Beanie Babies and Tulips

A bubble occurs when the valuation of an asset disconnects from fundamental metrics. The Beanie Baby bubble (mid-1990’s) is an extreme example of this; there was no fundamental justification for anyone to pay hundreds or even thousands of dollars for a $5 plush toy. It was a case of group-think, greed, and devious marketing by the toy’s creator, Ty Inc. (Ty Warner Inc. at the time).

The 2007 housing bubble, is another example. It came about thanks to the same group-think and greed, nourished by the government’s encouragement of home-ownership, and dispatched by financial industry over-reach and larceny.

Other famous bubbles, such as the South Sea bubble and the ridiculous (relatively speaking, since all bubbles are ridiculous) tulip bubble, had slightly different technical causes. But they, along with every other bubble that Humans have ever been involved in, have the same Human behavior/emotion of crowd mentality and individual greed as common factors.

Source: www.bostoncharts.com

Some bubbles, like the Beanie baby bubble and the last housing bubble, have wide mainstream participation, while bubbles like the present bond and equity bubbles have a more limited and technically sophisticated participation. It is a narrower slice of the population that can participate in these latest bubbles, mainly because the QE funds that are being used to inflate them are only available to the top of the pyramid. The group-think and greed, however, remain constant.

This narrower participation, may mean that the bursting of the bubble could happen without the characteristic public mania phase that normally occurs just prior to the ‘pop’; the public just can’t afford to attend this FED-fest.

While this game of financial musical-chairs is a consequence of central bank monetary largess, one has to understand that it was unintended and unanticipated by the FED et. al. Even though the FED wants the world to think that they can do amazing things such as: rescue the real economy, create jobs, and increase inflation; the truth is that the FED can do none of those things.

What the FED Can Do:

  • It can control the lending rate between banks.
  • It can buy and sell Treasury bonds along with other securities, thereby affecting money supply (but not velocity).
  • It can provide the financial industry with funds; in 2008, the FED gave the industry $16 trillion which is equal to the entire GDP of the U.S.

What the Fed Can’t Do:

  • It cannot force anyone to borrow more money
  • It cannot determine which are value-creating investments, and which are financial speculation.
  • It cannot deliver money to the base of the economic pyramid where it would increase the velocity of money and create value; all it can do is provide liquidity to banks. (http://www.financialsense.com)

The crucial aspects of the real economy that matter are beyond the FED’s sphere of influence, so it is no great mystery that there has been no recovery on-the-ground, and no spike in inflation.

The FED never predicted, nor intended to do this:

And one assumes (incredibly) that they didn’t see this coming:

The bond and equity bubbles continue to move in-synch and ignore EVERYTHING that isn’t interest rate related. NOTHING matters:

Our Price Modelling System is still neutral, but is trending lower and could become negative shortly, especially if volume on the S&P 500 continues to stay low or decrease. Now that 25% of companies have reported earnings and are out of the black-out period, we are starting to see a resumption of share buy-backs. This ploy is a non-productive exercise that is taking stock valuations even further off the normal curve. It seems that only an increase in interest rates could stop this fatuous practice. However, the CME FED Tool is calculating only a 2.4% chance of a rate hike next Wednesday, but a 48% chance of at-least one hike before the end of 2016.

How Are Some of the Patterns Holding-Up?

This week, the investor sentiment came in as follows:

· Bullish, 35.4% (-1.4%)

· Bearish, 26.7% (+2.3%)

· Neutral, 37.9% (-0.9)

The CNN Fear and Greed indicator, which tracks seven market components, is at an extremely greedy 86%, down from 90% earlier in the week.

The Rydex bull funds were down slightly, while the bear funds were up slightly which matches the sentiment trend. The chart below shows both of these metrics continue to build toward a topping pattern.

Forty years of private equity trading, and still learning.

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