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On My Radar: The Secret Goldman Sachs Tapes

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October 3, 2014
By Steve Blumenthal

 “A lot of people are not psychologically suited to buy stocks that bump around all the time.”

Warren Buffett (CNBC Oct 2, 2014)

Last week it was Dalio, Bloomberg, Dudley, Cooperman, Robertson and Conway as well as Julian Robertson’s “we have created two bubbles that will bite us” (referring to both the stock market and bond market bubbles).  This week I share a few notes from the John Bogle vs. Cliff Asness debate (Bogle is his usual straight-forward and strong self while Asness is perhaps a bit too kind).

I thought about the two polar ends of the investment mindset and for some reason religion entered my mind. (Politicians entered my mind as well but that made my stomach turn.)  Far right, far left, my way is right, your’s is wrong, etc.  Bogle is steadfast in his “buy-and-hold at the lowest fee possible” mindset and Asness focuses on years of academic research and real life performance experience that reveal the advantages of price momentum and relative strength.

Asness’s belief (and mine) is that price momentum can identify market leadership and that the proper positioning of leadership can enhance returns and, importantly, better preserve your principal in periods of market dislocation.  Bogle can sit tight and has the steadfast belief to do so.  I’m not sure most people can hold his depth of conviction when crisis comes.  Both approaches require a systematic, disciplined process and belief.

As you may know, I favor combining both together.  For the Bogle piece, inexpensively hedging that risk exposure when risk is high simply makes sense.  It costs a little more but so does fire insurance on your house.  It is all about keeping your clients fixed to their investment plan.  Another -50% is coming, yet no one knows when.  What we can measure are levels of risk.  Today risk is high.

At the end of each month I like to take a look at the most recent valuation charts, which are based on actual reported earnings, and I also like to keep an eye on Buffett’s favorite valuation measurement.  The first shows the market overvalued, the second, Buffett’s measure, shows the market in bubble territory.  You’ll find the charts in the full piece (link below).

Forget the coffee this week; grab your favorite calming medication (a nice red wine or some warm tea for me).  You may just need it when you read The Secret Goldman Sachs Tapes by Michael Lewis.

The reporter, Jake Bernstein, obtained 46 hours of tape recordings, made secretly by a Federal Reserve employee of conversations within the Fed, and between the Fed and Goldman Sachs. The Ray Rice video for the financial sector has arrived. (link to the full piece provided below)

Included in this week’s On My Radar:

  • Valuation Charts – Stock Market Cap as a Percentage of Gross Domestic Income and Medium PE
  • Additional Notes from the Bloomberg Influence Summit – Bogle and Asness
  • The Secret Goldman Sachs Tapes – By Michael Lewis
  • Trade Signals – Technical Market Support at 1900 (10-1-2014 Blog Post)

 Valuation Charts – Stock Market Cap as a Percentage of Gross Domestic Income and Medium PE 

Here is what I call the Buffett valuation chart.  Orange area highlights the stock market’s total capitalization (the number of all shares times their stock prices on 9-30-2014 compared to gross domestic income).  In short, the market is in bubble territory above a ratio of 85%.

It stands higher today than it was at the market peak in 2007.  Personally, I feel the 2000 peak is an outlier.  Also note 1919, 1966 and 1974.  Look too at the ratio after the last market crash on 2/28/2009.  Think in terms of using valuation as a risk measuring tool.  It is a poor market timing tool.

10.3 chart 1

Following is the most recent Medium PE valuation measure.  The orange box highlights “Mean Fair Value” with an S&P 500 level of 1544.27, which is based on a 42.8 year mean PE.  It’s clear to me that the market is a better buy at 1544 than it is today.  The yellow box shows over and undervalued levels and reflects just how much PE jumps around over time.

You can see that Overvalued (a 1 standard deviation move above that 42.8 year mean PE) is at 2064.39.  Undervalued is at 1024.15.  As of 9/30/14, based on a median PE of 20.4, the market is just 4.7% shy of the overvalued territory.  Also note 2007’s Very Overvalued spike peak.  Again, I feel 2007 is an outlier.  I believe it highly probable we will not see such overvaluation again, at least in my lifetime, but who knows.

10.3 chart 2

I think Julian Robertson summed it up best last week…“own equities but hedge”.

Additional Notes from the Bloomberg Influence Summit – Bogle and Asness

Notes from NY Fed President William Dudley:

  • He wanted to call QE “large scale asset purchases” but that name didn’t stick.
  • When liftoff occurs, the Fed believes it has the tools to keep inflation in check (personally speaking, I have grave doubts).
  • World risks: Ebola, Ukrane, ISIS and China/Japan tensions
  • Don’t put too much weight on the Fed’s dot plot interest rate projections as his confidence is low even on his own interest rate projections.
  • Being at zero interest rate is not a comfortable place to be.
  • It would be a good thing to increase rates for savers.
  • There is concern that when the economy lifts off, will it be real and will the Fed be successful (sited Japan in the 1990s and U.S. in 1930s). There is reason to be patient.
  • The Fed really wants the unemployment rate to go down. Getting people back to work is food for them and the economy.
  • If the dollar appreciates too much it will dampen inflation and hurt exports while helping imports.
  • The Fed does need to try to identify emerging imbalances (bubbles). He mentioned Greenspan didn’t (he was more of the “we’ll fix it later” mindset).  Dudley sees the Fed’s new Financial Stability Committee headed by Stanly Fisher as the next step in growing the Fed’s ability to identify such imbalances.
  • He mentioned that the Fed is exploring executive compensation that is now tied to stock and stock options and perhaps changing it to some form of debt. The belief is then that the executive will take a longer-term view with his pay tied to the long-term health of the company.
  • Expects labor market slack to continue to come down.
  • Expects liftoff in the economy in 2015.
  • He sees interest rate increases in 2015. And lastly:
  • He would love to raise rates.

Unfortunately, no video link to the interview was provided.  Notes are mine. I believe them to be accurate.

Several more links from the conference (several of which were shared with you last week):

The Secret Goldman Sachs Tapes

Confirming what we all suspect.  Here is a short intro to The Secret Goldman Sachs Tapes written by Michael Lewis.  A link to the full piece is provided below.

“After the 2008 financial crisis, the New York Fed, now the chief U.S. bank regulator, commissioned a study of itself. This study, which the Fed also intended to keep to itself, set out to understand why the Fed hadn’t spotted the insane and destructive behavior inside the big banks, and stopped it before it got out of control. The “discussion draft” of the Fed’s internal study, led by a Columbia Business School professor and former banker named David Beim, was sent to the Fed on August 18, 2009.

It’s an extraordinary document. There is not space here to do it justice, but the gist is this: The Fed failed to regulate the banks because it did not encourage its employees to ask questions, to speak their minds or to point out problems.

Just the opposite: The Fed encourages its employees to keep their heads down, to obey their managers and to appease the banks. That is, bank regulators failed to do their jobs properly not because they lacked the tools but because they were discouraged from using them.

The report quotes Fed employees saying things like, “until I know what my boss thinks I don’t want to tell you,” and “no one feels individually accountable for financial crisis mistakes because management is through consensus.”  Beim was himself surprised that what he thought was going to be an investigation of financial failure was actually a story of cultural failure.

Lewis goes on to say,

“I don’t want to spoil the revelations of “This American Life”: It’s far better to hear the actual sounds on the radio, as so much of the meaning of the piece is in the tones of the voices — and, especially, in the breathtaking wussiness of the people at the Fed charged with regulating Goldman Sachs. But once you have listened to it — as when you were faced with the newly unignorable truth of what actually happened to that NFL running back’s fiancée in that elevator — consider the following:

  1. You sort of knew that the regulators were more or less controlled by the banks. Now you know.
  2. The only reason you know is that one woman, Carmen Segarra, has been brave enough to fight the system. She has paid a great price to inform us all of the obvious. She has lost her job, undermined her career, and will no doubt also endure a lifetime of lawsuits and slander.”

Here is the link to the full piece: http://www.bloombergview.com/articles/2014-09-26/the-secret-goldman-sachs-tapes

Trade Signals – Technical Market Support at 1900 (10-1-2014 Blog Post)

The weight of evidence continues to support the cyclical bull. Trend evidence is favorable and short-term sentiment has reached extreme pessimism (bullish for the market). High yield remains in decline (typically a leading indicator to equity price movement) yet low interest rates, the Fed and the global central banks continue to support the positive equity market trend.

I remain in the cyclical bull market camp until trend evidence turns bearish (as measured by either Big Mo or the 13/34-Week Trend chart. The Zweig Bond Model remains in a “sell”, suggesting the shortening of fixed income maturities to an ETF such as BIL.

There looks to be solid S&P 500 Index technical market support at 1900. That would mark just a 5% correction for the S&P. The chart (click link to full piece) shows the support in greater detail (orange area). A one-third correction of the 2011 low to the recent high puts the market at 1661. A 50% correction of that move would put the market at 1550.  That level would represent a much better buying opportunity.

Click here for a link to Wednesday’s Trade Signals (updated market and sentiment charts)

Conclusion

I’m off to Dallas this weekend to celebrate my good friend, John Mauldin’s 65th birthday.  I’m really looking forward to the party.  We met more than 15 years ago.  He was looking to put his clients in my high yield bond strategy as he was looking to expand his writings and leverage his business opportunities.  We shook hands and have been partners since.  At that time, his weekly e-letter was going to just 2,500 readers, today it is north of one million.  If you are not reading his letter, sign up. It’s good – really good.

Wishing you a fun filled weekend!

 

PS:  Note to John: It’s been a real joy watching you rise to the top of the financial industry.  I’m looking forward to the party.  Happy Birthday buddy!

With kind regards,

Steve

Stephen B. Blumenthal
Founder & CEO
CMG Capital Management Group, Inc.
Philadelphia – King of Prussia, PA
steve@cmgwealth.com
610-989-9090 Phone
610-989-9092 Fax

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