Running in place

A 1.5% downday, and the SPX is basically unchanged on the year.   There's a reason that Macro Man hasn't written too much about equities recently, and that's it in a nutshell.  For the first three months of the year, US equities have been a bloke on a treadmill, running at a brisk pace simply to stay in place.

Not that this has come as any great surprise.  In October, Macro Man noted that liquidity factors were the primary explanatory variable for the S&P's stellar run of performance over the past few years, and with the tap being turned off (in the US at least) there was naturally some reason for concern over future returns.

Indeed, more than a year ago Macro Man performed an analysis of the SPX's return and vol by Fed policy regime; he thought that he had published it here at some point over the summer, but he's deuced if he can find it.  Regardless, the analysis suggested a very bullish outlook for US equities as long as the Fed was a net purchaser of assets, and a dim prognosis whilst the Fed did nothing.   He's taken the liberty of updating the study for the full body of the Fed's QE Era (Dec 2008- Oct 2014); a summary of the results are below.

As you can see, based on this study, the right question for US equities is not "why aren't they going anywhere?", but "why are they doing so well?"  Since the end of October, the SPX has generated an annualized price return of 5.4%, with a vol of just over 13%.  Of course, a number of ancillary factors have also impacted the price- ECB QE, the collapse in energy prices (bad for producers, good for energy consumers), and of course, the shifting sands of Fed policy expectations.

There are, of course, limits to this type of analysis, given the paucity of truly independent samples.  Even going back several decades delivers little more than a handful of policy cycles, which is really an insufficient number from which to draw strong statistical inferences.  For what it's worth, a year ago Macro Man also performed a study on SPX performance by orthodox Fed policy regime, splitting the cohort into the first 6 months of tightening/easing, subsequent tightening/easing, and on hold (defined as no policy moves for the last 6 months.)  The results are set out below.


On the face of it, this might suggest that a rate hike might be the best thing to ever happen to the US equity market, but correlation does not of course imply causality.  One might posit, for example, that early-stage and subsequent tightening cycles are driven by robust economic activity, which would naturally prove supportive of stock prices.  The lower returns from on hold and easing, meanwhile, would reflect the weak underlying economic conditions justifying those policy stances.

In the current environment, the expansion is already somewhat long in the tooth when measured by the calendar (though not by the credit cycle), and earnings have had a lot of "unnatural" support baked into the cake thanks to uber-accommodative policy over the last six years.  This is unlike any of the scenarios captured in the data set above.

Current and future financial conditions in the US look set to be tighter than those of the past several years, so it seems natural to expect equity performance to be worse (and, cough cough, macro performance to be better.)  That being said, Macro Man's model is still somewhat bullish of the SPX, which informs a moderately long strategic position even as he is agnostic tactically.  He is following developments in the model and the market from afar, however, and is ready to change his stance when and if circumstances warrant.

In the meantime, there's always the DAX, though it certainly looks like at least a good chunk of the easy money's been made in that one for the time being....



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Anonymous
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March 26, 2015 at 1:14 PM ×

You said Deuced
haha

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Anonymous
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March 26, 2015 at 2:45 PM ×

http://fat-pitch.blogspot.com/2015/03/can-money-flows-push-equity-prices-much.html

"In summary, investors, large and small, have a high allocation to equities and those allocations seem to no longer be rising. Margin debt has flatlined. And whatever impact buybacks had in raising equities seems to be waning. We're not sounding an alarm but it takes increasing money flows to push equities higher and its not immediately clear from where the next huge source of additional demand for equities will come."

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Anonymous
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March 26, 2015 at 3:11 PM ×

it will come from you, silly, when you cover your shorts much quicker and more desperate than how you 'scaled; into them.

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Dan
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March 26, 2015 at 3:35 PM ×

Can one of the smarter folks explain to this lesser mind the accounting 101 mechanics of the BOJ buying all JGBs, canceling JGB debts, Ms. Watanabe (she's single, un-sexed now) buying japanese equities and then BOJ buying all equities until Japanese secular island of Eden manifests?

I want to believe I am not the only person smart enough to see all of the basic logical impossibilities here. There are mutually exclusive events being assumed in the aforementioned scenario.

I believe it is very critical to remember that the financial system is first and foremost a credit system based upon asset-based lending and classical double-entry bookkeeping. If you cancel a JGB, where is the corresponding currency now?

JGBs are claims on yen currency, correct? If the repayment risk on a self-referencing currency is zero because the treasury can print currency to cover obligations and the currency is secured by like-denominated sovereign credits, what should the entire yield-curve yield? Theoretically speaking...it can't happen.

;)

The markets are all about currencies, politics and war now. It's not that they aren't always, but most of the time the skirmishes are between very unequal competitors.

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Dan
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March 26, 2015 at 3:43 PM ×

My two cents: terms go to the zero boundary and yields go to the zero boundary to reflect the likeness of currencies and their corresponding credits.

As long as the political spheres adequately hold up, the CBs can, theoretically, hold the sovereign credits on their balance sheets and the treasuries can modulate taxes to manage inflation, interest rates and runoff the CB balance sheet over time.

A major political dislocation is how we would get a real mess in the financial markets with wild interest rates, IMO.

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washedup
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March 26, 2015 at 4:26 PM ×

@Dan:
Not sure what the inconsistency is - say taken to an extreme BoJ will ultimately own all equities and bonds issued in yen - in the process it will debase paper currency, thereby decreasing the nominal value of the debt and also increasing the value of japanese equities, keeping down the implied leverage and financing costs low both for itself and other entities. As long as Japan is a closed economic system this would be fine for a very long time - over time, living standards would go down as the percentage of domestic savings (or forced savings via consumption taxation) required to maintain this ponzi would keep increasing, but as long as there is no 'run on the bank' or a nasty rebellion it can be self sustaining. It can even end well provided the rate of technological innovation in japan goes higher.
Basically if you have a docile population that is willing to believe in the cause of higher inflation for the sake of it, this can be done, and thats what their long game seems to be. There is nothing in this game that rewards the kyle basses or other japan doomsayers, just a long steady grind down to a non-market based system.

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Polemic
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March 26, 2015 at 5:44 PM ×


Agree MM .. not much to say

My esoteric-o-meter is flashing amber. Its when debate runs low on new themes and so has to look down the back of the sofa for bits of crumb and dust to raise as topics.

It is normally a good indicator of general market lostness. Stuff that correlates is wandering and so are thoughts.

Slack tide, could be high tide or low tide though.

Pol

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mcr
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March 26, 2015 at 7:43 PM ×

Great post! When is the first QE allocation fund to be launched? Maybe in a structured note to really top it off... and call the PEAK-QE.. moment... :)

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Dan
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March 26, 2015 at 8:29 PM ×

1) a docile population assumes the current peaceful state persists ad infinitum.
2) a closed economic system assumes a closed economic system that doesn't remotely exist today and won't emerge in the future.
3) as I view the CB portfolio expansions, central bankers have cunningly multiplied the collateral for the currency holders and not the other way around.
4) general populations don't believe in inflation or deflation, the believe in potable water, food, shelter, clothing and sex. screw with those enough and personalities shift real quick.

I anticipate more treasuries shifting their borrowing terms down to take advantage of the free money and to defer a secular shift in preference toward the precious metal complex and paper currency hoarding.

Polemic, when can we expect that long bonds trade to start selling or the euro to firm?

I eat at the table, so no crumbs in my "sofa".

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abee crombie
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March 26, 2015 at 8:46 PM ×

Let's take a step back. Rates are negative in Europe. Real money has to go somewhere. US bonds have all too apparent fx risk. Buy EU equities. First it was Dax and. Now it will be the rest.

Nico, what are your thoughts. It's all funny money when rates are 0. I can see eu PE 's getting a lot more extended.

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Polemic
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March 26, 2015 at 9:12 PM ×

Hi Dan ,. No idea But I have to say I m looking at EU long end rather than US, which seems to go through Manic depressive style bouts triggered by FOMC snetence constructions .SO am clueless over those.


But as for EU long end? Well. I am told by everyone that it is never becuase banks will be buying froever on reserve requirements, curve plays, lack oof supply and all the normal stuff . But I would suggest that Bund prices are looking like a classic carry trade in the way the price trades. creep creep creep collapse. so the asymetry in the price action will be large, as it is in classic carry trade wash outs. Which would tempt me to put on the classic carry trade risk reversal play ( http://polemics-pains.blogspot.co.uk/2014/05/carry-creep-and-risk-reversals.html ) but being too far away from teh pricing to see how vast the skews are at the moment i can t really get down to structuring it.

So in short .. I dunno but I ref to that link re expected price shape and am looking for european growth to pick up and tweeks of inflation expectation ( just look at 5yr/5yr moving up) to at some point t hit ECB talk. I know we've already had taper talk from the mkt re ECB QE but that aside, when this elastic band snaps back its going to be viscious.

As for teh EURO I dont have any strong feelings on it actually. On one side it had gone yennish, but on the other it does have trade in its favour and positioning. But whilst the rest of teh world issues EURO debt to repay USD debt the pressure s going to be steady. So basically .. FX is a mugs game and I should know I was one of the mugs for years.


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Polemic
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March 26, 2015 at 9:13 PM ×

And any way Dan, being short of negative carry actually pays to run!

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Polemic
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March 26, 2015 at 9:15 PM ×

AQctually htats interesting .. Bunds price behaves like a positive carry but is actually negative. We ve got negative carry creep! Nuts, so best to be short on both arguments.

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Nico G
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March 26, 2015 at 10:15 PM ×

yo Abee

yeah Dax no longer leads EU equities - and this has never been a good thing in the past

the quick smart money has already been made in Europe and some late folks are picking up laggards

keep in mind that ECB could stop their program sooner than initially engineered, from mounting pressure by ze Germans

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Winging_it
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March 27, 2015 at 7:02 AM ×

Are we at the juncture where equity longs are not comfortable anymore? Shorts are being put on by smarter swifter money? Depending on if we really will continue down and the depthless of short monies pockets will drive equities? We would then have volatile markets going forward.

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abee crombie
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March 27, 2015 at 2:08 PM ×

Pol, I hear what you are saying about the Short bund possible correlation but I think we need to see it play out in a few episodes before all the quant guys really change their models. Until then, or until -0.20% rates in the Bund, I see no big opportunity, but it might be a great cheap hedge. I still like long JPY as well

Nico, yes the easy money has been made in EU equities, as well in Japan. But I remember hearing the same arguments in the US in 2010, 2011 and 2012, and then we had an amazing 2013.

I feel like we are in uncharted waters here and missing the first leg is no excuse for missing the next 2/3rds.. Assuming global growth starts slowly picking up and no big shocks ( a big if, and very dependent on EU & China) earnings revisions will likely start to pick up which will be the fuel to light the PE expansion fire underneath equities, and which is exactly what kuroda and draghi want.

I'm thinking the same US playbook works. Dividends and Share buy backs.

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abee crombie
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March 27, 2015 at 2:10 PM ×

As for the ECB stopping QE or tapering at some point, I think that is when this great experiment blows up. Seriously. When that happens just buy gold and wait.

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washedup
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March 27, 2015 at 2:35 PM ×

@abee - good point on the 2/3rd of upside being left in european equities - however, unlike the US where the right trade was to simply buy macro risk on baskets, I suspect it may be more of a sector play in europe i.e. more interest rate and currency sensitive sectors - reason? tech was major driver of the US performance 2012-2014, and there is really no analogy to that in european equities. I would also argue the US benefited from the return from crisis level activity after major layoffs and deleveraging, where european corporates will have to fight for every morsel of profit the QE fueled GDP addition provides them.

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Anonymous
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March 27, 2015 at 2:55 PM ×

BEA:... Corporate Profits Now in Contraction YoY for 4 Consecutive Quarters: Prior Instances since 1972

On the other hand...this week there's been an AVALANCHE of new issuance: $14.8B on Monday ($6.6B Tuesday, and $8.5B Wednesday; this makes it almost certain that March will tally more than $200B); the IG CDX is still under 65bps.

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checkmate
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March 27, 2015 at 3:38 PM ×

This was above average from Buiter.

http://ftalphaville.ft.com/2015/03/27/2125141/buiter-on-soggy-global-growth-in-2015/

Currency wars are a bit like the old waterbed effect !

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Leftback
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March 27, 2015 at 4:04 PM ×

I am still bearish the US here, and maintained a modest QQQ short position. Qs are boxed in just below the 50 day ma here at 106ish, which is acting as resistance, and it's some way down to significant support around 100. SPY is similar. The data on Q4 corporate profits were startlingly bad.

Sentiment reads: AAII bulls still quite high, there is a strange amount of optimism out there. Otoh, from this punter's view, doesn't seem to be much reason for traders and buy side punters to buy this market here. FOMC still on hold, for now, but we priced that in last week. The Q2 401k fund flows are the only positive thing I can see ahead of us.

In the Euro sentiment remains miserable: there is still an enormous spec short position, while commercial hedgers are almost as long as during 2012 crisis. Once again, there is a high likelihood of a neck-snapping squeeze in EURUSD perhaps released by a "Grextension" agreement. When that happens everything denominated in USD is going to suffer, even Treasuries.

I agree completely with Abee on European equities. DAX first to break out, others will follow, driven by rotation out of negative yielding govies etc, and also giving up profits to Pol. It's likely we are only 1/3 of the way into a multi-year bull.

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washedup
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March 27, 2015 at 4:17 PM ×

lb/abee - what etf tracks eurostoxx best in your opinion(s)?

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abee crombie
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March 27, 2015 at 4:27 PM ×

washedup

I hear what you are saying regarding no tech in EU and also that a large part of the US rally was simply a bounce from panic oversold (hence why my call on EU banks didnt work so well, they only work when valuations get stupid cheap and sentiment is washed out, clearly EU banks didnt have that this past summer and only recently go there at the end of last year).

On profits, you are spot on as well, just read something that says households have benefited much more in the EU vs corporate (as EU companies horded labour vs US companies who slashed and burned) over the past 6 years. So this does pose a risk that it continues

as for sector picking, I think the US rally has taught us do so at your own risk. Yes Nasdaq has lead and been an easy call, but many sector specialists have under performed this bull market.

DIVIDEND ETF makes the most sense to me. Am i being a carry monkey, yes, but i dont think I am smart enough to really pick out banks, real estate or exporters and time it correctly in line with industry fundi's.

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abee crombie
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March 27, 2015 at 4:29 PM ×

FEZ is eurostoxx (no FX hedge)

DBEU, HEWG, HEDJ are currency hedged

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washedup
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March 27, 2015 at 4:33 PM ×

abee - much appreciated - thx.

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Leftback
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March 27, 2015 at 5:38 PM ×

FEZ tracks STOXX very closely. An alternative ETF that is worth looking at is VGK, which offers a higher dividend yield and slightly lower expenses.

Buy the dips...

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washedup
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March 27, 2015 at 6:36 PM ×

thx LB - i looked at both vgk and fez - prefer the latter since its much more liquid. Call me paranoid, but one of these days we will wake up to find some crazy dislocation in ETF land from the underlying - if us treasuries won't be spared nothing will, just a matter of time.

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Anonymous
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March 27, 2015 at 7:53 PM ×

Cftc - record euro shorts this week

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Anonymous
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March 28, 2015 at 1:02 PM ×

If US markets catch a cold, or worse, European markets are likely to suffer too:

http://www.hussmanfunds.com/rsi/eurval.htm

Rossmorguy

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washedup
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March 28, 2015 at 1:41 PM ×

@rossmorguy - thx much for that link - definitely makes me rethink the european equities bull thesis. To LB's point, it is a long or flat kind of market but only after the US markets have corrected more than the usual 2-3% (if that ever happens!)

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Macro Man
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March 28, 2015 at 1:49 PM ×

So having been bearish and wrong for half a decade in the US, Hussman has turned his eye towards Europe? Back up the truck!

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Anonymous
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March 28, 2015 at 3:15 PM ×

Has the time come to order EuroStoxx50 "4000" party-hats for use later this year?

Credit Suisse: "GDP this year should be 1.5% to 2%, yet, we believe, markets are only priced for 0% to 0.5% GDP growth. Earnings revisions, relative to global, are close to an all-time high and we now expect EPS growth estimates to be higher by 10% for this year from 8% previously while sticking to 13% growth for next year."

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Anonymous
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March 28, 2015 at 3:45 PM ×

Words of caution from Howard Marks on liquidity

http://www.oaktreecapital.com/MemoTree/Liquidity.pdf

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Anonymous
admin
March 28, 2015 at 3:52 PM ×

Europeans will wake up one day and find themselves owned by China...

http://imgur.com/0zba8ki

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Anonymous
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March 28, 2015 at 3:56 PM ×

Yanis Varoufakis takes a cue from Rodney King...can't we all get along?

http://www.project-syndicate.org/commentary/greek-bailout-restructuring-by-yanis-varoufakis-2015-03

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washedup
admin
March 28, 2015 at 8:09 PM ×

@MM:
"So having been bearish and wrong for half a decade in the US, Hussman has turned his eye towards Europe? Back up the truck!"

oh just leave the poor guy alone - like his vanishing investor base wasn't punishment enough, now people are using him as a contra indicator - that crown belongs to Dennis Gartman once and forever.

I actually find Hussman intellectually honest and internally consistent - that said, clearly he is missing the 'liquidity' variable in his predictive equation.

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Anonymous
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March 29, 2015 at 4:04 PM ×

Steen on Europe:

Europe: The big start to the year will fade as there are no “export markets” growing into Q3 and Q4. Expect a sharp slowdown over the summer and Bunds below zero.

Of course that is the economy not the. stock market

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Anonymous
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March 29, 2015 at 4:15 PM ×

"What we have at the moment is the end of a long period of divergence, a period where the supply of broad money relative to economic growth in key economies has been out of balance (and where this imbalance has even been supported post crisis by QE generated deposits) and where the demand for assets relative to growth and various other metrics is likewise.

http://blog.moneymanagedproperly.com/?p=4178#more-4178

"My point for some time has been that the relationship between asset valuation and GDP, amongst other reference points, is excessive and out of alignment with slower GDP and income growth. As with many of my other posts the point is this: the financial economy, asset and debt valuations and the complex financial system linking them, has become much bigger and therefore much more important to keep alive. I would go as far as saying that the financialization of the global economy has become too big too fail, an extension no less of the banking dilemma."

http://blog.moneymanagedproperly.com/?p=4140

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