Tuesday, January 02, 2007

"risk blindness / hussman

looks like hussman nails is once again. almost every "risk barometer" is at sleep..........
sieht so aus als wenn hussman wieder einmal den nagel auf den kopf getroffen hat. nahezu jeder risikobarometer ist in den tiefschlaf gefallen.


Contrary to popular assertions, the recent advance is emphatically not the result of an ocean of “liquidity.” The rate of money growth has slowed considerably both domestically and abroad, particularly on an inflation-adjusted basis. Mortgage equity withdrawal is also slowing. Foreign central banks continue to tighten.
What we're seeing is not liquidity, but risk-blindness.

Corporate and junk yield spreads are very narrow, which has allowed private-equity investors to acquire capital for risky acquisitions at nearly risk-free rates. If you think about it from an overall equilibrium standpoint, what's really going on in a leveraged buyout is that certificates of stock ownership are retired, and certificates of debt are created (though the holders of those certificates may not be the same).
Equity risk is thereby transformed into default risk, that's all.
The bagholders here will ultimately be investors who purchased that debt, either directly or indirectly through hedge funds, but it may take a while.

Meanwhile, stock market investors are pricing stocks with similarly low risk premiums, along with the added assumption that current record profit margins are durable. A multiple of 18 times record earnings is already historically quite high, but on normalized profit margins, the current P/E multiple on the S&P 500 is about 25. I should quickly note that (except in combination with overbought, overbullish conditions that will probably clear soon) valuation is not a short-term negative, because over the short-term, investors may be quite willing to continue speculating. Regardless, currently rich valuations will have a profound influence on long-term returns. The fact that the S&P 500 has underperformed T-bills over the most recent 8-year period (through December 31, 2006) should be adequately up-to-date evidence that valuations matter and that the fundamental rules of investment haven't changed.

Perhaps the most important area to monitor here is the corporate debt market (for example, 6-month commercial paper, and the yield on the Dow Jones Corporate Bond Index). An increase in the Dow corporate yield much above 6% (recently 5.71%) would represent an important warning that the current speculative binge is reversing course. As Nobel economist Joseph Stiglitz recently noted, "the prospect of risk premiums returning to more normal levels is itself one of the major risks the world faces today."

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