Switching To Bear Status

[scrappycocco]

After more than 18 months since stumbling across HPC via an excellent article on K Winters and waiting for the various markets to reach potential price targets its finally time for me to switch over to the dark side of Bear Status.

Technically great potential for a reversal from these values, ( if its still a nominal price bear market id say it pretty much has to reverse from these levels)

Sentiment wise although for completely different reasons to 07 the extreme asset price bullishness is about as perfect as it gets for a top

In homage to CGNAO by Mid 2013

Halifax Index 164K to 100K

FTSE 5890 to 2500

Dow 11420 to 4000

Gold 1394 to 500

Silver 2673 to 850

GBP/USD 1.62 to Sub Parity

Protect Yourself - Buy A Fondue Set

Disclaimer: The information/material provided in this post may be misleading due to the owners keyboard running out of zeros, the poster expressly disclaims to the maximum limit permissible by law, all warranties, express or implied, including, but not limiting to implied warranties of merchantability, fitness for a particular purpose all responsibility for any loss, injury, liability or damage of any kind resulting from and arising out of this post, very few cats were harmed in any way in the creation of this post

I'm missing something here, isn't silver around $19 an ounce at the moment?

[The Masked Tulip]

I'm missing something here, isn't silver around $19 an ounce at the moment?

Nah, it is about 26 bucks an ounce plus you pay VAT here in the UK.

[scrappycocco]

The OP states "Silver 2673 to 850" does that mean 26.73 to 8.50?

[scepticus]

The present value of a perpetuity is conventionally calculated as: A / i , where A is the value of the individual payments and i is the compounding interest rate. (Notice how you don't' get infinity out of this).

from here:

http://www.marketoracle.co.uk/Article8847.html

For example, the 4% perpetual with face value $1000, yielding $40 per annum, can be traded in the secondary market for $1000 as long as the market rate of interest b is 4%. However, if it is halved to 2%, the same perpetual can be sold for $2000, because at the lower rate it would take two debentures to generate the same income stream.

For example, the 4% perpetual with face value $1000, yielding $40 per annum, can be traded in the secondary market for $1000 as long as the market rate of interest b is 4%. However, if it is halved to 2%, the same perpetual can be sold for $2000, because at the lower rate it would take two debentures to generate the same income stream.

So, what is the value of the perpetual security paying > 0 nominal return when the market rate of nominal interest is 0? Infinite.

(the market rate will be zero when everyone is to fearful to lend or invest).

If the security is NOT a perpetuity then presumably one can calculate a non-infinite price since there is an expiry date on it so the sum of payments received as a result of owning the security is necessarily finite. However look at it from the point of view of the debtor.

Fekete explains it well:

"If as a corporate treasurer you have sold a $1000, 30-year bond and the interest is halved next day, you could liquidate that debt only if you are willing to shell out a sum closer to $2000, even in New Jersey. Nobody will sell your bond back to you for $1000, because it yields twice as much as do the new issues of the same face value and same maturity."

In this case the liquidation cost of the debt is infinite.

Now to move onto your point about value an opportunity cost. What matters for the price of the security in question ( including the goose) is what you can sell it for. You may value it above or below that price personally but the value of it is set by the market, not the holder. Therefore if the rate the market is using at any one time is zero then that is how they will price it.

So according to the standard method for valuing debt the price of the security is infinite if the discount factor is zero. If a security can attain an infinite price under any conditions then it would appear to be a ponzi scheme.

Accordingly, a genuinely risk free nominal interest paying security is a ponzi scheme.

[LuckyOne]

from here:

<snip>

Accordingly, a genuinely risk free nominal interest paying security is a ponzi scheme.

In your initial calculation, you assume that growth is zero.

While I agree with you that growth might eventually tend towards zero or even a negative number, I think that we are a long way from reaching that point. A term structure of growth rates might reveal that there are some shorter dated risk assets that can have a price below infinity.

[scepticus]

In your initial calculation, you assume that growth is zero.

there is no reason in the long run analysis to make any assumptions about growth at all.

a rational investor will not make such assumptions.

the value of the security is determined by its performance under all conditions of growth, contraction, inflation and deflation.

if its value in any of these circumstances becomes infinite then that is a clue that something fishy is going on.

[scepticus]

Again demonstrating why you aren't as good at thinking as you believe. I enjoy insulting people on the internet, but I do not lie and I take great pride in admitting my rare but nonetheless extant mistakes. Arsehole. (well you called me a liar).

fair cop. I retract the offending remark - please accept my apologies.

[gravity always wins]

After more than 18 months since stumbling across HPC via an excellent article on K Winters and waiting for the various markets to reach potential price targets its finally time for me to switch over to the dark side of Bear Status.

Technically great potential for a reversal from these values, ( if its still a nominal price bear market id say it pretty much has to reverse from these levels)

Sentiment wise although for completely different reasons to 07 the extreme asset price bullishness is about as perfect as it gets for a top

In homage to CGNAO by Mid 2013

Halifax Index 164K to 100K

FTSE 5890 to 2500

Dow 11420 to 4000

Gold 1394 to 500

Silver 2673 to 850

GBP/USD 1.62 to Sub Parity

What qualifies you to come out with this stuff?

I notice its always nominal and the charts are never on a log scale.

The charts look perty for sure, nice colours and stuff must have taken you ages but of course you can't create them using real prices coz they'd look sh*t wouldn't they? (bit like your "nominal" commodoties chart from last week heh! your case looked a shambles as soon as we saw the real price chart)

Don't be fooled by these line drawing, charting charlatans. Charts show nothing but the past and to try to extrapolate the 29 crash to today is impossible especially as money is fundamentaly different from today.

But do keep up the good work with the crayons though.

[scepticus]

there is no reason in the long run analysis to make any assumptions about growth at all.

a rational investor will not make such assumptions.

the value of the security is determined by its performance under all conditions of growth, contraction, inflation and deflation.

if its value in any of these circumstances becomes infinite then that is a clue that something fishy is going on.

bump. S,o about the right price for nominal income paying securities, where were we?

[LuckyOne]

bump. S,o about the right price for nominal income paying securities, where were we?

Honestly, I am stuck.

I cannot identify any risk free securities (on either a nominal or real basis).

If the securities do not exist, their price is hard to understand.

To roughly paraphrase your argument, they might not exist because their price would be infinite.

[mirage]

from here:

http://www.marketoracle.co.uk/Article8847.html

For example, the 4% perpetual with face value $1000, yielding $40 per annum, can be traded in the secondary market for $1000 as long as the market rate of interest b is 4%. However, if it is halved to 2%, the same perpetual can be sold for $2000, because at the lower rate it would take two debentures to generate the same income stream.

For example, the 4% perpetual with face value $1000, yielding $40 per annum, can be traded in the secondary market for $1000 as long as the market rate of interest b is 4%. However, if it is halved to 2%, the same perpetual can be sold for $2000, because at the lower rate it would take two debentures to generate the same income stream.

Yes, clearly. Does this mean that you are going to give us the time value of money (gold) for your hypothetical? One way of doing that would be to specify a market interest rate for gold in the example.

So, what is the value of the perpetual security paying > 0 nominal return when the market rate of nominal interest is 0? Infinite.

(the market rate will be zero when everyone is to fearful to lend or invest).

Er, no. Think about it for two seconds. Which would you prefer in this environment? A perpetuity paying 0.000000000001% or one paying 1000%? And what is the value/price of this preference? Zero according to you, since infinity=infinity. Clearly you have made at least one mistake. What mistakes?

Well, firstly you are thinking in nominal returns. Instruments are priced in terms of their expected real value over time. You even mention that "the market rate will be zero when everyone is fearful to lend". You are describing positive real returns on zero nominal rates, since people place value on the return of capital. In reality of course, nominal rates may easily go below zero as they have recently in short term US govt debt.

You will find that the simple division of income stream valuation method you quote applies only to real returns, and when you think about it, for bloody obvious reasons.

More importantly, (let's assume precisely zero inflation in everything), the valuation method still doesn't actually work. We could have zero inflation and zero future inflation, and zero market rates on risk free capital. (This will never occur, but let's say everybody just goes mad). My reductio still works - if the positive yield perpetuities are priced infinitely, you have priced in zero preference for a 1000% security vs a 0.00001% one.

So what's wrong? Well in this environment an investor can still choose to take risk and invest in productive enterprise, giving a chance of positive real return. So you actually have to calculate cost of risk-free instruments relative to the expected returns on risk and the overall risk appetite of the market. Finite yielding risk free will never be priced at infinitity, since you will mathematically always be able to find a higher yield for any given time period at a finite price, with an arbitrarily large degree of certainty (e.g. 99.999999999999999999999999999999999999999999%). And the price of insuring against that infinitesimal risk will never be infinite.

Still not happy? OK, then lets remove any hope of generating real returns from risky investment by deeming this impossible. What will the market look like? Say there is one single risk-free positive return instrument. The price still isn't infinite. It is the costed against the value of other commodities in the market, which will only ever be finite. What happens if we add in a plurality of such instruments at different positive yields? Then the instruments compete against each other in the finite marketplace. (In fact, given the presence of these instruments competing for cash, the market rate cannot be zero!)

Your little example of of a $1000 perpetual bond costing $2000 when market rates halve is all very well, but at the same time pretty goddamn simplistic (or stupid, as I prefer). It ignores the returns available on risk assets. As you attempt to approach your beloved asymptote of zero (real rates remember) the returns on risk compete more strongly with risk-free and become increasingly large distortions on the simplistic linear relationship. This can be seen more directly if you just consider the price of risk across all instruments.

At the risk of blowing your mind, the linear relationship between real return on capital and price is also a gross oversimplification. As an extreme example an individual may value a return of 5% many millions of times over a return of 4.9% at the same risk. (Perhaps he will be killed next year if he can't pay a sum equivalent to a 5% return. ). Since this is possible for an individual it follows that it is possible for a market (though presumably not to such an exaggerated degree). The time value preferences of a market will depend on a subjective factors.

Fekete explains it well:

I don't need the blatantly obvious explaining to me by Fekete. You need the subtle and interesting explaining by me.

Now to move onto your point about value an opportunity cost. What matters for the price of the security in question ( including the goose) is what you can sell it for. You may value it above or below that price personally but the value of it is set by the market, not the holder. Therefore if the rate the market is using at any one time is zero then that is how they will price it.

Except you didn't give me a market rate. You gave the return in terms of gold alone of one instrument.

So according to the standard method for valuing debt the price of the security is infinite if the discount factor is zero.

Obvious ******** as I have demonstrated.

Accordingly, a genuinely risk free nominal interest paying security is a ponzi scheme.

Leaving aside the mathematical fact that nothing can be genuinely risk-free, this still isn't true. Value of such securities will be priced as a function of the real expected return of the instrument and the market yield curves over the risk spectrum and the maturity. Really, it is a 2D risk/maturity surface. You can look at tiny areas on this surface which are approximately flat and trot out your simplistic linear relationships between return and price. What you cannot do is ****** about trying to derive nonsensical infinite prices by attempting to pretend that this surface is precisely flat.

OK? If that just washes over you, then stick to explaining why you don't want my 1000% perpetuity in exchange for your 0.0000000000001% one.

Or why you don't want my 10000000000000000% instrument at p0.00000000000001 risk?

That should be a laugh.

[mirage]

.

Edited November 8, 2010 by mirage

[mirage]

Honestly, I am stuck.

I cannot identify any risk free securities (on either a nominal or real basis).

If the securities do not exist, their price is hard to understand.

To roughly paraphrase your argument, they might not exist because their price would be infinite.

Of course they don't exist. It amazes me that you even try to think of any. They are a convenient approximation.

Nonetheless, risk X securities do exist, and the price of (even perfect) insurance against p1-X is not generally infinite.

Come on Lucky, you hardly strike me as a slow one. Or do you seriously think that anyone would pay an unlimited amount for a mathematically infinitesimal real return just so long as it was positive?

[LuckyOne]

<snip>

Leaving aside the mathematical fact that nothing can be genuinely risk-free

<snip>

I was slow to get there but it appears that you agree with Scepticus : There are no genuinely risk free securities avaialable because they would be infinitely expensive.

[mirage]

fair cop. I retract the offending remark - please accept my apologies.

Don't mention it! It gave me the chance to say "arsehole". Feel free to return the compliments, I don't get offended.

[LuckyOne]

Of course they don't exist. It amazes me that you even try to think of any. They are a convenient approximation.

Nonetheless, risk X securities do exist, and the price of (even perfect) insurance against p1-X is not generally infinite.

Come on Lucky, you hardly strike me as a slow one. Or do you seriously think that anyone would pay an unlimited amount for a mathematically infinitesimal real return just so long as it was positive?

But then you need to buy insurance against the probability of that the insurance against p1-X is not delivered. And then you need to buy insurance against the second set of insurance not being delivered etc etc.

I wouldn't pay an infinite price for an infinitesmal real return. There are some risks that I am happy to take. I have come around to the point of view that it would be infinitely expensive to have a completely risk free return even though I don't want one.

[mirage]

I was slow to get there but it appears that you agree with Scepticus : There are no genuinely risk free securities avaialable because they would be infinitely expensive.

No, there are no risk free securities available because our entire conceptualised world is based on logical induction, which can never generate confidence of 1 in any empirical proposition.

This still doesn't mean that risk-free returns of effectively nothing in the lifetime of the universes would be priced at infinity.

I don't seem to be getting anywhere with my points regarding that absurdity so how about the different tack of pointing out that a finite market, being a mechanism for deciding value ratios, can never price anything at infinity without pricing everything else at zero?

Eh?

Come on people!

We can do this! I know we can!

[mirage]

But then you need to buy insurance against the probability of that the insurance against p1-X is not delivered. And then you need to buy insurance against the second set of insurance not being delivered etc etc.

Yes, but total cost converges asymptotically on a finite value. (This is pretending that the risks of insurer default are statistically independent, which of course they aren't since there are large asteroids whizzing around up there in space after all).

I wouldn't pay an infinite price for an infinitesmal real return. There are some risks that I am happy to take. I have come around to the point of view that it would be infinitely expensive to have a completely risk free return even though I don't want one.

Do you think you are some kind of freak that is entirely unrepresentative of the market. In fact, I can assure you, you are not. The market also "doesn't want" to pay infinitely for a negligible risk-free return. Not-least because there is no reason whatsoever to contemplate such a high price.

[LuckyOne]

No, there are no risk free securities available because our entire conceptualised world is based on logical induction, which can never generate confidence of 1 in any empirical proposition.

This still doesn't mean that risk-free returns of effectively nothing in the lifetime of the universes would be priced at infinity.

I don't seem to be getting anywhere with my points regarding that absurdity so how about the different tack of pointing out that a finite market, being a mechanism for deciding value ratios, can never price anything at infinity without pricing everything else at zero?

Eh?

Come on people!

We can do this! I know we can!

I am still missing something.

I understand the concept that we can never generate confidence of 1 in any emprical proposition.

I understand the idea that in a finite market, we can never price one security at infinity without pricing everything else at zero.

By definition, a risk free return demands a confidence of 1 therefore it falls outside of the two conditions above.

[LuckyOne]

Yes, but total cost converges asymptotically on a finite value. (This is pretending that the risks of insurer default are statistically independent, which of course they aren't since there are large asteroids whizzing around up there in space after all).

Do you think you are some kind of freak that is entirely unrepresentative of the market. In fact, I can assure you, you are not. The market also "doesn't want" to pay infinitely for a negligible risk-free return. Not-least because there is no reason whatsoever to contemplate such a high price.

I am very representative of a portion of the market.

I understand that it is impossible to eliminate risk and generate risk free returns.

I use historical data to try to construct an asset allocation with a high expected return and low volatility. I know that this is a very flawed approach on its own so I then use my experience and intuition to try to create a set of scenarios against which I then test the portfolio. I then accept a sub-optimal return when measured against history to protect against extreme outcomes (usually by buying deep out of the money options and tweaking the allocation rules to include floors in the holdings of some asset classes to prevent portfolio rebalancing into oblivion to chop off parts of the distribution of outcomes that scare me the most).

I think that my approach is rational and reasonable but I understand that I am taking a lot of risk and that I might get wiped out although the likelihood is possibly lower than average.

[mirage]

I am still missing something.

I understand the concept that we can never generate confidence of 1 in any emprical proposition.

I understand the idea that in a finite market, we can never price one security at infinity without pricing everything else at zero.

By definition, a risk free return demands a confidence of 1 therefore it falls outside of the two conditions above.

Well, yes, but that makes it impossible, not infinitely priced!

We can still conceptualise the value of a hypothetical such as genuinely risk free returns, just as we can estimate the price of a putative second Mona Lisa, or any counterfactual. If we can express risk-return preference in terms of price, then we can price the additional small lowering of risk from, say short term US treasuries to a hypothetical risk-free instrument, and it would be small.

To further see that there is nothing magical about the number zero in terms of risk, we have only to remember that our own existence has a substantial positive chance of ending before the investment period. Clearly the higher the risks of externalities like this, the lower the price of additional small lowerings of financial default risk in the market. In an uncertain world, an additional small benefit in terms of default risk, even to the impossible level of zero, is not going to be worth all that much.

Sceppy's ideas on this subject simply illustrate the problems you get when you take simple linear economic models that approximate small scale market behavior within a narrow range, and try to apply them to mathematical extremes. Well, you get problems until you remember that the world is a little more complicated than an x-y graph.

[mirage]

I am very representative of a portion of the market.

I understand that it is impossible to eliminate risk and generate risk free returns.

I use historical data to try to construct an asset allocation with a high expected return and low volatility. I know that this is a very flawed approach on its own so I then use my experience and intuition to try to create a set of scenarios against which I then test the portfolio. I then accept a sub-optimal return when measured against history to protect against extreme outcomes (usually by buying deep out of the money options and tweaking the allocation rules to include floors in the holdings of some asset classes to prevent portfolio rebalancing into oblivion to chop off parts of the distribution of outcomes that scare me the most).

I think that my approach is rational and reasonable but I understand that I am taking a lot of risk and that I might get wiped out although the likelihood is possibly lower than average.

Need any clients?

[LuckyOne]

Need any clients?

I am scared enough of the consequences of the remaining possible negative outcomes on my own life. I could never take the responsibility of managing someone else's money. I could not make an implicit promise that I know is impossible to keep.

[scepticus]

To further see that there is nothing magical about the number zero in terms of risk, we have only to remember that our own existence has a substantial positive chance of ending before the investment period. Clearly the higher the risks of externalities like this, the lower the price of additional small lowerings of financial default risk in the market. In an uncertain world, an additional small benefit in terms of default risk, even to the impossible level of zero, is not going to be worth all that much.

Sceppy's ideas on this subject simply illustrate the problems you get when you take simple linear economic models that approximate small scale market behavior within a narrow range, and try to apply them to mathematical extremes. Well, you get problems until you remember that the world is a little more complicated than an x-y graph.

I pick simple examples because most people are simple. Whenever I get complex, simple people claim I am over intellectualising and vice versa.

What matters here in the real world is the nominal bonds are ALWAYS less risky than EVERYTHING else. The point about theoretical pricing is interesting but ultimately detracts from the outcome.

That is why they have been bid up in price again, and again, and again.

Its why we hear crap like 'risk on, risk off' spouted by professionals who should know better.

Each time a recession hits, a bunch of so called investors rush out of the real world and into the convenient fiction of government bonds, and as such are protected from losses they would have occurred in a system in which actual money was used and actual government debt was issued and defaulted on.

But that has not been our world, and as a result the yields on these so called risk free assets is almost all gone, and then we are going to see some serious investor roadkill whoopass that we are 70 years overdue for.

But its not gonna happen the way they think its gonna happen.

Winners: consumers, the FED and BoE

Losers: investors escaping treasuries and trying to corner yields by bidding up commodity prices.

Winners are winners, because consumers are the ones with their foot on the break and the fed has the accelerator.

[Timm]

I pick simple examples because most people are simple. Whenever I get complex, simple people claim I am over intellectualising and vice versa.

What matters here in the real world is the nominal bonds are ALWAYS less risky than EVERYTHING else. The point about theoretical pricing is interesting but ultimately detracts from the outcome.

That is why they have been bid up in price again, and again, and again.

Its why we hear crap like 'risk on, risk off' spouted by professionals who should know better.

Each time a recession hits, a bunch of so called investors rush out of the real world and into the convenient fiction of government bonds, and as such are protected from losses they would have occurred in a system in which actual money was used and actual government debt was issued and defaulted on.

But that has not been our world, and as a result the yields on these so called risk free assets is almost all gone, and then we are going to see some serious investor roadkill whoopass that we are 70 years overdue for.

But its not gonna happen the way they think its gonna happen.

Winners: consumers, the FED and BoE

Losers: investors escaping treasuries and trying to corner yields by bidding up commodity prices.

Winners are winners, because consumers are the ones with their foot on the break and the fed has the accelerator.

I'm a simple chap.

Are you saying consumers will go a little hungry, resulting in commodity prices being much lower than bet on?