Extreme Value

Today, everyone is on vacation here. It’s May Day – the international worker’s holiday. But our labors continue. Fortunately, our vocation is also our avocation. “Love and need is one,” as Robert Frost put it.

So even on this holiday, we continue trying to understand what is going on not only on the ranch, but also in the economy. First, we recall with some satisfaction that we told readers in the March 20 Diary to “Sell the US; Buy Russia.”

Naturally, this annoyed some readers, who saw something unpatriotic in investing in Russia. But the idea proved to be a good one. Since then, the big Russian ETF, Market Vector Russia ETF Trust (NYSE ARCA:RSX), is up 21%. US stocks are more or less flat. The S&P 500 is down about 0.5% over the same period.



How did we know Russian stocks would go up? Of course, we knew no such thing. All we knew was that they were preposterously cheap and that most investors based their judgments on little real knowledge of Russia.

Extreme valuations – high or low – are usually wrong. And they are most probably wrong when they are mixed with political nonsense, media claptrap and popular prejudice. As for the US stock market, we judged it preposterously expensive.

1-RSX-SPY ratio

The ratio of RSX to SPY – since the panic low in the ruble in mid December, Russian stocks have been among the best performing in the world – click to enlarge.

Not that it couldn’t become much more expensive. But every day brings more evidence that:

  1. The recovery is more fake than real.
  2. The US is in a long-term growth downturn.
  3. US stocks are overvalued given these underlying conditions.

2-RSX alone

RSX by itself – since its intraday low at $11.99 on December 16, the ETF has risen by roughly 65.72%. The difference between Russian and US stocks is mainly valuation. At the points when Russian stocks and the ruble made their lows last year, an entire smorgasbord of negatives had been priced in – click to enlarge.

Cheap Tricks and Speculation

Jeffrey Snider of investment firm Alhambra Partners tells us that it is unusual for “final sales” – which measure demand from US residents for imported and domestically produced goods and services – to fall. (By contrast, GDP measures demand from foreigners or US residents for US-produced goods and services.)

But that’s what happened between the last quarter of 2014 and the first quarter of 2015. And this wasn’t the result of some adjustment. This was the real thing, unvarnished and undiluted. Here’s Snider:

Seeing a negative nominal growth rate in final sales is highly unusual, which might as well be expected given that we have been under some form of an “inflation” appeal of monetary theory since 1965.

In the twin of final sales accounting, Final Sales of Domestic Product, there have only been four instances of a negative quarter since 1958. Three of those were during the Great Recession… and Q1 just produced the fourth!”

3-April-2015-Final-Sales-Nominal-Domestic-ProductNominal final sales – negative for only the fourth time since 1958 (The complete report by Alhambra Partners can be seen here). The other three occasions were not a happy time period.

To what do we owe this crummy economic performance? To the Fed! It has shifted the economy from the hard work of saving and investing to the cheap tricks of speculation and financial engineering. Reagan’s former budget adviser and Wall Street watcher David Stockman explains:

“Self-evidently, the Fed’s 5x balance sheet expansion since December 2008, which has resulted in 77 straight months of zero money market interest rates, has massively subsidized carry trade speculators.

The latter use this free short-term money to fund (i.e., “carry”) their stock, bond and other asset positions, and thereby bid the market for these assets to higher and higher levels.

So doing, they are not bringing new savings into the investment market and thereby augmenting honest demand for stocks, but are merely enlarging their bids with zero cost credit made from nothing.”

That is what gives us $1 trillion of stock buybacks and roughly zero real economic growth. Had the figures not included growth in inventories, the GDP figure for the first quarter would have been negative.

And now, our own research department believes US stock market investors are being led into the manga [a cattle squeeze chute, through which cattle are run inter alia to be castrated, Ed.]. “Give ‘em the works,” a voice yells.


NYSE margin debt has just hit a new all time high in March, and investor credit balances are now more deeply in the red than ever before. Some people doubt that this will end well, mainly because it never has before – click to enlarge.