that he is fairly bullish on not just the market, but also the economy.

I am a rational optimist and I would like to be as optimistic as “valueplays”, but he is wrong to assume that the reason for the concern about market valuation is merely because of the level of the CAPE. As I have written in more detail before, and even indicated in that last post, it is the other statistics that consistently corroborate the CAPE that indicate there is not something fundamentally different about this period compared with prior periods.

Consider, for example, Tobin’s Q ratio, which measures the market’s price relative to the replacement cost of the assets for all of the companies in the market. It is higher than at any time in history bar the dot com bubble when investor psyche went overboard on “it’s different this time” thinking.

Notice that Tobin’s Q is not a straight measure of corporate book value, for which it is possible that one component–retained earnings–could be distorted by FAS 157. Tobin’s Q is an estimate of the cost to replace the assets that are already in productive use. It may not be perfect, but it corroborates the implications of the CAPE.

Consider, also,  Warren Buffett’s favorite indicator of market valuation known as Buffett’s P/E given by the following ratio:

(Market capitalization) / (Nominal GDP)

Notice FAS 157 would have little influence on nominal GDP. Buffett’s P/E is more than two standard deviations higher than it’s average since 1950. Again, the only time it has been higher was during the ridiculous dot com bubble.

I have also written that the recovery has been weak based on my favorite employment statistic. But, earlier this month ”valueplays” saw “Positive Signs Everywhere“. I certainly hope he is correct, but this market looks to me like it is one misstep away from a long fall based on the above statistics and:

1. Total debt is higher than at any time in history (there was no de-leveraging);
2. Interest rates are lower and the Federal Reserve Balance Sheet is higher than any time in history. The Fed is practically out of bullets; and
3. Corporate profits–the most mean-reverting statistic in finance according to Jeremy Grantham at GMO–are as high as they have been in history;

Invest accordingly.

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It is the same with the exponential growth in technology; near us in time it doesn’t look like much is happening, but not long from now it will increase dramatically. For a hint of that, look at all of the stories that hit Ray Kurzweil’s website every day, or try to remember what it was like to use dial up internet just twenty years ago or no internet thirty years ago. The gains in technology from 1900 to 1930 were substantial, but they pale in comparison with the gains from 1984 to 2014.

(Update 7-15-15: On last night’s MLB All-Star Game broadcast Fox referenced the record number of players who were under age 25 with a vignette showing those players holding up “ancient” technology that they had never seen or used before such as VCR players and rotary dial phones. It was pretty funny.)

Here, Ray Kurzweil talks about the rapid development of our brains in a TED Talk and explains that soon our brains will be connected directly to the internet. Can you imagine that? Like curved earth, it is difficult to imagine, but not impossible, especially when we are armed with information. It is likely to happen in the next thirty years.

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The best way to describe the current market, then, is to say that there is “an unusually large herd of grey swans” about. It refers to an outcome–a single impactful event–that is quite possible and therefore should be anticipated but it is not because too much attention is focused on the low probability of each separate event occurring instead of the collective likelihood of any one event occurring. I guess it is another way of saying that we miss the forest for the trees. As the number of grey swans in the herd increase, the likelihood of an impactful event increases.

The conditions that make this market a herd of grey swans are as follows: The market is priced for perfection as the Graham-Shiller CAPE and Tobin’s Q ratio are near all-time highs, by which we can infer that investors are sensitive to momentum and are ignoring risk and values. At the same time, the number of low-probability events that could cause a major correction also seems to be high. This environment is different from one described by the adage that “rising markets climb a wall of worry” because those environments start at low prices relative to fundamentals. That is, there is always more worry immediately after a correction–such as in the first quarter of 2009–than after a significant rebound, which is where we stand right now (2/25/12) with the S&P 500 just 15.4% from its all-time high.

The large number of grey swans include (not in any particular order):

1. a sovereign debt default (either legally or de facto) by any one of Italy, Spain, Portugal, Japan, France, Ireland, or some other country not yet on the radar in addition to the default that has already occurred in Greece;
2. austerity throughout Europe and the US in order to pay the bills for previous overspending (US and Europe) and low productivity (Europe);
3. a collapse of the European Union or the Euro
4. a surge in inflation around the globe;
5. a war with Iran and its supporters or instability due to Iran’s development of a nuclear weapon (the collective probability of this must be close to 100%);
6. a Chinese economic implosion as inordinate government command of the economy cannot be sustained;
7. a collapse of the Russian banking system;
8. unrest in the US as a significant amount of promised public-sector post-retirement pension and health benefits must be cut or eliminated in order to balance state and local budgets;
9. significant instability in the Muslim world (excluding Iran) for many reasons, but particularly as US influence declines with US military withdrawals;
10. something unexpected from North Korea;
11. a less-than-peaceful transition of political power in the US in November; and
12. a large natural disaster–earthquakes, tsunamis, droughts, volcanic eruptions–(for example, see Nova’s excellent and recent “Deadliest Volcanoes.”  A preview:  http://www.youtube.com/watch?v=CEjnIPRuhvk)

Separately, these events are not black swans; they are grey swans–low probability events but not rare ones like black swans. Together they are a herd of grey swans where only one event need occur to cause major problems; imagine if two occur. On the surface most appear to be independent events, but what is to stop North Korea from doing something stupid if China is focused on a war in the middle east or its own economic collapse? What would happen to economic activity and political stability if lingering ash from volcanic eruptions caused a significant reduction in food production? If we add a black swan event that no one is even thinking about, the outcome could make us nostalgic for 2008-2009.

In the very long run, I am a rational optimist. In the near term, I am a rational zoologist. If you can buy cheap insurance, do so. On that note:

http://finance.fortune.cnn.com/2012/02/16/is-japan-next/

While the Japanese debt bomb isn’t expected to go off tomorrow, Japanese CDS is now 50% higher than where it was a year ago. Wall Street involvement in the Japanese debt market has grown in the last few years, which could bring increased pressure on the government to try and solve its debt dilemma. Eventually, though, the Wall Street bond vigilantes could drag Japanese bond yields up to levels that could cripple the government’s  ability to pay off its debts, setting the stage for one of the most prolific sovereign debt defaults in history.

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Guess what I “predict” for 2012? Years highlighted in orange relate to the Great Depression; blue relates to the credit crunch. Notice that there were many more extreme years during the Great Depression than recently.

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I love browsing the mathematics section of book stores. Yesterday I found a book on complex adaptive systems written by Len Fisher that so far is outstanding; I suspected as much after I bought it and noticed that Michael Mauboussin offered suggestions for the manuscript. The Kellogg’s creation/discovery of Corn Flakes is but one example of economic evolution at work.

http://www.bloomberg.com/news/2011-12-15/the-accident-that-started-the-breakfast-cereal-business-echoes.html

The brothers developed breakfast flakes by accident in 1893, when Will abandoned a pot of cooking wheat to attend to business matters. He returned to find a mixture with a stale and hard consistency. Unwilling to waste the food, the brothers forced it through rollers with the hope of forming long sheets of dough. Instead, they created wheat flakes, which they toasted and served to the San’s patrons as a breakfast cereal.

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Another example of the beauty of free markets in the spirit of the famous: I, Pencil.

We rarely examine sufficiently the counterfactuals to the success of free markets, which allows anti-capitalists such as Michael Moore (as big an exploiter of capitalism as ever existed) and the OWS movement to win public relations campaigns. As I, Pencil has aptly demonstrated, private property rights and free markets have created remarkable wealth for EVERYONE, so much so that we take it for granted.

“We are perishing for want of wonder, not for want of wonders.” –GK Chesterton

Michael Moore should pledge a food boycott until he is capable of creating a cheeseburger from scratch; “eat local,” and all that…

http://waldo.jaquith.org/blog/2011/12/impractical-cheeseburger/

A few years ago, I decided that it would be interesting to make a cheeseburger from scratch. Not just regular “from scratch,” but really from scratch. Like, I’d make the buns, I’d make the mustard, I’d grow the tomatoes, I’d grow the lettuce, I’d grow the onion, I’d grind the beef, make the cheese, etc.

It didn’t happen that summer, by the following summer, my wife and I had built a new house, started raising chickens, and established a pretty good-sized garden. I realized that my prior plan hadn’t been ambitious enough—that wasn’t really from scratch. In fact, to make the buns, I’d need to grind my own wheat, collect my own eggs, and make my own butter. And I’d really need to raise the cow myself (or sheep, and make lamb burgers), mine or extract from seawater my own salt, grow my own mustard plant, etc. This past summer, revisiting the idea, I realized yet again that I was insufficiently ambitious. I’d really need to plant and harvest the wheat, raise a cow to produce the milk for the butter, raise another cow to slaughter for its rennet to make the cheese, and personally slaughter and process the cow or sheep. At this point I was thinking that this might all add up to an interesting book, and started to consider seriously the undertaking.

Further reflection revealed that it’s quite impractical—nearly impossible—to make a cheeseburger from scratch. Tomatoes are in season in the late summer. Lettuce is in season in spring and fall. Large mammals are slaughtered in early winter. The process of making such a burger would take nearly a year, and would inherently involve omitting some core cheeseburger ingredients. It would be wildly expensive—requiring a trio of cows—and demand many acres of land. There’s just no sense in it.

A cheeseburger cannot exist outside of a highly developed, post-agrarian society. It requires a complex interaction between a handful of vendors—in all likelihood, a couple of dozen—and the ability to ship ingredients vast distances while keeping them fresh.  The cheeseburger couldn’t have existed until nearly a century ago as, indeed, it did not.

 

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I think Jobs would have been impressed…and probably would have spent hours trying to figure out how to build a robot that could kick this one’s ass.

H/T Marginal Revolution

Mona Simpson’s Jobs Eulogy Here: http://www.nytimes.com/2011/10/30/opinion/mona-simpsons-eulogy-for-steve-jobs.html?_r=2&pagewanted=all

H/T: Cafe Hayek

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I, however, think a better idea would be to place these wealthy families at the top of the INS list and invite the whole family to receive citizenship as soon as possible, assuming that they are not security risks. We could probably solve the current US financial cirsis/housing depression overnight if we simply required these wealthy people to buy a house with at least 40% in unborrowed capital and own that house for, say, seven years. Of course, making citizenship contingent on keeping a job and buying health insurance could be another stipulation. And, that says nothing about the productive capacity that we would add to US rsources after they move here. We all benefit when productivity rises, even when our own productivity is stagnant.

Visit msnbc.com for breaking news, world news, and news about the economy

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First, from my perspective, Scott Shellady, a pit trader in Chicago, was spot on this morning on CNBC when he called the optimism over Europe, “Hopium.” The hope that people have of a very positive outcome in Europe may not be based on opium consumption, but something similar—just hope. Any news is greeted positively and all bad news is ignored. When most market observers think that Greek debt needs to be haircut by 60- to 70-percent but European banks are objecting to any haircut over 21- to 30-percent, how can any news be good news? And, Greece is just the tip of the iceberg. (Sorry, no video.)

Shellady also thinks the 30% drop in the VIX in the last eight trading days is a sign of weakness, not strength. Strong markets move in a steady, upward fashion.

Second, is a Wall Street Journal Market Beat column that was published online this morning. In it, the Economic Cycle Research Institute (ECRI) finds that their leading index is “rolling over even harder, suggesting a deeper slowdown ahead even as trailing economic data are coming in better than expected and the stock market rallies.” I am not a fan of economic and market forecasters, but according to The Economist the ECRI has “never issued a “false alarm” on a recession call” and it has been around since the 1960s.

http://blogs.wsj.com/marketbeat/2011/10/14/ecri-leading-index-keeps-getting-worse/?KEYWORDS=ECRI

Finally, with the focus on Europe, we seem to be forgetting other parts of the globe. A piece in today’s Wall Street Journal by John Bussey discusses the very serious threat that the Chinese government is to foreign businesses. It reminds us that china is a tough place to do business because there is no rule of law. It reminded me that my friend and former colleague James Penrose, circa 1994, criticized the Chinese government for abrogating a valuable real estate lease that McDonalds Corporation possessed in China. His criticism made the front page of the Wall Street Journal Asia the next day. Nothing has really changed in seventeen years with respect to the rule of law.

http://online.wsj.com/article/SB10001424052970204774604576629200721570470.html

I worry about my own confirmation bias. I think I will start a new feature soon called Counterfactual Friday in which I write about the rationale behind the opinion of everyone who disagrees with my thinking and write about the facts that undermine my thinking.

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I hope these scientists become fabulously rich, which would mean great things for the other seven billion of us (minus one Michael Moore and his Cuban witchdoctors).

Aug 10, 4:55 PM EDT

‘Amazing’ therapy wipes out leukemia in study

By STEPHANIE NANO

Associated Press

NEW YORK (AP) — Scientists are reporting the first clear success with a new approach for treating leukemia – turning the patients’ own blood cells into assassins that hunt and destroy their cancer cells.

They’ve only done it in three patients so far, but the results were striking: Two appear cancer-free up to a year after treatment, and the third patient is improved but still has some cancer.

Scientists are already preparing to try the same gene therapy technique for other kinds of cancer. “It worked great. We were  surprised it worked as well as it did,” said Dr. Carl June, a gene therapy expert at the University of Pennsylvania. “We’re just a year out now. We need to find out how long these remissions last.”

He led the study, published Wednesday by two journals, New England Journal of Medicine and Science Translational Medicine.

 Read the whole thing:

http://hosted.ap.org/dynamic/stories/U/US_MED_GENE_THERAPY_LEUKEMIA?SITE=AP&SECTION=HOME&TEMPLATE=DEFAULT&CTIME=2011-08-10-16-55-12

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