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Show HN: Is the stock market going to crash? (isthestockmarketgoingtocrash.com)
813 points by truffle_pig on Aug 7, 2017 | hide | past | favorite | 325 comments

If you're looking for The Single Greatest Predictor of Future Stock Market Returns[1], here it is: http://www.philosophicaleconomics.com/2013/12/the-single-gre...

This is a long read, but it's worth it. The metric can be calculated in FRED[2], and as a predictor of future returns, it outperforms all of the most common stock market valuation metrics, including cyclically-adjusted price-earnings (CAPE) ratio[3]. (Basically, the average investor portfolio allocation to equities versus bonds and cash is inversely correlated with future returns over the long-term. This works better than pure valuation models because it accounts for supply and demand dynamics.)

[1]: http://www.philosophicaleconomics.com/2013/12/the-single-gre...

[2]: http://research.stlouisfed.org/fred2/graph/?g=qis

[3]: http://www.multpl.com/shiller-pe/

Wow, really interesting read. Thanks for the link.

Only trouble is that once people find patterns like this, they have a habit of disappearing. Hopefully this one is based on solid enough fundamental market forces that it persists after its publication. It was published in 2013 so we won't know for sure until after 2023.

I actually made an automatically updating chart for this using FRED data: http://financial-charts.effingapp.com

TLDR: The correlation did go down a bit since publishing but still seems alright.

This is awesome. Would it be possible for you to extend the spx 10 year return line with a greyed out or dotted line from 2007 onwards that shows the running annualized return so far? So for example for 2012 it would show the spx annualized return from 2012 to 2017.

Thanks for this. Can you also add a way to change the window for S&P returns from 10 years to other time windows? It'd be interesting to see how the plot changes with adjustments to the window.

I remember looking at other time windows, anything 5 years or below wasn't great.

this is great! you should add shaded areas for official recession periods, it's pretty easy to find:


I saw lot's of suggestions above, how about making it on github so anyone can hack it?

Just found its repository here: https://github.com/effinggames/financial-charts

> Only trouble is that once people find patterns like this, they have a habit of disappearing.

It took me a few seconds to figure out that you meant the patterns and not the people as the targets for disappearing.

> Hopefully this one is based on solid enough fundamental market forces that it persists after its publication.

If you can find any way to predict the future price of things, you can make money by performing arbitrage across time (instead of space, which is how people usually think of arbitrage). This (nominally) describes all types of model-informed time-based investment.

The thing with arbitrage is that there's a finite amount of money you can make. If there's a price difference on some cross-listed stock between HKEx and SZSE, you can make money by buying on the cheap one and selling on the pricier one. But, as a side effect of doing so, the price goes up on the cheap one and goes down on the pricier one. There is only a finite amount of stock you can exchange before the price difference approaches zero and you can't make money. The price information has been communicated, and the market has served its function.

The same is true for arbitrage across time. There's only so much money you can spend before the "prices" (more complicated than spacial price differences, because you have to worry about some more complex utility theory to find the expectation value of something in the future) equilibrate and market information has been propagated "through time".

This is why these things "have a habit of disappearing"; every single way of making money via models corresponds to a market inefficiency. Model-based traders are eliminating market inefficiencies and making a cut off the benefit, just like any other good business. The inefficiencies are just more abstract than usual.

So if a model is good, there's no way for it to persist. If it actually predicts something we didn't expect, that corresponds to some inneficiency in the market that some trader can eliminate in exchange for a nice fee.

Which is all just another way of saying (albeit more interestingly and in more detail), that when new information becomes available, the market adjusts to better reflect the true value of things.

This is true in a theoretical free market where there is price discovery. In the "markets" that actually exist, though, we don't have true price discovery. We have a market with centrally controlled interest rates, central bank purchasing (in a variety of ways) and other institution-based interference that create inefficiencies that are not organic, and are therefore not self-correcting.

I don't think that changes the previous statement. It just changes the value of truth. Maybe not self correcting, but certainly self regulating towards the new normal as set out by regulatory constraints.

None of the stuff you mentioned invalidates any of the mechanisms I described, although regulations may decrease their effectiveness (as with any other price-discovery mechanism) by introducing friction or breaking efficient instruments.

aka "policy". Also self correcting, but with a longer time scale.

Depends on what your modeling. A risk vs inflation vs ROI curve should be maintained by the market rather than destroyed by it.

This should be baked into your calculation of future expectation values. This factors in risk, uncertainty, time preference, inflation, etc.

You should read the author's next post where he pokes a bit of fun at his metric:


self destructing prophecy :)

The 10-year window is kind of arbitrary, and knowledge of this pricing model won't erase the pattern, but may change the window over which it is effective to something much shorter as timescale compresses.

> "... once people find patterns like this, they have a habit of disappearing."

Hah! Grammatically, "they" refers to the people (not the pattern).

IMHO, sometimes these details matter, as in:

"Let's eat grandma!" vs "Let's eat, grandma!"


"know your shit" vs "know you're shit"


what makes his sentence not an amphiboly? What's the grammatical rule that fixes the "they" to apply to the people not the pattern?

Thanks jxramos, good questions. FTR I had to look up "amphiboly":

  > "Linguistically, an amphiboly is an ambiguity which results from ambiguous grammar, as opposed to one that results from the ambiguity of words or phrases—that is, Equivocation."
Your reply - and a handful of rare / unexpected downvotes led me to re-read my comment, and in retrospect I realize I did a poor job communicating. I intended simply to convey my amusement at the ambiguity. I think for all intents and purposes his sentence was an amphiboly.

"Fixing" it would probably involve rephrasing to reverse the order of "people" and "pattern" in the sentence or just put all the emphasis on the pattern:

"... these patterns, when discovered, have a habit of disappearing"

Strict correctness regarding subject:verb agreement can, like other grammatical constructs, lead to non-idiomatic, awkward phrasing. Formal "rules" about prepositions are the first related example I can think of. ("... of which I can think" is awful, right?). My point was just to laugh at the ambiguity. (shrug)

PS The sinister "people are disappearing" interpretation was the 1st way I read it.

That "predictor" or monetary stock and flow theory that blog post describes is well over 100 years old now and very well known (pre-Keynesian and going back to at least Irving Fisher). It has also been studied in detail in academia for decades if anyone wants to look up proper research studies about it. The blog author maybe should have mentioned that this is already a well known and tested predictor, and if the author hadn't heard of before writing that blog post I would question that entire site.

There are also several companies that specialize in providing this exact cash/equity data research to financial firms to help them manage their trading strategies and offering more practical details in their data than FRED data offers. For example TrimTabs [1] (no affiliation) has been around since 1990 according to their website [1] trimtabs.com

One thing to keep in mind is that predicting a downturn in the short-term is different than predicting long-run performance over 10, 20 or 30 years. I think the website is trying to do the former and your article is talking about the latter.

After being receptive to this article at the outset, I've become much more skeptical after thinking about it some more, to wit:

1. Why 10 years as the forward return period -- would be nice to see the situation for other return periods, even close to 10 years. Granted, it is a round number and doesn't appear to be cherry-picked, but still.

2. Why 1952 as the starting point -- presumably because the data from FRED starts there, but can this not be extended further back?

3. Why an implausibly linear relationship between the equity allocation percentage, which is bounded (0%-100%) vs. the returns, which is unbounded on either side, over such a large range of values? What is the mechanism to explain this? In other words, what is the proposed model that transmits allocation percentage into a return, even if the directionality of correlation is at least likely? What happens around 0% and 100% allocation -- do the extreme cases make sense?

I'd like to run my own data before I believe this.

The idea definitely makes sense, but what is the use of this graph? It only shows past returns based on information we already know. Far more interesting is the realization, which is not news for people who observe these things, that prices cannot go down until there is a crunch on the money supply. After all, the allocation of stocks usually remains constant or goes up when prices are going up, so only money supply can change the dynamic of price escalation. The same happens on the way down, because prices are decreasing, the allocation naturally reduces, even if investors want to keep it constant. Only new money supply can reverse the trend of equity price declines.

In the same blog as your reference [1] you can find one of the more thought provoking essays I have read in the last little while. It's a discussion about how easier stock market diversification should lead to permanently higher multiples on earnings.


Highly recommended.

"Unfortunately, when we flip the point around, and say that the universe of risk assets should grow more expensive in response to improvements, people get concerned, even though the exact same thing is being said."

Discredited the article to me..

Improvements of a market reduce its friction and make it more efficient: transaction costs disappear for instance. Cost and price aren't the same thing. The latter includes the former.

Price can be seen as formed by a supply-demand process. In this process investors and capital seekers are BOTH subject to the cost of an inefficient market. They're not two sides of a coin.

Maybe not so recommended.

Nothing he says is contradictory to the point you are making here. As markets grow more efficient it become easier for buyers to enter the market which increases demand which causes asset prices to rise.

You are right in saying he doesn't contradict me as I am giving precision and I am trying to contradict him. :-)

Basically you say that the decrease in friction in a market drives the demand up: as markets grow efficient it become easier for buyers to enter. However I see that it become easier for seller to enter as well! So it is not necessarily a driver of demand..

This argument can be correct in an asymmetrical market like the ones for bonds, equities, real estate, commodities but it doesn't hold in FX markets for instance (perhaps the money market as well) or other derivative markets where there is not so much bias in being a buyer rather than a seller.

Although, I might say this argument can be available in a world were investors are in majority of the 'buy and hold' type. Which is the world we live in actually! So I can agree with him that new market opportunities and improvements in market efficiency can be an explanation for the flow of cash, and thus inflated prices... even bubble genesis! The venture capital markets or the crypto-currency ones are perfect examples.

To conclude you made me think twice about that and I kind of agree with him but I still don't think it is a universal argument.

Thanks, it would be interesting to see how this has trended throughout this year. The FRED chart is only current to January 1 2017, despite the terms being updated quarterly.

I personally don't think the past 100 years are going to look anything like the next 100 as far as the stock market is concerned. But we will see.

Pure astrology

Not nearly as bad as some of the "Technical Analysis" I've seen. From what I gather, "Technical Analysis" just amounts to this is what the stock has done in the past, maybe it will do that in the future?

Yes and no. It depends what type of technical analysis you are doing... If your technical analysis has no other inputs except the price(over any period(s) of time), then you may as well go buy a lottery ticket.

If you are wondering which category you are in, if at any point during your "analysis" you find yourself looking for things with names like "evening star", "bullish engulfing", "head and shoulders", etc.... save yourself some time and money, and go buy that lottery ticket. Day trading is not for you.

If your technical analysis is looking at volume/price/depth-changes, then congratulations, you are on the right track. Next you have to overcome the largest and most devastating hurdle, which is your own psychology.

Could you suggest books that go deeper in the second type of technical analysis? Most of what I find online fits well in the first type you described.

The best resource I know is John Grady's "No BS Day Trading" book. It's part of his basic course at http://www.nobsdaytrading.com/courses/basic-course/

Reading that and applying it was a huge turning point for me in my trading.

Couldn't this strategy be easily automated, and therefore, probably has been competed away by now?

The more this strategy is automated, the more effective it becomes. This is a simple explanation for "trends", as people see liquidity consumption and enter on the side to further consume it - more people repeat the pattern. The net result is a "trend", which is a blunt way of saying "demand exceeded supply in <x> direction".

There is no sane way to automate this, since everyone's description of "enough" volume delta is different. Perhaps I open positions at a CD imbalance of 15%, bank of america waits on 19%, and chase at 25%. My actions at 15% further the delta, causing bank of america's 19% threshold to fire, which in turn increases the delta to 25% causing chase's threshold to fire. Until every day trader "gets on the same page" so to speak, this will not be automated. And...if they ever do get on the same page, then it only takes 1 person with decent equity to take the other automated strategies to the cleaners.

tldr; This will be automated away when greed no longer exists, i.e. never.

This is most adaptive algorithms work, though. As your scenario gets played out over and over, the high threshold people will notice the decline in profitability and look for ways of improving the algorithm. They'll look at the various parameters and notice that the lower the volume delta the higher the return, so the volume delta parameter will come down. As everyone's volume delta comes down, the strategy will work less and less until it roughly equals the discount rate.

Anything that can be completely automated will lead to an elimination of excess returns. Having a single parameter that differs between market participants is not enough to stabilize a long-term imbalance.

I appreciate the comment, but it just doesn't work out that way. In theory yes, what you are saying holds up. In practice(I'm running these 24/7 and generating my income solely from them) this has not happened yet, and is showing zero progress towards happening.

Can anybody explain the fundamental reason behind "resistance/support lines" in technical analysis?

I'm guessing it is a self-fulfilling prophecy (everybody believes in it, so it becomes true), but perhaps there is a logical explanation that I'm totally missing.

Quoting from Bruce Kamich's How Technical Analysis Works:

Support and resistance areas form because market participants remember price levels, and they tend to react as a group when a stock returns to those prices. A simple example will make the concept easy to understand. Let's imagine that you and other investors bought a stock at its initial public offering price of $20. People who did not buy the stock at the offering price are interested in buying it at that level, and they buy the stock at $20 or perhaps above $20 as interest in the stock builds. Other buyers come in and the stock trades up to $22.

The stock may trade back and forth between $20 and $22, but let's imagine that at some point the stock slips down to $16. Some traders will hold on to the stock, hoping that its fortunes will reverse and it will trade back above $22. But if the stock remains depressed, owners of the stock who bought it in the $20 to $22 area will begin to think it would be nice just to break even. If the stock does trade back up, the desire to get out at break-even will become even stronger as the stock approaches the $20 to $22 area.

To put this price zone into perspective, the more sideways trading that occurs, the greater the supply of stock will be. There will be more people who want to "get even," and therefore there will be more resistance to the stock's advance.

Support and resistance are not precise concepts. When support develops during a decline at a price short of the exact level, it is usually because traders are anxious. They remember the prior resistance level at $22, but they start buying on the way down at $22.75 and $22.50 because they are anxious or even fearful they will not have the opportunity to buy again at $22.

On a few occasions, eager traders might push a market too quickly through a support level, and support might not develop until just beyond the support area. Whether support is found short of the expected level or just beyond the level will tell you how eager or fearful traders are.

We have seen that when support is broken on the downside, it then becomes resistance. The opposite is also true; resistance, once broken, becomes support. This reversal of roles is due to the memory of traders and investors who want to get out of their losing trades at break-even, and traders who want to increase winning positions by buying more stock at or near support.

The role reversal of support and resistance leads to the formation of trends, because in an uptrend, market pullbacks or reactions will tend to find support at the last resistance level. In a downtrend, reactions or rallies will tend to find resistance at the last support level.

All support and resistance levels are not equal. The strength of a support or resistance level depends on several factors, such as the number of times the level or area was tested, the volume of trades transacted there, how long ago the formation appeared, and whether it was a round number of a "big figure." Even knowing the type of security will help in determining the validity of the support or resistance area.

The more times a level or zone of prices is tested, the more important that level becomes. A level that is tested six times and holds tends to be more important that one that was tested only twice. The more times a support or resistance level is tested, the more traders will remember it and the more traders will be likely to be committed near it.

When a large volume of trading occurs in a support or resistance area, that adds to its validity because a greater number of traders and investors will remember the level, so their commitment to the level will likely be greater.

The further back in time the support or resistance area was formed, the dimmer the memory, and the more likely that people have already acted on new information and may not respond in the same way again. They moved on by liquidating their positions. An area of support or resistance that was formed recently tends to attract a greater number of people who are still committed to the level. Thus, these nearby levels have more validity or potency.

When a support or resistance level forms at a round number or a big figure, such as $100 or $1,000 or DJIA 10,000, many more people will remember the level because it is easy to remember and obvious. In turn, the more people who remember and act at that level, the stronger the support or resistance will be.

This is a good explanation of the psychology when trading these "imaginary lines", but for example it does not explain why distances between horizontal resistance lines have the ratios of the Fibonacci sequence. Horizontal lines are not that interesting, even though they are powerful. What's much more astounding are the angled lines and things like the Gann fan, or the Fibonacci speed resistance arcs.

Thanks. I think this only explains resistance/support lines which are horizontal, but in technical analysis these lines may also have a slope.

From eye-balling the chart, it seems to consistently lag. Am I mis-reading it, or is this not actually a predictor?

You're mis-reading it. The blue line is subsequent 10-year performance, so it's already shifted back (left) several years from its natural alignment on the chart.

If I'm reading this correctly, the indicator is currently at 0.42? Somewhat above the lifetime average of 0.35, and well below the 0.50 mark which would indicate stocks are overvalued relative to other assets?

I believe that corresponds quite accurately with the assessment we are currently at the early to mid stages of a secular bull market in equities analogous to the runs during the 1950s and 1980s. But as others have pointed out, it doesn't say anything about the possibility of a correction in the near term. Be careful out there!

When the yield curve begins to dip, a flight to quality will begin into crypto's.

Good luck with that. Usually there's a exodus from speculation the minute things get hairy in the market. Nobody speculated in crypto right?

Like there was in 2008/09 when most people in the world lost confidence in banking systems followed by the bailouts and Quantitative Easing.

> in 2008/09...most people in the world lost confidence in banking systems

You mean when everyone sold securities, moved to cash, and bought Treasuries, CDs and bank deposits?

2008 was great. Everything was on sale, and I doubled down on my stock investments...

With money from where?

If your money wasn't in the market, you might have been lucky with timing but statistically if you replay that scenario, you're losing out on gains by not just parking your money in the market in the long run.

I did get lucky, to be honest. I had low 6 figures in a total stock market fund and a similar amount of cash sitting around.

> With money from where?

Your salary, invest you savings in the market.

> And Bitcoin

Given Bitcoin's "capitalisation" failed to hit even $10bn until well after the crisis [1], it's safe to say that more capital moved, in almost any single U.S. state, from stocks to corporate bonds, than from anything to Bitcoin. Being optimistic about the future of a technology is fine. Being delusional about its history is not.

[1] https://blockchain.info/charts/market-cap

Ignoring correlations to market downturns and ignoring the data is delusional https://www.google.com/search?site=&tbm=isch&source=hp&biw=1...

Bitcoin came into existence in 2009. Nobody was buying Bitcoin in 2008 because it did not exist in 2008. We don't have data to support the claim that people would rush Bitcoin amidst stock market crashes. We do have data supporting the claim that they rush into traditionally safe assets, i.e. insured bank deposits and Treasuries.

Regarding Cyprus, wealthy Cypriots--by and large--bought German and Greek government bonds, not Bitcoin.

The crash came into existence in 2008 and Bitcoin began to rise in 2009. https://www.washingtonpost.com/news/the-switch/wp/2014/01/03...

> Bitcoin began to rise in 2009

Bitcoin came into existence in January of 2009. What was it supposed to do? Start stealing its owners' money and go negative?

Also, everything rose in 2009. The S&P 500 was up 23%. Bonds were up, commodities were up...that's what happens after you scrape past a global financial meltdown. Sure, Bitcoin was up like five thousand percent, but that's the difference between a tens of millions and hundreds of billion in market capitalisation, things that are very volatile and things that are not, and venture versus mature.

Everything rose but not before everything crashed in 2009: https://www.google.com/finance/historical?cid=626307&startda...

Those who've hedged with crypto's as a trading vehicle are likely to win again during the next inevitable downturn.

AFAICT, the source you cited (dated 2013) quantifies the investors merely as 'many Spaniards', and from the grandparent's source, we know that the Bitcoin market cap around that time was around $1bn, which is not even rounding error on the scale of financial markets. You're not ignoring the data, you're imagining it.

The religiosity on the side of "traditional" assets is exactly why they missed the boat. Whenever traditional models are threatened, the pitch forks come out. The VC industry is having it's Uber-moment. The disrupters are being disrupted.

People are downvoting you, but you're not wrong. Bitcoin is legitimately seen as an alternative to gold. So it's not crazy to expect people to buy BTC when shit hits the fan in the fiat markets.

No it's not. The only people that view Bitcoin as an alternative to gold are the people buying/trading in Bitcoin. No one else is that delusional.

> Bitcoin is legitimately seen as an alternative to gold.

Bitcoin may be an alternative to gold but it is not the same.

1) Gold has intrinsic value.

2) Gold is a tangible asset.

Gold having intrinsic value is a straw man argument for it being different than Fiat currencies. Consider this thought experiment. You are going to live by yourself in the forest for a month. Would you rather have A) a weeks worth of food or B) 1 oz of gold. I think this highlights there is no intrinsic value or at least much lower than what people claim. Obviously, there is place for gold in electronics and circuitry, but aside from specialized applications, the need for gold is pretty low.

Now, I know that I've committed a straw man argument myself by using a contrived example. To that, I'll say that the only "value" one has by having gold in the real world is that other people will trade you for it. But this is exactly the opposite of intrinsic value. The value of gold being entirely fabricated by people's desire to hold it.

Gold's price is not supported by its instrinsic value, I'll give you that. But the "forest" test is absurd. By that definition computers, chemotherapy and candy have no instrinsic value.

Gold's value comes from its (a) millennia-long history of stably holding value across cultures and technological domains and (b) its tangibility and physically-enforced scarcity. Its intrinsic value is a fraction of its market value, in part because the inflated price deters lots of uses.

But point a and b in you're assessment of gold's value are two of the most common arguments for crypto, specifically bitcoin, as well.

a) crypto holders believe that the value will hold because as more individuals use it to store their net worth, the harder it will become to manipulate. ie. a history of price growth/eventual stabilization will occur in time.

b) its algorithmically-enforced scarcity, which many people believe is as valid as physically-enforced scarcity. So long as hash-based cryptography always works.

I think there's potential for cryptocurrencies to find homes in the modern financial landscape. But your counterpoint (a) is based on network effects. Distinguishing between short-term bubble behavior and long-term resilience can only be done after knocking the system with crises. Is there hope? Sure. Is it demonstrated? Absolutely not.

There is one feature gold has over Bitcoin that cryptocurrencies cannot replicate: resilience across technological domains. Gold holds value without computers or electricity. Bitcoin does not. Gold, on the other hand, cannot travel at the speed of light. TL; DR each solves different systems of trade-offs.

If we somehow get to a world without computers and electricity, I doubt gold has much value either. Water and bread though, those will be valuable.

> Gold's value comes from its (a) millennia-long history of stably holding value across cultures and technological domains

That's recursive - you're basically saying that gold has value because it has historically being valuable. Which begs the question of why it has been valuable.

I'm not saying that this doesn't add some (most, in fact) value to gold. I'm just saying that this isn't a property that is enabled by anything specific to gold.

> this isn't a property that is enabled by anything specific to gold

With money, you want five things: fungibility, durability, portability, cognizability and stability [1].

On fungibility, gold is an element. It can only be extracted, not produced in a conventional sense. In fact, before the 1669 discovery of phosphorous, humans had only purified, from oldest to newest, copper, lead, gold, silver, iron, carbon, tin, sulfur, mercury, zinc, arsenic and antimony [2].

Out of those, lead, gold, silver and mercury are chemically stable, though only gold and silver are also physically durable. Both are easy to recognize, though more metals are "silvery" in color than yellow.

Gold won due to stability, in large part because of a few flukes. For most of human history, growth was flat and gold mining was minimal. When we actually started growing, the major powers were using gold. The rate at which they added to global gold supplies happened to mirror their economic growth; this gave gold a few decades of price stability. That memory, together with the millennia of use, forged a cultural memory in the furnaces of the industrial revolution that remains, vividly, to this day [3].

> That's recursive

Cultural memories, like trust, are re-enforced by network effects. Your observation is correct. Gold got where it got, in part, due to luck and then just stuck.

Can that be replicated? Perhaps. I personally think our obsession with gold is silly. But engineering that properly means understanding why it happened in the first place. At least amongst Bitcoin enthusiasts, I come across the types of comments you see others making in this thread, as opposed to bona fide introspection and defenses.

[1] https://en.wikipedia.org/wiki/Money

[2] https://en.wikipedia.org/wiki/Timeline_of_chemical_element_d...

[3] https://core.ac.uk/download/pdf/6252203.pdf

So what you're saying is that gold is JavaScript - it got significant early adoption because the alternatives (like VBScript) were worse, and then that just amplified until it boosted it into an unassailable position. ;)

I do admit that my forest example is absurd. I just wanted to elucidate, as you pointed out, the price isn't supported by human's necessity to survive.

Your last point brings up an interesting tangent, if gold wasn't treated as a store of value, what would its price be? Would it be similar to diamonds where synthetic ones are half the price? Are you aware of any sources that try to answer this question?

I'm not sure gold has been stable recently. it has regularly had 30-50% swings up and down over the last 10 years. recently well off it's highs.

What if trade is essential to survival, and gold checks all the marks as the medium for trade? Of course this could only be the case in a primitive society. If you believe contemporary society could revert to a primitive one, then you would be compelled to hold gold as a hedge.

I've never seen market valuation expressed as market cap as % of GDP. I'm not an economist, so I'll leave the detailed arguments to them. But it would be at least useful to explain why you think this is a meaningful metric as compared to those typically used to measure market valuation (e.g. P/E ratios etc.).

Your graph also ties your valuation metric to the 2000 peak and the 2008 peak. However, there were crashes in 1990 and 1987 as well. Should readers conclude that the 1987 peak level was also too high, and that therefore the last ~30 years have also been too high as well? (Abstaining from investing in the stock market at levels above the 1987 crash would have resulted in the loss of tremendous opportunity for wealth creation.)

There are a lot of opinions implicitly expressed in this site; it would be good to try to make those explicit.

> market valuation expressed as market cap as % of GDP

This metric makes little sense for this use case. Consider two countries. They are identical in every way except in Country A 90% of the companies are publicly-traded while in Country B 10% are. Country A will have a market cap to GDP 9x Country B's. Does that mean Country A is 9 times overvalued relative to Country B?

The objection works in-country, too. Saudi Aramco is going public in New York or London [1]. This will lift one of those market's aggregate capitalisation by up to $1 trillion. Does this mean that market will necessarily become overpriced?

The answer to both question is of course not. Market cap to GDP tells you the degree to which a country has developed public markets. Not anything interesting about the levels in those markets.

[1] https://www.bloomberg.com/view/articles/2017-04-05/aramco-ip...

So I've had a fundamental complaint about Market Cap to GDP at least since 2005, which I've never gotten a good answer to:

There's this expectation that the market returns 7-10%... a number much in excess of the actual rate of GDP growth (over any significantly long period, anyway)

That can't continue forever. Especially in aggregate across the world. At some point the public market has captured substantially all the economic activity - after that there's no way for it to grow in excess of GDP without things like PE increasing (and again, that can't go FOREVER, regardless of what the "true" PE should be).

This is assuming all numbers are inflation-adjusted "real" numbers, of course, because the money supply CAN grow forever.

I'll probably get some of this wrong, but I read up on these arguments back when Piketty was in the news w/ his book:

Yes, it can go on forever -- the rates of retun in the stock market are based, theoretically, on the changing expectations about the future and not based on current income.

Thought experment: 100 of us live in small society producing widgets, we each make a widget a day at the factory. GDP is 36500 widgets/day. We also spend some time researching a way to make widgets faster. Yesterday we found a breakthrough that made it 50% likely that in 5 years we'll each be making 10 widgets a day.

It would be reasonable for the valuation of our widget company to go up something like 40% on that news, right? But GDP next year is stlil going to be 36500 widgets/day.

Since the stock market bakes in all optimistic expectations, then in the eras it that it outpaces GDP it could be the case that there remains unrealized optimism for the future.

If the question is "but where is the capital coming from that flows into the stock market?" The answer is that it can be created via credit, or it could be created via appreciation in assets not captured in the stock market (like housing, the major one).

Your example anticipates a huge growth in productivity, which is a factor in GDP; in that case, the stock market is a forward indicator of anticipated GDP.

Which, if so, still doesn't allow it to grow infinitely out of proportion to GDP, unless the time horizon keeps changing or the anticipation of the future gets steadily farther away from reality.

So you mention in the eras it that it outpaces GDP... I've consistently had the message drilled into me that in the long term (20+ year horizon), stocks will return something like 7-10%, while of course, nobody would expect GDP growth anything like that (outside of a rapidly industrializing environment where productivity is rocketing upward, like China).

An era is not forever, so...

5% of the returns is the profit being reinvested (for example stock buybacks), 2% is inflation, 2% is real gdp growth.

Nit pick: only about 5% of Saudi Aramco is going public, the total company is worth $1-2T (although this is a matter of some debate, as you might imagine), so aggregate market cap will only increase by $50B.

[0] https://www.cnbc.com/2017/04/24/saudi-aramcos-valuation-repo...

> aggregate market cap will only increase by $50B

If you list 5% of a $1 trillion company on a stock exchange, the aggregate market capitalisation goes up by $1 trillion. (Float goes up by $50bn.)

Market capitalisation is price per share times shares outstanding [1]. Float is price per share times publicly-trading shares [2].

[1] https://www.fool.com/investing/small-cap/2005/04/29/quotouts...

[2] http://www.investopedia.com/terms/f/floating-stock.asp

You sound knowledgable about these matters, and I am not. In my ignorance, "agg. market cap" sounds like an easily gamed number. For example, I could start an exchange and ask every company in the world to list 10^-10 of their shares, and so become the largest exchange in the world by agg. market cap. (Perhaps this doesn't come up in practice because most firms list in only one market, and so agg. market cap becomes a useful measure of how much of the economy a given exchange touches, in some sense.)

It does come up in practice. It's actually a common scam.

When only a small fraction of shares are on the market, it's quite easy to manipulate the price higher... buying pressure goes a relatively long way.

If you can get 1% of your shares to be worth $100k, it now appears as though you are a $10 million company. This makes you appear reputable.

Drive hype about your "valuable" company, and once the stock is sufficiently pumped, dump your shares for profit.

Market cap as % of GDP is a statistic famously used by Warren Buffett


Here is the case for looking at Market Cap / GDP: Warren Buffet looks at the total market cap vs GDP because it is free from the influence of corporate accounting, unlike the more traditional P/E ratio.

The case against: economic activity in the US has been concentrating in larger companies (less small companies being started for example) and there is more "financialization" in general. So you would expect the ratio of market cap / GDP to go up for those reasons as well.

One issue I see here is how much of the S&P500 (or general market cap) are we attributing to a US-centric view of global companies? That is, if a company is "in the US" but economically are not.

In fact unless I'm missing something the units don't match up:

  Total stock market value has units $
  GDP has units $/year
So expressing their ratio as a % is misleading.

The ratio has units of years - how many years of GDP does the value of the stock market represent? How long will it take the economy to produce the value assumed by the stock market valuations? Sure, that's not a pure number, but it's also not a totally nonsense number. At a minimum, it can be compared to historical values of the same number.

A good similar example would be speed as a % of distance. Eg going on a trip 240 miles at 60 miles/hour is 0.25. Same thing.

Good points, I might go into a bit more detail for how I calculate the risk for each factor.

Thanks for the feedback

It makes some sense if you consider market caps to be expectation of returns. All other things being equal (like the percentage of the GDP made by publicly traded companies) it makes sense to expect the market to expand at about the same speed as the GDP.

That this ratio doubled in 8 years is worrisome.

The thing is that an alternative analysis is to look at the linear regression since 1980 and it seems clear that a background upward tendency does seem to exist, so we can see 2009 as an adjustment to the 2008 crisis and 2017 as only slightly above the expected trend.

In particular, people's evaluation of a company are not (wholly) based on its current annual output, whereas the GDP is exactly the amalgam of all companies' output. People evaluate a company at least in part on the assets it holds, intellectual property, and future earning power, none of which are captured by the GDP.

You should always use separate validation data anyway.

For market overvaluation, it says: 9.1 / 10 "DEFCON 4"

DEFCON 5 is peacetime, DEFCON 1 is imminent nuclear war. For example, during the Cuban Missile Crisis, the US reached DEFCON 2. Should this say DEFCON 2 instead? Or is "above" normal readiness the intended meaning?

Yeah was trying to communicate "moderate risk", but it's kinda tongue in cheek.

We got the tongue in cheek point of the comment. However what is being discussed is the ordering. Defcon 1 is more serious than Defcon 5. ie it counts backwards from 5 to 1 as situations become more serious. So your comment should be Defcon 2.

Pedantics aside, I did enjoy those little comments you put alongside the threat level.

You can just write DEFCON 3 and this will communicate the same "moderate risk" message to everyone, no matter their understanding of how DEFCON levels work.

The movie Wargames guessed wrong. As a result, the public understanding is backwards from the real NORAD numbers.

https://en.wikipedia.org/wiki/DEFCON https://www.youtube.com/watch?v=UHBqJj0znYo Seems consistent to me, DEFCON 1 is war, 5 is peace

My comment was from memory, based on my recollection of the director's commentary on the DVD. I'll have to see if I can find any supporting doc.

The metric used to calculate market overvaluation is interesting but it has little value for predicting a stock market crash. Let's take he last 3 major US crashes:

1987: this crash was caused by automated trading systems which could run wild in the absence of any prevention regulations such as circuit breakers

2000: the collapse of the dotcom bubble

2008: start of the financial crisis caused mainly by opaque credit default swaps and packaged subprime loans

Of those 3, only the dotcom bubble seems to be a bit related to the market overvaluation metric. And even right before the dotcom bubble crash there were plenty of economic guru's who argued that classic overvaluation metrics were not valid anymore because we were now in a 'new economy'.

The other two crashes were caused by black swans; occurrences that nobody was aware of and that were only understood afterwards. Most likely the next crash will be a black swan as well.

No, the 2008 crash wasn't a black swan. It just came from the debt side, rather than the equity side. It was clear this was coming. In 2004, I wrote this, on my "downside.com": [1]

The next crash looks to be housing-related. Fannie Mae is in trouble. But not because of their accounting irregularities. The problem is more fundamental. They borrow short, lend long, and paper over the resulting interest rate risk with derivatives. In a credit crunch, the counterparties will be squeezed hard. The numbers are huge. And there's no public record of who those counterparties are.

Derivatives allow the creation of securities with a low probability of loss coupled with a very high but unlikely loss. When unlikely events are uncorrected (I meant uncorrelated), as with domestic fire insurance, this is a viable model. When unlikely events are correlated, as with interest rate risk, everything breaks at once. Remember "portfolio insurance"? Same problem.

Mortgage financing is so tied to public policy that predictions based on fundamentals are not possible. All we can do is to point out that huge stresses are accumulating in that sector. At some point, as interest rates increase, something will break in a big way. The result may look like the 1980s S&L debacle.

It took longer than I expected for that to kick in, but it happened.

[1] http://downside.com/news.html#comingmortgagecrunch

The Economist had strings of articles on this, about how the models used to price vast sums in derivatives were fundamentally flawed, the risks to the financial system, lack of regulatory tools to address possible issues. Warren Buffet famously called CDS/CDOs weapons of financial mass destruction. But when people are making money and everything looks sunny side up, warnings like yours are rarely heeded.

so "black swan" is a paradox. a black swan is when something that happens outside of the models. it being in YOUR models means it wasn't a black swan for YOU.

as such there are probably no such things as black swan events. I mean, until there is. Its more like Schrödinger's swan.

For this kind of event, you can see the pressure building up well in advance. Often, it's not clear what's going to break, but at some point, something has to give. A real "black swan" event was Hurricane Sandy. Flooding of Lower Manhattan was not expected.

What looks risky now?

> 2009-05-31 - Conventional wisdom

>The future is now in the hands of political forces. We can't predict that from fundamentals. So we have no further predictions at this time.

So diversifying ones portfolio based on ones portfolio exposure to "political risks"? Usually you see people trade on that in currency markets? If most of ones portfolio is dominated by a single currency (and hard to liquidate to another asset?) one will have the most exposure to the political risks in that particular locale?

That reflects the TARP bailout and the Fed's policy on interest rates. The Fed bailed out the banking system by lending money to banks at very low rates, which they could then profitably re-lend at much higher rates, allowing banks to pay back the TARP loans. My point was that this was a political decision, one not predictable by financial analysis.

Through all that neither the dollar nor the Euro moved all that much compared to other markets. Housing, oil, stocks, and gold all moved more.

student loans.

The government owns student loans.

> The government owns student loans.

To back up your point, the US federal government guarantees the vast majority of the student loan market: https://fred.stlouisfed.org/series/FGCCSAQ027S

I believe the total student debt market is estimated somewhere between $1.3-1.4 trillion these days, so at least 77.5% backed by US taxpayers. I don't know what TARP topped out at, but I doubt it was 75% of banking assets.

A) not all of them.

B) the government owned the mortgage debt, given that they paid it.

I think the main question is how to get access to capitalize on the downside risks of A).

- Find out who has exposure to student loans portfolios and what percent is non performing?

- Find out what other assets A) is holding that will have liquidation pressure if *-swan occurs?

- What extent is B) tied to A)?

- What pressures B) would face long term due to non performance of student loans that would influence A) and the larger market of assets under the jurisdiction of B)?

- How much could be made from theoretically capitalizing on the downside risks of A) vs other assets in the mean time?

Subprime auto loans.

I see this as fundamentally different, mostly because it is far easier to repo a car and auction it off than it is to foreclose on a house and sell it to someone else.

Another thing is that no one is wildly pricing cars; the fact that lots of subprime people are buying cars does not drive up the price of cars for everyone else. Thus, if a whole bunch of subprime borrowers default, the rest of us aren't sitting there with a car that's actually worth a quarter of what we thought it would be worth.

We also don't keep an enormous share of our equity in cars the way that we do in housing.

True. Except it may be able to be used as a proxy for larger economic issues. If borrowers are defaulting on their car loans at a higher rate than usual, it begs the questions: "why" and "why now"?

Everything based on crypto currency.

It only counts if it's something that's riskier than it seems. Everyone knows cryptocurrency is extremely risky, the problem in 2008 was that these packaged mortgage products were far riskier than they appeared, far riskier than they were rated by Moody's, S&P, etc.

Maybe you only meant your comment as snark, but if not it's important to understand the difference between simple risky investments and potential structural flaws in the finance system, like the ones we saw in the financial crisis.

Do you think there's another housing bubble now?

To answer that, look at the ratio between median house price and median income. Historically, that's around 2.2. Freddy Mac says 3.5 is the new normal. It got up to around 4.7 before the 2008 crash, and peaked around 10 for California.

This is a measure of whether people can make their mortgage payments. When that ratio gets too high, foreclosures rise.

The Economist has an interactive chart, but, annoyingly, they don't let you see the absolute ratio number, just its trend.[2]

[1] http://www.freddiemac.com/research/insight/20160531_how_to_w... [2] https://www.economist.com/blogs/graphicdetail/2016/08/daily-...

I don't see it.

"occurrences that nobody was aware of and that were only understood afterwards"

Umm, I'm no genius but I was managing my mother's money at the time of the 2008 crash. It was very obvious to me that there was going to be a crash, I pulled out of the market in late 2006 and didn't lose a dime in the crash.

I think the better statement is "The 2008 crash was obvious but many people were in denial".

Again, I'm not a financial wizard, I could just see the writing on the wall on that one, everyone was getting approved for houses they couldn't afford, you just knew that was not going to end well.

You can see the writing on the wall now, with stocks being pumped up around the world by central banks and with margin debt at an all time high.

The problem is, it could be years before there is a collapse, or it could be tomorrow. That's a lot of yield you might be losing out on. A near similar argument could be made in 2014. You probably could have doubled or tripled your money in that period.

And even if there is a correction, not all equities will decline significantly (some will stagnate, or just decline a few percentage points, some will still double), whereas others will lose 80% of their value.

> The problem is, it could be years before there is a collapse, or it could be tomorrow. That's a lot of yield you might be losing out on. A near similar argument could be made in 2014. You probably could have doubled or tripled your money in that period.

All true. I think what makes sense then is not to get out of the market entirely, but depending on your risk tolerance, simply re-balance so that you own less stocks at a time like this, while holding more cash or alternative investments.

Look into structured notes. You can get some gains with sort of an insurance policy.

I just started reading about structured notes.

How does one go about actually purchasing them? It doesn't seem they're available through typical online brokers like Etrade or Scottrade.

Predicting a crash is easy but timing it with accuracy is extremely difficult. In fact you were two years too early and lost out on a lot of potential return.

There will always be a crash/correction. Easy. But when?

Completely agree. Yeah luckydude I can say with 100% certainty that if you took all of your money out right at this moment, you won't lose any money in the next crash. Give me the nobel prize in economics guys.

unless the 'next crash' is runaway hyper inflation.

Great point! Important to look at crash in real, not nominal, terms.

More: https://en.wikipedia.org/wiki/Money_illusion

The correction will happen immediately following the moment the tape prints it. It always has, it currently is, and will continue to do so in the future.

The problem is people aren't watching the tape. It's thought of "too hard"(by those who fail), which is another way of saying their net ability is inadequate for a career in trading.

The market has always told us what it is going to do, seconds before it happens. You have to be willing to watch those seconds though, and capable of interpreting the tape during them... 1 day candles? too late. 30m candles? too late. 1m candles? maybe, but overall too late. The timeframe you are looking for is "real time", which is present in time and sales(and nowhere else). Anything else is inadequate for consistent profitability, but there is no shortage of people failing to be the exception.

You did well (you are a lucky dude), but I'm sure there was someone else who pulled out in 2003 and looked foolish.

If it was obvious, more people would have pulled out.

A crash is simply the result of it becoming obvious that the market is overvalued, is it not? Everyone heads for the exit at the same time.

Not really, it can be obvious the market is overvalued, to the point where almost everyone agrees this is true, but there is still money to be made and the momentum is still upwards so it keeps getting even more overvalued. A trader doesn't care how overvalued a share is compared to fundamental economics, he cares whether it's overvalued compared to it's likely price tomorrow or in 10 minutes, or in a few milliseconds. Then something happens that makes it real, like Lehmans being unable to meet its obligations.

Yeah, there were a huge number of articles in 2006 with a theme of market doom and housing debt and CDOs being the culprit.

So you pulled out in 2006... When did you get back in? Timing the market is hard...

Like I said, I'm not a financial wizard, so I'm mostly in cash and I've missed some upside. Not completely, have a pile of Apple stock that's done well, but I'm not the right guy to be managing money. So I've moved most of it to a guy at Morgan Stanley that a friend has been using for a long time.

What are you paying, out of curiosity? 1% of AUM?

It varies based on what gets traded. And I don't really know because I stopped thinking about what I was paying and started thinking about what I'm earning. I really don't care what his cut is if I'm netting 3.75-4.0% on average.

If that works for you, that's fine... It's your money. You're probably paying this guy 1% in fees and expenses, minimum.

To be frank, 4% is not good. For comparison, my Vanguard account, which is mainly low cost ETFs and index funds, has had a 11.8% average annual return over the past 5 years.

Enjoying those fees?

Are you in the market presently or have you pulled out again?

Mostly in cash but I would not base decisions off of where I am. Investing is complicated, I've decided I suck at it and have handed it off to someone with a good track record.

There's a proximate vs. root cause argument going on here. In 87 and '00, the stock market was absolutely overvalued relative to historical metrics like the ones linked (and in '08 the real estate market was). It is today too. Now, the proximate causes were not "overvalued" because ultimately something has to "happen" to push an unstable system into a correction.

But realistically the corrections were inbound regardless of the specifics about automated trading, the startup economy, or bank solvency.

There's one coming "soon" now, too. Eventually.

Can someone with an actual economics degree explain to me whether it's a valid criticism of the "Market cap as % of GDP" metric that many US companies derive value from multinational labor and consumption, and if not, why not? Thanks in advance.

SB in economics here and current business school student (I know, I know: burn the future MBA at the stake!).

Indeed, it is a valid criticism. The market cap/GDP measure is mismatched, since market cap theoretically reflects investors' expectation of future cash flows globally while GDP is a measure for only one country. Also, GDP is problematic for a bunch of reasons, so even if all companies were only operating in the United States, GDP would still only be a crude measure of economic output.

Plus, as you mentioned yourself mcap corresponds to the present value of all future cashflows and GDP to one years output. The only way this would make sense is you were comparing changes in GNP to changes in mcap.

It is valid criticism. The rule is a rule of thumb, so isn't like a law of physics. The amount of internationalization would be relatively similar over short periods of time, so is an OK measure cf 10-20 years ago, but yes has problems comparing over a century.

Other similar issues are the amount of private ownership of US companies (that aren't included in Total Market Cap), and also foreign ownership of US companies which is higher than it used to be (I think).

What about student loan debt, how does that factor into the economy or the stock market being affected?

Right now student loan debt is at 1.4 trillion

source: https://www.debt.org/students/

I wouldn't worry about student loan debt being a problem. It's very likely that they're going to get a bailout before a bubble bursts. Where on earth did I come up with this, you ask? Easy - I just paid my student loans off last week. It's only natural that everyone else will now get bailed out!

Seriously, though, this is a real problem and we need to do something. Even if it doesn't have a direct effect any time soon, it's going to have an indirect effect as our generation (I'm some kind of X-ennial, apparently, but let's just say everyone 20-40) continues to replace retiring boomers in the economy. If we're all saddled with non-dischargable debt, it's going to hurt the housing and consumer spending segments.

> Seriously, though, this is a real problem and we need to do something

the thing we have to do is not borrow money we can't repay. capitalism is a distributed system. borrowing money you can't repay is a broken local protocol. don't try to fix that with anything but fixing it locally.

If all loans were always repaid, we'd have no risk premiums, and the world would be incredibly different than it really is: Almost every worthwhile investment that has moved the world forward involved significant chances of loans not getting repaid.

What is broken with student loans is that the current scheme messes with almost every sensible market incentive out there: Colleges get more expensive for little to no reason, people can get into big loans for degrees that will never pay off, and the companies lending the money are, in practice, guaranteed repayment by the treasury, so ultimately the whole scheme leads to far higher prices than, say, college in Europe, but only provides better outcomes for some school+major combinations.

Let's not forget, the system leads to degrees that have low expected values to end up being unaffordable, while prices would go down if the system wasn't built with the silly guarantees that it has. Putting the blame on the borrower alone and ignoring the insane system design is just shortsighted.

If someone went to try to launch pets.com today, we'd not blame the founders alone for the VC's loss: They carry responsibility too for betting on a horse that had no chance of even finishing the race. A VC takes risks, but also expects losses. Anyone making loans should consider chances of delayed payments and of losing all the money completely.

Let's go back to your idea of protocols. Imagine we are making a requests over a network and expecting the network to not be lossy, and to never have long network partitions, or for other servers to go down. We can be angry at the network or the server on the other side, but in practice, what we do is understand that failures exist. Expecting everyone to pay you back all the time is like expecting a distributed database to be reliable all the time. I can scream at the network or the database vendor, but ultimately the joke is on me for expecting impossible things.

I was forced when I was 17, to pick a private college, people didn't let me do what I wanted.

At same time, I was repeateadly promised by all 'adults' that I was very intelligent, and that getting into a college would ensure I would get a job, and it is why it was so important.

After lots of struggling I ended doing what people wanted, got in a college, and I had no way to pay for it, so I got into debt too. (and I hate debts, I used to never get into any debt at all).

Around time I graduated, the last crash happened, my country never really recovered from it...

I am 29 now, and I can't get unemployment benefits, because I was NEVER employed in first place, all work I list on my LinkedIn was by freelance-style contracts, I never found the promised jobs...

I did recently finished paying almost all my debts (I still have some, and my net worth is still negative).

But 'not borrowing money' wasn't really an option.

This is at least partially true, but ignores the "reality on the ground." Even many entry-level jobs require a college degree now, and forgoing a college education makes you unhirable in many markets. Until that changes, "college you can't afford" is pretty much a mandatory expense.

There are ways to minimize the cost -- basically two years at a community college and two years at a state school -- but the days of being able to afford college by working a part time job are long over. The reality is, if you want to participate in today's job market, you probably must take on at least some college debt.

I think college degree is highly overrated, and higher education is very inefficient overall. But it is like a prisoners' dilemma, where all of the to-be-students would be better off if say 70% of them didn't go to college, but no individual has the incentive to decide so.

They wouldn't need to pay the enormous tuition, and as the job market would change (as far less people would have a college degree), the lack of degree wouldn't hurt them.

College degrees are oversaturated, but there's no real alternative outside of a few fields where education isn't as important as experience.

College degree nowadays is basically a pre-requisite for not getting your resume thrown out at first glance.

College degrees used to be a signaling method. It was something rare and desirable. And like many rare and desirable things, the intrinsic value gets bolstered by a perceived value. The value and rarity drives commoditization, eventually making it not rare. (unless it can't or is too exepensive e.g. changing platinum to gold)

Everything has a mix of intrinsic and perceived value and this changes over time. The more a thing is composed of perceived value the more volatile it is. I'd say all stocks are composed of at least 50% perceived value.

Perceived value can often drag intrinsic value upwards so investing in things with high perceived value can still be lucrative. Analysis moves from fundamentals to psychohistory. (bad psychohistory) Probabky based on some combination of time to death of cultural momentum and half life of faith isotopes.

College degrees were a thing that quickly lost perceived value because it was based on rarity. (the only rarity that doesn't drive itself to commoditization is useless rarity like expensive wines and designer bags. 100% pure perceived value things not worth commoditixation)

At an individual level the high intrinsic value degrees do well but overall they haven't as most degrees in the US were supplementary for Masters of the Universe type. Education to fill the void in your life.

The post WW2 dominance faded though and the upper levels of Maslow's pyramid were no longer the issue. Basic survival and making a living was. Globalization also created huge pressure and competition for useful jobs.

What happened in the US was essentially a dearth of sinecure positions based on a secure moat that is now deteriorating. Those who are hit hardest by this desire a return to the past, in their eyes this is being "More American". They simply can't compete with a workforce with much stronger work ethics out of having much more experience with dealing with daily survival of a more extreme kind.

This is how the education system is failing. A country for abundance needs either output or the ability to extract rent via moats or force. The US also has a strong immigration culture that can "steal" output from other countries. Though at the cost of making "doing right by americans" a very loaded and confusing idea to parse.

> the thing we have to do is not borrow money we can't repay.

Literally nobody takes student loans that they are capable of repaying. Why would you, unless you could get a 0% APR?

It'd be nice if young people - possessors of great foresight and fonts of wisdom, all - could predict whether they will be able to repay the very substantial loans they're likely to rack up in college. We are not living in a world, or an economy, where making such a prediction is easy or straightforward.

Literally nobody? My younger brother went to a state college during a time where he qualified for a ~3.4% loan from the government. I told him to take his time paying (for now), because a no-load passive index fund will yield higher than that. The past 3 years have been tremendous in terms of returns. He essentially used his student loans to net 12-18%. When family members caught wind of this, they told him it's not the best move, and our father paid off his loans.

So. No. Not literally nobody.

Using student loans as a form of leverage to invest in the stock market isn't new, so yeah, not "literally nobody." Point taken I guess.

It's just such a shockingly bad idea. We went from the topic of the average kid's inability to gauge the future value of their degree to the topic of the average kid's ability to predict the stock market well enough that using leverage to invest makes sense.

> Literally nobody takes student loans that they are capable of repaying.

Probably one of the most incorrect sweeping generalizations I have ever seen.

I finished my BS in CS about 3 1/2 years ago with about $44,000 in student loan debt. I'm currently on track to pay them off within the next 3 years. It'd probably be only 1 or 2 years if I didn't buy a car.

> Probably one of the most incorrect sweeping generalizations I have ever seen.

Not really, you simply didn't read my comment and the comment I responded to very thoughtfully.

The point of my reply is twofold. First, the obvious: you wouldn't take that loan unless you needed the money for your education (or wanted to gamble on the stock market, apparently, as one poster mentioned, but let's put that aside). If you can pay for your education without it, with saved money or through scholarships or grants, you'll do it. If you can't pay for your education, you take the loan. In that sense it wasn't a deep point, it was basically a tautology to point out how vapid the grandparent's comment was: "the thing we have to do is not borrow money we can't repay," "borrowing money you can't repay is a broken local protocol." As if arranging student loan financing were in some way similar to extending credit to a successful business that needs a little extra cash on hand until the end of the month. Ridiculous.

Second, and on to the more important point that I made in the second paragraph: if we assume the grandparent really means "will not be able to repay after several years of college" the problem with this whole line of thinking becomes obvious. The average student embarking on college has no idea whether they'll graduate successfully. They have no idea whether they'll be able to find a job in their field and they certainly have no idea how much they will be paid. In short, they have no idea whether they'll be able to repay that loan. In terms of policy, saying they should not take a student loan which they will be unable to repay is not an answer to anything since at best they're making an educated guess. In a situation like that, where people are guessing, the expected outcome is that a lot of people will guess incorrectly.

What if I can afford to repay it? So what? My wife and I can easily afford the 1500$ a month minimums we have to pay(We pay more than our minimums in an effort to expedite the process) but while we do pay off these loans we also choose not to have children, or buy a house, or buy cars. I can say without a doubt that our educations have been valuable, but not in the sense that we learned have anything other than that higher education is a signaling scam designed to keep people poorer than ourselves outside of the working class.

Money is not as important as living a full life. Sometimes trade offs must be made

What you're suggesting means abolishing student loans, since no student can (presently) repay their loan amount (or they wouldn't need it), and you're speculating on their future prospects. That is one option, but as I said elsewhere in my post, most options make it so that poor people can't go to college. That, IMHO, is bad for society.

That just drives down the price of borrowing money until a borrower is found and the market clears. You could just as well place the blame on aging savers driving the price of borrowing down until taking on massive amounts of debt to get ahead in life through college looked reasonable.

And we also need to make the loans dischargable and place some of the burden on educational institutions. Aside from universities that can be very selective, all other schools have an incentive to bring in as many students as they can. They have no financial risk if the students drop out.

> They have no financial risk if the students drop out.

I like this and would love to see more commentary on it. Taking one step back, the system is broken because we removed the primary safeguard: Bankruptcy. If we could declare bankruptcy to discharge loans, it puts the burdens on banks to only make loans they evaluate as having a reasonable rate of repayment on. We've removed that check. In turn, we have a completely predictable outcome. So, as far as I know the only alternative is to provide another, equally robust counter (like your suggestions, or just "free" tuition) to balance.

I completely agree, this is going to be a problem for our generation. For those of us who are lucky enough to not have any student debt, how can we take advantage of this?

Well, as someone recently off the scrolls of student loan debt, I can tell you this -

Save. Don't spend it. Save it. Invest it wisely.

Paying my shit off gave me an incredible sense of freedom, even though I still have a wife and kid and household to maintain, the usual job pressure, etc. I thought about it, and the sense of relief was from knowing that I was free of debt service, so the best thing I can tell you is to save your money and not make a single interest payment more than you need to.

Save and invest as much as you can. 10% of income is a good goal, more if you can do it.

I think that there has to be some responsibility pushed back onto the universities and banks that are selling these loans for defaults. I think it's obscene that colleges are selling near-useless degrees to 18 year olds for $50k+. There has to be some incentive for either colleges to charge less for certain degrees or push people into degrees that will lead to higher paying jobs, or simply get pickier about who they admit.

But there isn't any risk to the school or the lender. Anyone can get student loans up to the federal cap, and they're practically not dischargeable, either.

The incentive has to come from somewhere else, but most solutions involve making it a lot harder for poor people to go to college. It's a tough problem.

Make the schools have to refund some of the money if their students default.

I paid off most of my loans the first year after graduating, but held onto the lowest interest one with minimum payments despite having been able to pay the whole thing off for five years because I expect the same - the week after I pay the damn thing off is the week unconditional loan forgiveness happens and I wasted all my money.

It's already hurting the housing and consumer spending segments, as per the incessant and continuous "Millenials are killing the X industry" clickbait every other hour.

Replace X with home ownership, car ownership, renovation, Chili's, Applebee's, and whatever else services the traditional nuclear family.

Damn millenials killing everything indiscriminately.

Our economy is built off of the boomer generation and their behaviors. They enjoyed stable, living-wage jobs, affordable housing, dirt cheap education, etc.

Now we have an emerging gig economy, ridiculous tuition costs (and the expectation of a degree to do more or less anything), cheap credit to prop up the housing market (did we learn nothing in 2008?).

IMHO, it hasn't hurt housing enough, and politically, that's going to stay as long as possible. A lot of boomers also have a large portion of their net worth tied up in their home, and letting that bubble burst will just swap economically disadvantaged millenials for economically disadvantaged boomers. Even setting aside the fact baby boomers also run our political institutions, for a variety of reasons, it's still better to have young people who can't buy anything because they still at least can work, versus a bunch of displaced retirees who also can't work any more. It's a really shitty situation. I try not to blame an entire generation too much because it's more complex than that, but I'm in my mid-30s and feel like I got really lucky. The generation right behind me really had the ladder pulled up before they could get to it.

The baby boomers cry about millennials killing X industry while in the same breath cry about millennials acting entitled for demanding reasonable wages.


Student loan debt factors into "Household Debt".

The vast majority of student loan debt is already guaranteed by the US government: https://fred.stlouisfed.org/series/FGCCSAQ027S

So something like 77.5%+ of that is already bailout guaranteed. Taxes (or more likely US debt) will rise to cover it, which will have its own long term negative effects, but barring a US default that market is very well covered.

It's also very, very challenging to discharge US student loan debt, much more than housing debt. How that really works in the end, especially if a large number of people go into default, hasn't really been tested, and it will be a political hot potato when it does.

As another commenter has said, student loan debt is included in household debt.

No one is "flipping" student loans though. I don't see student loan debt being a trigger of anything market-disrupting.

A site like this seems dangerous at best. Nobody can predict the stock market. Nobody can predict when a stock market is more likely to crash. This site tries to indicate otherwise. Whatever causes the crash it probably won't be one of the indicators listed here.

I think the subtitle sets expectations pretty clearly:

> No one knows for sure, but there are indicators that can help us guess. We can chart these indicators to give us the illusion of foresight.

Holy shit, just seeing the "indicators that can help us guess" gives me shivers. The person who utters that phrase is admitting to guessing with their money. Does anyone else find that as absurd as I find it? If I hire a pro to enter/exit a position, if they are guessing(with or without the assistance of indicators), I have made a very bad decision to hire them.

Perhaps you and I have different definitions of the a word 'guess'. To me, it includes 'Making a logical estimate based on available evidemce'. Every investment decision is a guess.

>indicators that can help us guess

this is the dangerous part. No, they can't, even though it seems like they could. If they could, they would be used by people to make money and deflate the bubble that would have caused the crash in the first place. That's the theory, anyway

Predicting the actions of human being is very difficult. The market "crashes" when 2 people throw in the towel. One of those groups is the aggregate of retail+institutional buyers. The other group is market makers. When neither group is willing to bid the price, then that price decreases. When neither group is willing over an extended period of time(say, an hour), we have a "market crash". It's a very hyperbolic way of saying no one is willing to buy, but others are still willing to sell. In that state, the price retreats as buy-side liquidity is consumed, and continues retreating until buy-side liquidity is equal to sell volume. Once buy-side liquidity is in excess of sell volume, then the price moves up.

tldr; "crash" is used to describe a very natural condition, caused entirely by the emotions of human beings.

The real problem with these sites is that it is super easy to overfit to historical data. Try enough indicators and enough parameters and you can fit historicals to the dot. Except, no one knows how the model performs on a go-forward basis. On Wall Street, these are often easy to debug -- you just run on live data, often with live trading to see if the signal is real. However, with economic data, the velocity of new data is too low to really test models on a go-forward basis...so you just have a theoretical model, likely overfit, that has little predictive value.

I love the design and phrasing. This is just a well-done website.

It would be really interesting to see your collapse pyramid over time. How did it look in 2000? 2008?

This is a good idea. I'm going to implement it as a timeline I think.

Since the diamond is a 2D figure, then if you add time as a third dimension, you'd get a diamond-shaped cylinder. Add a blue-red spectrum color code, whereby blue is a time slice with a small surface area and red is a time slice with a large surface area, and you'd be able to plot the dangerously large Diamonds of Economic Failure over time in a way which clearly indicates when the danger signs were worst.

It not really an easy thing to do, but value weighted price/earning would probably be the most common way to do it.

Good idea for a website, should be able to get you some nice revenue from intermittent visits. You probably want to focus on financial services for your ads.

I'm not going to say anything about your numbers and your models other than, without the ability to see how they looked at previous crashes, it's hard to see if the site is useful. To the innumerate masses and emotional investors the flickering numbers are persuasive enough. So they really don't matter.

On the bad side, your UX is god-awful. Use an oldish, slightly crappy monitor to look at it and you will discover that your background is indistinguishable from the foreground. The top bar of the box completely disappears, too. Also, a row of buttons is NOT a good tabbed interface--there is no indication that clicking on "Market Volatility" is going to reload all the content below the row of buttons. Maybe make actual tabs, at least make that stuff a distinct box.

This could be a nice little side product to make you some extra money. Get some GA on there, and slowly add features. I think a bit of interactivity and the ability to customize the predictive models through some drag and drop could actually make the page sticky and get people coming back.

How is the heat matrix diagram calculated? It seems to be wrong. Public Debt has a 3.7/10, while it looks like its around 8.5 in the heat diagram.

Looking at the individual ratings: - Household Debt: 5.5 / 10 - Market Overvaluation: 9.1/10 - Market Volatility: 0.3/10 - Public Debt: 3.7/10 --> SUM = 18.6/40 or 46.5%

Also I noted: Drawing a linear trend line through the "Market Overvaluation" diagram, does make it look a lot better though. One could argue that people get used to certain levels, hence a growing trend over time.

Taking only these factors into account, it does not look like the market is gonna crash soon. In my opinion it's likely going to be caused by another factor not listed here ;)

I'm also confused by the public debt number. It is far higher now than in 2008.

Thanks Obama!

Thanks for bringing this up - turns out that was a bug. I've fixed it now so they're the same.

Site just displays a blank page. No error or anything.

I think that's a better statement than whatever the app actually does.

You need to switch Javascript on.

Thus crashing my browser and answering the question at the same time.

Mine took a while to load all the data. (I have a very fast internet connection). The site loaded, but the inside data took a while, like the graph, and the "Current Risk" numbers at the bottom.

Correct answer, of course, is no one knows, because the future is opaque and unpredictable. And indeed you have some very smart professionals going to cash or directly betting on a 5-10% correction in the S&P500. And a set of equally smart fund managers calling for a 2600 target by mid-2018.

What we can say with some certainty, based on options activity, is that if a single day 3-4% drop in the S&P500 occurs it can trigger a massive unwind in short volatility positions:


And with several political risk factors on the near term horizon, including the possibility of a government shutdown in late September due to the failure of Congress to extend the debt ceiling (yes, they are arguing over who is going to pay to fund the border wall with Mexico). It certainly should surprise no one if a coming tomorrow could be very different than the extraordinarily low-volatility landscape we face today.

The Case For Long Volatility by Eric Peters


I was (sort of) there when the 2000 tech crash happened and was in the thick of it when the 2008 crash happened.

This thread and a few offline conversations made me reexamine what I believe about the stock market and the nature of the 2000 and 2008 collapses. Of course, I'm not an econ nor do I have data to back up anything I'm saying.

All manias, from tulips to tech IPOs to housing bubbles are born when the common person joins the frenzy. On the flip side, the mania collapses when the common person walks away or never shows up the party. For the tech IPO frenzy of 2000, the common person never even showed up to use all those exotic new ideas which were getting funded and going public. During the housing bubble, the common person bought and sold houses which setup the flywheel. Eventually, the common person walked away from the asset in question bringing down the entire charade.

Today, the market is soaring. People are starting to wonder when gravity will reassert itself but in my view, this time the difference is that the common person cannot walk away. Unless adblocking and disdain for social media become extremely mainstream, the common person is so busy amusing themselves to death online that they are not going to leave the tech mania. Companies like FB and Google have made the web sticky.

Does this mean the stock market will rise indefinitely? I don't know. I do know that once there is a captive market comprising everyone online, no company is going to stop advertising or figuring out ways to reach buyers online.

We are in a new age where you just can't get away from the web. We are the product but we also have no way of exiting the dragnet.

This is probably the most insightful comment here. When your grandma is buying some asset class, it's time to sell. I think the biggest complicating factor here is the US government debt and the massive amount of it that the federal reserve owns via its treasury bond buying program since 2008. Who's on the hook for this debt? The common person, via the value of the US dollar. The next crash will be precipitated by actions of the fed and creditors to the US government, not stock market investors. Incidentally, in this environment, cryptocurrencies could emerge as a safe haven.

Economist here. You should really keep in mind that the same GDP must go both towards paying off the national debt and paying off household debt. Also you should track commodities (at the very least, the ratio between put & call options).

Are you familiar with MMT?

If you mean Mark To Market, yes. It you mean anything else (and I am wracking my brains trying to come up with another relevant meaning for that acronym), no.

I think he is talking about Modern Monetary Theory, where one of the conclusions they arrive, after studying how modern economies work, is that private sector debt grow when there is not enough government deficit.


Another of the conclusions is that the national debt, for countries with a floating sovereign currency, is just a number without real meaning.


Ah. I'm dyslexic and ashamed and I'm going to put myself to bed and try to forget this before the morning comes.

I don't think you are at fault. We abuse acronyms.

Modern monetary theory.

Normalizing household debt against the GDP makes the assumption that we are comparing the debt with the ability to pay for it.

But according to graphs like this, even though the GDP has been rising, median households have not been getting a corresponding increase in income: https://en.wikipedia.org/wiki/Household_income_in_the_United...

So the income we are adjusting against is not necessarily going to the people that are in debt!

Household debt to GDP tells you the state of the society. Household debt to income tells you households' ability to repay. If Debt/GDP is fine but Debt/Income is not, you're looking at (a) default (lenders eat dust), (b) inflation (savers eat dust) or (c) public assistance (non-borrowing taxpayers eat dust). That's a political question. If Debt/GDP isn't fine, option (c) flies off the table.

That sounds reasonable, but aren't all of those mitigations for after the shit hits the fan? None of options will prevent a crash unless you can actually exercise them pre-crash.

> aren't all of those mitigations for after the shit hits the fan?

Not necessarily. Raising minimum wages or cutting certain taxes are examples of pre-emptive steps political systems can take to increase households' incomes. Making debt harder or easier to discharge, or raising or lowering policy rates, can be similarly prophylactic.

Your volatility section seems to be a very poor indicator of a future crash in the manner you are using it. Volatility is not a predictor, but instead a descriptor. An analogy I think is the weather stick - Is this stick wet? Then it is raining. It is a very poor item to use in your context.

Further, sustained periods of low volatility often are sometimes indicators of complacency among investors and indicators of higher chances of bubbles. Sustained periods of low volatility are at times indicative of higher future risk of a market crash, not a low predictor. I think you need to re-evaluate how you use volatility.

Well, he's using the VIX, so it is technically market implied future volatility. Whether it has predictive power is open to debate, but it is technically a forward-looking indicator.

Matt Levine wrote an article (with charts!) on VIX[0] back in 2014 that basically says the same thing: VIX is more of a measure of past volatility than an indicator of future volatility.

[0] https://www.bloomberg.com/view/articles/2014-06-09/the-vix-i...

"NaN% more overvalued than just prior to the 2008 financial crisis,"

I think there might be a few coding errors still lurking in there.

I got that in Firefox, whereas it works in Chrome. Poor cross-browser testing?

Seems to be because all the market data hasn't loaded yet. If you look above it should say "Loading data" under one of the categories in the text.

Yeah, on a second visit, everything seems OK.

Didn't notice the loading indicator myself.

American companies sell products & services outside of the United States. Comparing American GDP with the aggregate value of the US stock-market is deeply misleading, especially given a historical comparison: foreign markets such as China have gained in relative importance over timeframe under consideration.

When looking at debt, one should not just observe the nominal amount, but also the interest rates, which have never been lower. Large companies can tap public debt markets and borrow billions at 1.5% over a timeframe of ten years. Risk is thus lower than the website suggests (at lower interest rates, a company can carry more debt). Additionally, returns to equity will be higher (the I in EBIT is smaller, so profits are bigger).

The American GDP includes net exports, ie: goods that are bought in other countries. So its not a crazy comparison. But it is not great ratio for long historical comparisons because of the changing nature of economies and markets.

GDP is a correlated measurement. Trying to use correlated measurements as a leading or primary measurement is one of the many steps on the stairwell down to bankruptcy for a trader.

Really cool idea. As someone that hasn't really investigated the market indicators for collapse this is really eye opening. It really breaks things down into plain english. Hope this goes to the top for some rational/interesting conversation.

Don't put too much weight into his analysis. There are folks who spend their entire professional careers studying the economy and they haven't, on average, ever correctly predicted how the stock market will perform.

I don't want to knock on OP's analysis here, but it's important to remember the famous quote (maybe by Keynes?), "The market can remain irrational much longer than you will remain solvent"

Thanks for the kind words! I'm not an economist myself so I'm hoping others on HN might be able to correct any inaccuracies.

Is this open source? Id like to see how/where you are pulling your data.

The source is not minified.

As the site makes clear, nobody really ever knows if the market is going to crash. On the market valuation side they claim the current market is overvalued. But overvalued is a relative term... As you have to value versus something, and that something is usually something historical.

The way I see it though is the markets are a big voting machine.. and they're making predictions about the future and incorporating future expectations. With the current US administration still pondering over tax plans and infrastructure stimulus packages that are promised, market may be underpriced???

> The way I see it though is the markets are a big voting machine.. and they're making predictions about the future and incorporating future expectations

This is likely true because of "wisdom of crowds" (aka regression to mean of randomly-sampled human estimates).

> With the current US administration still pondering over tax plans and infrastructure stimulus packages that are promised, market may be underpriced???

The president doesn't control taxes or spending, and he can't do anything about infrastructure on his own. All he can do is use political capital to push Congress in a certain direction. So far, he's been totally unable to do that.

In terms of the national economy, the US is the same as it was under Obama -- House totally under Republican control, Senate mostly under Republican control, Janet Yellen running the Fed, no major shocks.

There's little unity among Republican Congresspeople, and even less when you include Democrats. Tax reform may be a bipartisan issue, but it's likely going to be limited to simplifying the tax code (lowering taxes while closing corporate loopholes). If all the trickle-down dinosaurs believe that higher corporate taxes will harm the economy (which it almost surely won't), then the stock market should -- if anything -- go down.

This could mean that it's underpriced, but not for the reasons you seem to suggest.

I feel as though the "stock market" following the 2008 crisis has become further insulated from the larger economies fundamentals. wages can continue to not keep up with inflation, savings rate continues it's downward slide, household debt service payments consume an ever increasing slice of disposable income, etc... all the while the type of dramatic dislocation event similar to 1929, 1987 are unlikely to occur. the market "circuit breakers" ensure any crash is a slow moving trend and not a single calamitous event.

the stock market is so divorced from the actual economy that over half of Americans don't participate in any way at all whether through direct purchase, 401k, mutual funds, etc.. most of the action on the stock markets is companies rebuying their stock to generate earnings and hedge funds and the less than half of Americans who have access to retirement planning.

What percentage of Americans have historically participated in ownership of capital?

Given that like 75% of corporate profits are used for share buyback schemes, stock market is a rigged shell game.

The volatility index, or VIX, has become a popular measurement to reference in the context of predicting the market over the past couple years.

The problem is that it does not seem to have any real predictive power and I have yet to see any shred of evidence that the VIX has been shown to have predictive power over the future value of the stock market.

It is calculated from past price variance and is used in calculating the theoretical price of options, but that is it.

Does anyone have any evidence the VIX has value?

It is calculated from the (theoretical) implied volatility of listed S&P options, so it is indeed forward looking (not past variance).

But it is riddled with microstructural issues and to my knowledge doesn't really have any track record of predicting crashes. It will react to market events contemporaneously though, so it is a decent measure of expected future volatility.

Besides household debt, the rest of these indicators don't make much sense either. Much better would be measures of the yield curve, inflation, and corporate credit quality.

There is actual money behind the number of the VIX, but I'm not sure if you'd call it value.

There are ETFs and other vehicles that buy VIX futures, and either go long or short, which people can buy and sell. Like TVIX, XIV, etc.

There's some worry that a quick spike in VIX futures from such a low level at the wrong time could cause a catastrophic unwinding of these instruments.

But I'm not an expert in these things.

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