Hedge Fund CIO Asks If We Have Reached The “Capitulation” Point

Excerpted from the latest weekly note from Eric Peters, CIO of One River Asset Management

Capitulation

 

“He was extremely intelligent, high-profile, and operated with data and models that people didn’t understand back then,” said the historian. “But nine days before the 1929 Crash, Irving Fisher abandoned his long-held bull market skepticism and said that stock prices had reached a permanently high plateau.” Irving went all in, leveraged up, and was eventually bankrupted.

 

“On the first leg down, he claimed the market was simply shaking out the lunatic fringe.” It kept falling. “Thoroughly discredited, he wrote about debt-deflation. No one listened.”

 

“Are we at that point yet?” asked the same historian. “Are we at the point in the cycle where people conclude that it’s been going on for so long that it can’t possibly ever end?”

 

The Shiller P/E ratio was 32 at the 1929 peak. It was 44 in 1999. Those were the only other times in history when it’s been higher than today’s level of 29 (it’s now 73% above the 135yr mean of 16.8).

“It’s hard to argue that we’re there yet. Valuations are high, but investors still seem to be concerned. They remain obsessed about the unsustainability and fragility of this bull market.”

 

“I’m going to make an educated guess,” said the historian, lifting his head from a book and walking to his looking glass. “This cycle ends not because things go wrong, but rather, because they go right.”

 

Every great bull market ends in fabulous fashion. And this one started in 1981 – with a Shiller P/E of 6.7 – and after decades of declining bond yields it’s been turbo-charged by $ 14trln in central bank purchases.

 

“Financial asset prices finally crack once economies heat up, skeptical investors fall in love, capitulate, and we get an interest rate shock.”

And some bonus thoughts on today’s French election outcome though the eyes of traders vs investors:

“Traders trade prices, investors trade outcomes,” said the trader. “You may love the Patriots, but there’s a spread where you can no longer be in that trade.”

 

Lose sight of the line, and you lose your grasp of risk-reward.

 

“If Macron/Fillon win Sunday, the 10yr France/German spread trades at 40 (closed Friday at 66bps). If it’s Le Pen/Fillon we trade 82. Le Pen/Macron trades 55 if they get even votes (roughly consensus), but if she gets close to 30% it trades 88.”

 

And if it’s a Le Pen/Melenchon victory, chase that spread until it’s well above 200.

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