Ghosts of Irrational Exuberance

Dallas Federal Reserve President Richard Fisher was in Mexico City this week and spoke with his usual candor on Fed policy, asset pricing and the ineptitude of our current government. Fisher has an interesting vantage point on our economy and fiscal/monetary policy and his frankness is refreshing. In his speech Fisher warns that the Fed’s bond buying may be distorting markets and that some indicators like price to forward earnings ratios, margin debt and market capitalization to GDP have risen to levels not seen since the dot com boom of the late 1990’s.

I fear that we are feeding imbalances similar to those that played a role in the run-up to the financial crisis. With its massive asset purchases, the Fed is distorting financial markets and creating incentives for managers and market players to take increasing risk, some of which may result in tears. And all this is happening in uncharted territory. We have aided creation of massive excess bank reserves without a clear plan for how to drain them when the time comes. And there is the challenge of doing so while keeping inflation expectations stable.

 We must monitor these indicators very carefully so as to ensure that the ghost of ‘irrational exuberance’ does not haunt us again.’

On the subject of margin debt comes these stats from Jason Goepfert of SentimenTrader by way of Arthur Cashin.

 The latest margin debt figures were released for January showing another uptick in debt and decrease in the net worth of investors. The “available cash” for investors to withdraw is now negative $159 billion, another record low. As a percentage of the market cap equities of all US equities, it amounts to -0.75%, tied with February 2000 for the most extreme figure since June of 1987.

Our attention turned to bonds when it was reported by Bloomberg that Warren Buffett has taken his bond holdings down to their lowest level in over a decade. Buffett, never one to hold an overweight in bonds has lowered his bond holdings at his insurance units to just 14%. Buffett typically holds between 20-25% of his insurance units holdings in bonds. As Fisher said in his speech in Mexico City this week, all asset valuations are getting distorted. The only question is which is least overvalued or do you hold significant amounts of cash earning very little or nothing. Buffett’s cash position has risen to almost 26% of the assets at his insurance units. Buffett is overweight cash, earning very little, and he is not happy about it either.

Insiders at some of the largest and most successful money management firms are moving money to the sidelines in their personal accounts. Executives at Carlyle and Oaktree sold $250MM and $300MM respectively of their personal holdings. Follow the smart money.

 It seems reasonable to be prudent here as the bull that started in March of 2009 is now 5 years old. This bull is now the 6th longest on record and the 4th best performing. Could we be in a bubble like that of 1997-1999? It is possible with the Fed still pouring money in. My philosophy here is to keep our hands in the game, find the cleanest dirty shirt and keep your options open if things begin to turn south. Cash pays nothing but we feel that we are in good company with Buffett as he is also underweight bonds and overweight cash.

 To learn more about us and Blackthorn Asset Management LLC visit our website at .

A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty. – Winston Churchill

Disclosure: This blog is informational and is not a recommendation to buy or sell anything. If you are thinking about investing consider the risk. Everyone’s financial situation is different. Consult your financial advisor.


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