The last decade or so has witnessed a productive run of research on the ever-topical issue of detecting market bubbles in real time. Quite a lot of attention has recently been focused on a series of research studies by an academic team that includes Peter Phillips, Jun Yu and others, and rightly so. Last year’s working paper “Testing for Multiple Bubbles 1: Historical Episodes of Exuberance and Collapse in the S&P 500”, for instance, breaks new ground with econometric testing, outlining what appears to be a powerful system for detecting the arrival of irrational exuberance in asset pricing. As Fulcrum Asset Management noted earlier this year in a review of revised bubble analytics: “Recent advances in econometric methodology allow us to detect explosive dynamics in asset prices.”
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US industrial production in June is projected to increase 0.3% vs. the previous month in Friday’s release (Aug. 15) from the Federal Reserve, according to The Capital Spectator’s median econometric forecast. The expected gain represents a slightly faster pace of growth relative to June’s previously reported 0.2% advance.
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US retail sales are expected to rise 0.2% in the July report (scheduled for release on Aug. 13) vs. the previous month, according to The Capital Spectator’s median econometric forecast. The prediction matches the previously reported 0.2% gain for June.
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Worrying about risk witnessed a revival last week amid a mix of heightened concerns on geopolitical and economic fronts. But the US stock market, although off its recent highs lately, remains a leading source of strength in absolute and relative terms. Upbeat economic news in recent weeks has been a key reason, although the macro trend for the US will be tested anew in the days ahead with updates scheduled for retail sales (August 13) and industrial production  (August 15). Meantime, US equities remain firmly in the lead among the major asset classes, based on the trailing 250 trading-day total return (a rough proxy for one-year performance) via our usual set of proxy ETFs.
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● Unmasking Financial Psychopaths: Inside the Minds of Investors in the Twenty-First Century
By Deborah W. Gregory
Summary via publisher, Palgrave Macmillan
As financial markets expand globally in response to economic and technological developments of the twenty-first century, our understanding and expectations of the people involved in these markets also change. Unmasking Financial Psychopaths suggests that an increasing number of financiers labeled “financial psychopaths” are not truly psychopathic, but instead are by-products of a rapidly changing personal and professional environment. Advances have been made in identifying psychopaths outside of situations accompanied by physical violence, yet it is still difficult to differentiate psychopaths in cultural settings that have adopted psychopathic behavioral tendencies as the norm. Within the investment sector, a fundamental transformation has occurred: the type of person employed by financial firms and the environment within which finance is conducted have both changed. Society’s expectation of financiers adapted to these subtle, behind-the-scenes shifts, resulting the public at large perceiving more individuals in the financial sector as acting in a psychopathic manner. Being able to distinguish the truly psychopathic financier from individuals who conform to behavioral expectations is the first step towards a cultural shift away from accepted psychopathic behaviors in the financial sector.
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Treasury yields fell again yesterday, with the benchmark 10-year rate slipping to 2.43% at Thursday’s close—marking a 13-month low. More of the same is on tap at the moment: Early trading on Friday shows the yield dipping below 2.40%. Lower yields at this stage are a warning sign, of course, albeit inspired by a hodgepodge of factors. The good news is that macro weakness in the US isn’t a catalyst at this point, as suggested by yesterday’s drop in weekly jobless claims, which left the four-week-average for this leading indicator at an eight-year low. The unexpected decline in claims points to the possibility that growth in the US labor market is picking up. But the improving macro news comes at a time when risk-off sentiment is on the rise.
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Late last month I wondered if lower yields were signaling higher risk? The question still resonates. Indeed, the benchmark 10-year Treasury yield is under 2.50% again, or near the lowest levels for the past year. This is a bit odd because US economic data continues to trend positive, although the housing sector still looks wobbly. Nonetheless, nonfarm payrolls and other major macro indicators betray no conspicuous warning signs at this time. In turn, the moderately upbeat profile on the economy suggests that the Fed will continue to wind down its quantitative easing program in the autumn, which lays the groundwork for raising interest rates next year. But there are risks bubbling around the world that are weighing on interest rates and so demand is rising for a safe haven in the world’s reserve currency.
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The economic trend for the US remained positive in early August, albeit at a relatively subdued level in comparison with recent history, according to a markets-based estimate of macro conditions. The Macro-Markets Risk Index (MMRI) closed at +7.7% yesterday (August 5), or near the lowest level in two years. The latest reading is also well below MMRI’s recent peak of +13.7% in mid-June of this year. Nonetheless, the persistent run of positive numbers suggests that business cycle risk remains low. A decline below 0% in MMRI would indicate that recession risk is elevated. By comparison, readings above 0% imply that the economy will expand in the near-term future.
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Whenever I update returns for the Global Market Index (GMI) and its components (as I did last week) or crunch the data on projecting risk premia, I invariably receive emails asking for the associated asset allocation percentages. I get the impression that some readers see the asset weights for GMI as the keys to the kingdom. In fact, the weights aren’t all that useful–except as benchmarks for customizing a portfolio and related risk management/analysis. Knowing that you’re holding more, less, or the equivalent of Mr. Market’s asset allocation is valuable information.
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Most of the major asset classes took a hit in July, a month that witnessed the broadest set of corrections for global markets since January. Yet the impact was minimal for this month’s update of risk premium forecasts. Long-run projections based on the July data range from unchanged to slightly lower vs. the previous month’s numbers.
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