Cape Fear? S&P Peak PEG ratio At All-time High, Shiller CAPE Ratio At Second All-time High As Dow Pierces 26K Mark

Yes, the stock market is on a roll with the Dow recently piercing the 26,000 mark. And the S&P500 index has pierced the 2,800 mark. Of course, the massive Federal Reserve intervention (along with other global central banks) has certainly thrown gas on the fire.

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Looking at price levels alone is not meaningful. So, let’s look at two stock market adjusted indices.

First, there is the S&P Peak PEG ratio.  It is a price to peak-earnings multiple, adjusted for long-run trend growth. It is at the all-time high.

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Second, we have Bob Shiller’s CAPE (Cyclically Adjusted Price-Earnings) ratio that is now at the second highest peak (after the Dot,com bubble) and above the notorious Black Tuesday of 1929.

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But it is not just the stock market that may be overheated. How about home prices … again?

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And if we adjust home price growth by hourly earnings by the majority of the population, we see that home prices YoY are growing 3 times faster than hourly earnings YoY.

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This might help explain why The Fed is so timid about unwinding its balance sheet.

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Did someone mention fear?

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Fed Dumps $2.63 Billion of Inflation Protected Treasuries [TIPS], Battle of The SOMH?

Like every Thursdays afternoon, The Fed of New York announced their balance sheet holdings.  Unlike the anticipated unwind that Janet Yellen had been promising, The Fed actually INCREASED their holdings of US Treasury Notes and Bonds and increased their holdings of Agency MBS.

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Did The Fed unwind anything? Yes. They dumped $2.63 BILLION of Treasury Inflation-Protected Securities (TIPS).

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Did The Fed just surrender on the inflation front? The Battle of The SOMH (System Open Market Holdings)?

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Core Inflation Rises 0.3% MoM In December, 1.8% YoY, Owners’ Equivalent Rent of Dwelling Rises 3.1% YoY (Fed Still Can’t Generate Inflation)

I remember when Federal Reserve Chair Janet Yellen said that inflation is just around the corner. It must be a really long street.

Consumer price indices for December are out and CPI MoM rose 0.1%, but Ex Food and Energy it rose 0.3%. CPI Ex Food and Energy YoY rose 1.8% from 1.7% in November.

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Despite its wishes to generate inflation with zero interest rate policies and QE, inflation remains stubbornly low (below 2%). Core PCE Prices YoY is even worse at 1.50%.

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Of course, home prices are growing at 6.6% YoY, over 4 times core inflation (PCE). 

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Although imputed rent growth YoY is only 2x core inflation (PCE).

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So, home prices and imputed rent of dwellings are both rising at multiples of the core inflation rate … and wages.

Hopefully Yellen’s replacement can do better in terms of slowing down bubbles. But I doubt it.

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Fed Paid $29.3 Billion To Banks NOT To Lend In 2017 (Excess Reserves), Fed Earned $80.2 Billion For Treasury

Yesterday, The New York Federal Reserve announced that it actually increased their $4.2 trillion balance sheet by $1 million rather than shrinking it.

This comes on the heels of The Federal Reserve announcing that it provided $80.2 billion in payments to the US Treasury in 2017. This is the lowest remittance to Treasury since 2015, but still positive.

The Fed’s $4.45-trillion of assets – including $2.45 trillion of US Treasury securities and $1.76 trillion of mortgage-backed securities that it acquired during years of QE – produce a boatload of interest income. How much interest income? $113.6 billion.

Which brings us to excess reserves. Excess reserves—cash funds held by banks over and above the Federal Reserve’s requirements—have grown dramatically since the financial crisis. Holding excess reserves is now much more attractive to banks because the cost of doing so is lower now that the Federal Reserve pays interest on those reserves.  Excess reserves as of the end of 2017 are around $2 trillion and the interest rate paid on excess reserves is now 1.50%.

In 2017, the interest that the Fed paid the US banks and foreign banks doing business in the US jumped by $13.8 billion to $25.9 billion. The Fed also paid banks $3.4 billion in interest on securities sold under agreement to repurchase. That brings the amount that the Fed paid to banks of $29.3 billion.

The Fed will likely raise rates further this year, perhaps 4 times.

This would push the rate on excess reserves to 2.5% by the end of the year. Excess reserves will likely shrink as QE is being unwound, but I am doubtful. And the amount that the Fed pays the banks this year might surge to $40 billion or more (slow shrinking and rising interest paid on Excess Reserves).

So, Treasury is receiving a windfall every year from The Fed courtesy of QE. And Treasury receives another windfall from the notorious 2012 profit sweep from Fannie Mae and Freddie Mac. (Can you spot Treasury’s changing of the Fannie/Freddie bailout terms??)

Yes, Treasury makes good money from The Federal Reserve and having seized the profits from Fannie Mae and Freddie Mac. Will they relinquesh control?

Fed INCREASES $4.2 Trillion Balance Sheet By (Drumroll) … $1 Million

The Federal Reserve is shrinking their prodigious balance sheet by baby steps.  Like Steve Martin doing Michael Jackson’s Billie Jean.

According to the NY Fed, their securites holdings INCREASED by $1 million from th previous week rather than shrinking it. Not decreased, mind you,  but INCREASED.

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T-note and T-bond holding remained the same while Agency MBS holdings rose by $1 million.

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Way to unwind, Fed!

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Big Bubbles! House Price Bubbles and Financial Stress (The Do Ho Financial Market)

Yes, we live in a “Do Ho” economy where bubbles (and not tiny ones) are pervasive. 

Look at the YoY growth in the all-transactions index from FHFA for US house prices compared to the St Louis Fed Financial Stress Index.

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When the financial stress index is low (less than zero), we see BIG home price bubbles.

Of course, home price bubbles occur when YoY changes in home prices outpace household earnings growth YoY.

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If Don Ho were still alive, he could redo tiny bubbles as BIG bubbles.

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Addicted To Gov: VIX and TYVIX Volatility Have Been Suppressed By The Fed (And Aren’t Increasing YET With Rates Increasing And “Unwinding”)

In 2008, The Federal Reserve embarked on their infamous quantitative easing (QE) program, that together with their Zero-interest rate program (ZIRP) has suppressed both stock market volality (VIX) and Treasury note volatility (TYVIX).

(Bloomberg) It’s pretty simple: in three decades since the Cboe Volatility Index was invented, 2017 will go down as the least exciting year for stocks on record. There are three trading days left and the VIX’s average level has been 11.11, about 10 percent lower than the next-closest year.

It’s tempting to say nobody thinks it will last, but that would be to ignore the walls of money that remain stacked up in bets that it will. Going just by the sliver represented by listed securities, about $2.4 billion is in the short volatility trade as of this month, the most on record. Hundreds of billions more are betting against beta in things like volatility futures.

Still, that doesn’t mean investors are ignoring the possibility of a resurgence, or at least a reversion to the mean. Here’s a look at volatility positioning as it stands now.

Surging Cost of Protection Against VIX Upside

Nervousness about next year is visible in the relative cost of betting on an increase in volatility, which has surged to a peak compared with wagers on a decline. (The spread is based on three-month VIX skew in data compiled by Bloomberg.) Someone, somewhere is spending money to capitalize on a rebound in the gauge.

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But it’s the furthest thing from a one-way bet. The global short volatility trade currently has more than $2 trillion in various strategies, according to an October report by Christopher Cole, the founder of Artemis Capital Advisers hedge fund. He compared the strategy of betting that volatility, already near record lows, will fall even further, to a snake “blind to the fact that it is devouring its own body.”

Reptilian autosarcophagy aside, as of December 2017, betting against volatility has been the trade that worked. An analysis on the ETF.com website Tuesday said that seven of the 20 worst-performing exchange-traded securities this year were long VIX and other volatility measures.

Investors see a 74 percent probability that equity price swings will widen next year as the current levels of volatility are “unsustainable,” according to asurvey of 229 investors representing $6 trillion in managed assets conducted by Absolute Strategy Research. The VIX rose for a second day to 10.25 on Tuesday after hanging below 10 for about 20 percent of the time this year.

Record Number of Investors See Stocks as Overvalued
Between rising corporate profits, a pick-up in global growth and laudable message-management by central banks, volatility has had few catalysts. But as the S&P 500 Index has reached 62 all-time highs this year, a record number of investors see stocks as overvalued, according to a Bank of America Merrill Lynch survey last month.
Perhaps as a result, smart-beta exchange-traded funds purporting to offer a haven from chaos have taken in more than $3.5 billion in 2017.

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Anyone in a short-volatility position should be aware that when the end comes, it usually comes fast.

“Look at what happened in January 2016, a drop of more than 5 percent in the S&P — and a spike in volatility — came out of the blue,” said Michael Antonelli, an institutional equity sales trader and managing director at Robert W. Baird & Co. “When vol goes up, it moves quickly, making it hard to exit when you’re short volatility in a significant amount.”

Earnings Dispersion and Volatility Pick-Up
For Mike Wilson, Morgan Stanley’s chief U.S. equity strategist, the death knell for dormant volatility next year will come from less benign global macro conditions. A more challenging global growth environment, the Federal Reserve tightening coupled with the tax uncertainty will lead to a wider dispersion in economic data and earnings data, resulting in more volatility.

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Another hint that the low VIX doesn’t bespeak a dumbfounded unanimity is the volatility curve.

In a blog post last month, New York Federal Reserve economists pointed out that investors are paying noticeably more to hedge against price swings a year from now than for shorter-term volatility. Their analysis found that the difference between one-month implied volatility and one-year was about three times as steep as it normally is.

Ah, but what the New York Fed’s blog is not discussing is the impact that The Federal Reserve had on both stock and bond volatility due to their zero-interest rate policies (ZIRP) and quantitative easing (QE) 10-year programs.

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But as The Fed has started raising their target rate (4 times in a little over a year compared to once in 8 years under Obama) and unwinding their T-notes and T-bonds, we have yet to see a rebound (or mean reversion) in stock and bond volatility.

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The lack of mean reversion in volatility is largely because The Fed is SLOWLY raising rates and unwinding their $4.4 trillion balance sheet. What happens when The Fed REALLY starts raising rates to some long-term average (and shrinks their balance sheet to something like only $1 trillion)? By NOT being more “speedy” about withdrawing their tenacles in financial markets, The Fed is actually perpetuating low-zero volatility.

Did zero-interest rate policies get replaced with zero-volatility policies?

You might as well face it, you’re addicted to gov. And risk mispricing.

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