Tweet

Jurrien Timmer

13 Jul, 9 tweets, 2 min read

With stocks trading at near-record valuations and the Fed hoping to retreat from the zero lower bound (ZLB) and its $120 billion in monthly asset purchases, everyone wants to know: Is this market a bubble that is about to burst? Let's take a hard look. (THREAD)

I’m going to try the process of looking at all the market’s moving parts through the lens of the discounted cash flow model (DCF). It’s a good exercise in discipline in that it forces me to actually quantify the puzzle pieces.

For the DCF there are four important variables that we need to consider: earnings growth, the payout ratio (dividends + buybacks as a percent of earnings), interest rates, and the equity risk premium. /2

Then we can stress-test the DCF Model to see how changes in these variables might affect equity valuations. It’s no small task, but if the Fed has created an asset bubble, we should try to quantify its effects using this approach. /3

There will be several threads on this, but let's start with this one on fiscal and monetary policy, which are currently ultra-stimulative, as this chart shows: /4

When we adjust the Fed’s policy rate for asset purchases (which the Atlanta Fed does through its shadow rate), and we subtract the inflation rate, we see that the Fed is even more accommodative than it was during the financial crisis (purple bars). /5

I look at monetary policy relative to the natural rate of interest, or R-Star. If R*, which has fallen to near zero during the pandemic, recovers along with the economy, then the Fed should normalize policy just to keep up with R*. /6

But if the Fed remains on hold for whatever reason (or raises rates less quickly than R* would warrant), then the Fed would be de facto easing further, loosening financial conditions even more in the process. /7

Since financial conditions are usually inversely correlated to equities, such a dovish policy error could in theory lead to, or exacerbate, asset bubbles. To me, this could be a transmission mechanism between a policy error and the markets. /END

• • •

Missing some Tweet in this thread? You can try to force a refresh

This Thread may be Removed Anytime!

Twitter may remove this content at anytime! Save it as PDF for later use!

More from @TimmerFidelity

Jurrien Timmer

@TimmerFidelity

15 Jul

Is the market a bubble ready to burst? In this thread, we'll consider what share buybacks have to say about it: (THREAD)

With dividends being relatively stable and the DCF placing a lot of weight on the terminal value (long-term growth after 5 years), the main variable to consider is the pace of share buybacks, which affect the payout ratio. /2

Historically, earnings growth has been 6% in the US, and in recent years the payout ratio has been around 90%. Currently (a/o Q1) it’s 71%, with dividends comprising 35% and buybacks 36%. /3

Read 21 tweets

Jurrien Timmer

@TimmerFidelity

14 Jul

Is the market a bubble ready to burst? An important factor to consider is the risk-free rate (RFR), aka the 10-year Treasury yield. So let's dive in: (THREAD)

It doesn't take a leap of faith to see that monetary policy is suppressing interest rates. This chart shows it. Nominal yields on the vertical axis and TIPS break-evens on the horizontal. The size of the bubbles (no pun intended) shows the size of the Fed’s balance sheet. /2

Based on the regression between these two variables, the current level of the 10-year is about 100 bps lower than it “should” be. This chart shows the 10-year vs the above TIPS model. Are today’s subdued yields the result of policy? It seems that way to me. /3

Read 10 tweets

Jurrien Timmer

@TimmerFidelity

13 Jul

Following up on the previous thread, as we seek to answer the question: “Is the market a bubble that is ready to burst?” The next factor to look at is the equity risk premium. (THREAD)

The discount rate (or cost of capital) consists of the risk-free rate (10 year Treasury yield) plus the equity risk premium. The ERP is like a credit spread, reflecting the additional return investors demand as compensation for additional volatility vs. the risk-free asset. /2

The surge in “excess money” (money supply growth less GDP growth) resulting from the fiscal/monetary response to the pandemic has clearly elevated the market’s valuation, as the chart below shows. /3

Read 13 tweets

Jurrien Timmer

@TimmerFidelity

12 Jul

Sentiment. It finds its way into a lower ERP, as it did at the secular peak in 2000, but we can also measure it through investor behavior. (THREAD)

We know about speculation in meme stocks & non-profitable tech this cycle. Margin debt has growth dramatically on a year-over-year basis, although as a percentage of market cap, margin debt remains well below the peak in the 2000s. /2

With retail speculation presumably limited to a relatively small subset of the market, looking at long-term flows--that is, regular investors saving for retirement--we see very little evidence of exuberance. /3

Read 5 tweets

Jurrien Timmer

@TimmerFidelity

23 Jun

With all the speculation about the Fed raising interest rates sooner than later, let's take a look at how past "liftoff" attempts by the Fed affected the markets, and how the Fed then responded. (THREAD)

There have been four major liftoff attempts since the Global Financial Crisis. The first was in April 2010, after an 80% run in the S&P 500. The Fed ended QE1, producing a three month, 16% drawdown for stocks, which forced the Fed to start QE2 a few months later. /2

The second attempted liftoff gave us the infamous taper tantrum in May 2013 (8% drawdown). The third was the actual liftoff in 2018, which ultimately produced a brief but scary 20% decline for stocks. And now we are in the early stages of the fourth liftoff attempt. /3

Read 12 tweets

Jurrien Timmer

@TimmerFidelity

22 Jun

My “failed 5th” call last week was premature, but today’s undercut & subsequent reversal still fits with my 5th-wave thesis outlined earlier. Now too we have some interesting divergences, which only increases my conviction that bitcoin is bottoming. (THREAD)

Here is the 14-day slow stochastic: bearish divergence at the high and bullish divergence now. /2

The GS Bitcoin-sensitive equities basket remains in an up-trend (higher highs, higher lows), and in the process also appears to be flashing a bullish divergence against btc’s new low. /3

Read 4 tweets

Support us! We are indie developers!

This site is made by just two indie developers on a laptop doing marketing, support and development! Read more about the story.

Become a Premium Member ($3/month or $30/year) and get exclusive features!

Become Premium

Too expensive? Make a small donation by buying us coffee ($5) or help with server cost ($10)

Donate via Paypal Become our Patreon

Thank you for your support!