Tuesday, 28 March 2017

Sobrino de Botín: The Oldest Restaurant in the world

Sobrino de Botín Restauramt
Calle de Cuchileros, 17
Madrid

Madrid turned out to be the best place for experiencing Spanish food. This is hardly surprising as it's the capital of Spain, and so it's naturally to be the food capital of Spain as well. In the last few days, we had tried the best paella we have ever eaten in La Mi Venta thus far, as well as sampled the national dessert of churros in one of the oldest churreria Artesanos that established in 1902. That's more than 104 years old.

So relatively old folk like me would love to try out restaurant that are even older than Artesanos 1902. Well, 177 years older, to be exact. Speaking of old, i'm being told that i'm now a spring chicken. It seems we're all getting younger. As they say the new x is the old x+10 years old (so if you're 40, you're now the new 30. But in 10 years time, the old x+15 is the new x, etc. We're ageing slower every decade, and may never die, thanks to Zeno Paradox).

Greek philosopher, Zeno of Elea
Zeno of Elea. Greek philosopher. Born in 930 B.C.
This old guy is old. He's much older than Botín restaurant.

Anyway, back to the Early Enlightenment Spain from ancient Greece. According to the Guinness Book of Records, Sobrino de Botín is the oldest restaurant in the world and was founded in 1725. Ok, ok, restaurant history buff would jump at my throat (thus preventing me from enjoy my food) and say, "This isn't the oldest restaurant in the world. That title should go to Ma Yu Ching's Bucket Chicken House (马豫兴桶子鸡), which was opened during the Jin Dynasty in China in 1153."

Hey, don't shoot the messenger or strangle him.

Menu cover, Sobrino de Botín, Madrid, Spain
The restaurant's menu cover.
Is there a better plug for a restaurant?

Alright, if you let go of my throat, i can then tell you that Botín restaurant is the oldest continuing operating restaurant. The Bucket Chicken House is no longer there. The site is probably occupied by an apartment block, a mahjong club or blind man massage clinic today. Of course, Botín is probably not even the oldest restaurant in Europe. But it's the oldest one that you can reserve a table today. No need to install a flux capacitor into your DeLorean (if you own one. I think Tesla is a better choice because it's the fastest car that cracked the record 0 to 60 mph in 2.28s) to travel back in time in order to order a Bucket Chicken a-la-carte for this supposedly spring chicken (That's Bucket Chicken, not Chicken Bucket, which you can get from KFC's drive-in from your DeLorean or Tesla).

Facade, Sobrino de Botín, Madrid, Spain
It's located close to one of the entrance to Plaza Mayor


It's said that this is one of the fave restaurant for Ernest Hemingway , which i don't doubt as he was something of a foodie like myself. King Juan Carlos I also liked to dine here with his band of bodyguards. But most interestingly of all is that the greatest Spanish artist - to me anyway - Francisco de Goya worked here as a dish washer (just like me. Except that i washed dishes in a Burmese restaurant in Sydney. It was established in 1988 and no longer exists by 2002).  Yes, you need to have a morbid taste to like Goya's arts. Well, my taste is "morbid" enough that i do enjoy very much all kind of Chinese delicacies from pig ears, chicken feet, bone marrow or ligament,  sheep brains, pig blood jelly, snails, cow stomachs, bird saliva, etc (if you haven't tried them, you haven't lived), but i draw a line at fried scorpion and other assorted less poisonous creepy crawlies or duck embryo or kids (that's children, not baby goats.)  No kidding.

Saturn devouring his son, Goya
Saturn Devouring One of His Sons by Goya (1821).
Source: Prado Museum in Madrid.
Dunno if he got his inspiration from working in the restaurant.
I heard some adults say to babies: "you're so cute, i just want to eat you!"
I will then ask, "Who do you think you are, Saturn?"


Facade, Sobrino de Botín, Madrid, Spain


Receipt or docket, Sobrino de Botín, Madrid, Spain
Pan (or bread roll), as usual, is quite nice.
Why 2 forks? Why not 3 or 5? I would give them 5 forks. Are they selling themselves short?

We ordered 2 dishes: the house clams, and suckling pig that Spain is known for. While they're not the best of these dishes i have tried before. They're quite decent (they can't survive this long if they aren't, and their food are fit for a king. I know, i'm a little more picky). But then you are here to feast your eyes on history, soak in the ambiance of antiquity, meet your fellow travellers (who are considerably younger than the restaurant or Zeno, or me), and having a sparkling conversation (oh...never mind, just drink those sparkling mineral water then).

Clam, Sobrino de Botín, Madrid, Spain


Suckling pig, Sobrino de Botín, Madrid, Spain


The restaurant have a few floors, and the waiters galloping up and down those wooden stairs with loud thumps. If they quit their jobs, they can join the Spanish national soccer team based on the qualification of the stamina and strength of their legs. I also worked as waiter in a restaurant before, and i know i wouldn't last a week here. The only thump you hear from me is the sound of me rolling down the stairs like the boulder in Indiana Jones: Raiders of the Lost Ark (1981) because of over exhaustion. Run! Indie! Run!

Door to staircase, Sobrino de Botín, Madrid, Spain
Dining room to the staircase. The old wooden staircase creaks like old man's joints. Very genuine.


Dining room, Sobrino de Botín, Madrid, Spain
Looks like a scene from a 1970s James Bond film.
"Give me a Tío Pepe, chilled but no ice."


Dining room, Sobrino de Botín, Madrid, Spain
Looks a bit like an impressionist painting circa 1900


Ceiling, Dining room, Sobrino de Botín, Madrid, Spain
Ceiling with exposed horizontal beams are often seen in Spanish buildings.
And you don't see posts in restaurants anymore.




Saturday, 25 March 2017

Is the Trump Rally Over?

 A Rally is a Rally By Any Other Name 

Maybe the better question is, "Has the Trump Rally started yet?" The short answer is, kinda, even though none of his pro-growth policies have been implemented yet.

These 3 charts below are plotted on identical time frame, and their trend channels are shown in light purple. Note how identical are the angles of the 3 trends of these so-called judge! Sorry, i mean so-called Trump Rally.

This rally started from the low of 11 Feb 2016, indicated in the SPY chart as the Crude Deflation Low. This was the point when the crude price, equity market, bond yield bottomed. And from there, everything rallied.

These rallies occurred some 9 months before Trump's victory. You can't blame or credit Trump for the rally. Very few thought Trump could get into the office during the campaign. In fact, the evening Trump was declared victory, the market indexes plummeted in pre-market in amazing fashion. For more about what happened on the market on the Election Day, you can read my article Trump Election Victory and the Stock Market's Roller Coaster Ride.

SPY ETF chart showing bullish trend channel as of 25 March 2017
SPY ETF chart showing bullish trend channel as of 25 March 2017


QQQ chart showing bullish trend channel as of 25 March 2017
QQQ chart showing bullish trend channel as of 25 March 2017


IWM Russell 2000 ETF chart showing bullish trend channel
IWM (Russell 2000) ETF chart showing bullish trend channel as of 25 March 2017


 Post Election Elation  (aka Trump Honeymoon) 

Now that i make it clear that the market rally aren't due to Trump, at least, not all of it. Some of it could be attributed to his policies. But to call it Trump Rally is somewhat misleading, even the part of the rally after election. But some of the rally post election could be assigned to pro-growth Trump policy anticipation riding on top of the existing rally that dated from the Crude Deflation Low of Feb 2016.

For example, IWM was far more stronger than SPY or QQQ in the 6 weeks following the election. This is indicated by the prices spending more time above the centre-line in the trend channels than in SPY or QQQ charts. This is because IWM are made up of almost entirely small caps or U.S. domestically focus companies, which the market expected to be most beneficial in an American First policy. But it has fallen towards the centre-line lately. This is market's way of reducing the Trump effect on the rally.

Prices in QQQ do the exact opposite as IWM. For 2 months after election, QQQ spends its time under the centre-line, indicating its under performance to both SPY and QQQ. This is because the CEOs of the big techs were seen to be pro Clinton with their campaign contributions. There was in fact quite a bit of hostilities between candidate Trump and the CEOs of giant techs. It went so far that Trump said something to the effect of, "you people would be in trouble if i get elected". The market obviously took this to heart and stayed away from the big techs since election.

On 14 Dec 2016, Trump met with the big tech CEOs, QQQ rallied immediately after wards. The market clearly read this meeting as a positive development of relationship mending exercise. About 2 weeks later, QQQ prices returned above its centre-line. FAANG (extra 'A' is Apple) is back. In fact, since that meeting, QQQ has outperformed both SPY and IWM. Perhaps, it's playing catch up. Perhaps, while IWM is faded a little bit from Trump Effect, big techs could be benefited by it. Let say during the pre-Trump rally between Feb and Nov 2016, the big techs were market darlings. With Trump part of the Trump rally fades a little, big techs retains its former glories (if Trump leaves them alone. Trump doesn't need yet another group of enemies).

Trump's meeting with big techs CEOs on 14 Dec 2016
Trump's meeting with big techs CEOs on 14 Dec 2016. Don't the big tech heads look tense while Trump and Pence smile?
Jeff Bezos, sit at the end of the table, had a row with Trump on Twitter during Trump's campaign

Except for Brexit and the week leading to the election, when the market spent briefly below the centre-line of the trend. This is due to improving macroeconomic environment, where the rising crude price played the biggest role. Actually, the slow grinding down of the stock market just before election was corresponding to a continuing decline in crude prices, but not surprisingly, the blame went to the uncertainty of election, which probably played a role. But the lead role should go to falling crude prices.

One can't rule out the strong rise after election was propelled at least partly, if not entirely, by rising crude price that was fuelled by the OPEC talk of production cuts, which occurred a few days after election. How convenient! This isn't a mere coincidence with the strong move in November 2016. The Trump victory simply stole the limelight from crude price the way it stole the limelight from the Fed (with the help of the media. It's Trump Trump Trump everyday). Both of this - crude and the Fed - were all the market transfixed before the election. Now they're overshadowed by Trump's presence (we know that the media LOVES Trump, even if Trump HATES them). But the importance of crude and the Fed (less so) remain. If you like, read my article OPEC Vs Central Banks for the Battle of Inflation and Deflation to see how close are the relationship between OPEC and the Fed (much like the love-hate relationship between president Trump and the media).

I think the rally will continue after election with or without Trump. But Trump is the icing on the cake. It certainly has more impact on the sentiment than substance. But sentiment can add fuel to the rally. And entice more retail investors into the stock market.

In summary, since the majority of the 13.2 month long (so far) rally occurred on the back of improving macroeconomics (Trump only shows up in less than 40% of that entire rally). As long as that's happening, the rally will continue. There's no reason to think that the macroeconomic landscape is turning sour anytime soon. For one thing, several major economies in the world are also improving this year.

In short, i say that the Trump Rally is 20% due to Trump and 80% due to improving economic fundamentals (i won't argue with you with you if you say 30% or even 40%). It just feel like it's 100% Trump due to the the attention he gets from the media. Since they call it Trump Rally, how can it be anything else, right?

Even if there's something in the next few weeks or months that rattles the market (e.g. crude price dropped below $45), i think equity prices will spend briefly below the centre-lines of these existing uptrend channels. But it will quickly rebound from it as it have done so several times before.


 Trump Bump Stumbles Over A Speed Hump 

It's not just the media who called this rally Trump Rally, even Trump and his administration wants to own it. Weeks before election, Trump warned his supporters the dangerous lofty height that stock market was in, on several occasions. Here's one:




After the election, the stock market went up much higher. And as Dow reached 20,000, in a typical Trump's fashion, he said the rally was due to him, and it's going higher (again, on several occasions). This video shows one example. Go straight to 2:46 of this BBC video if you don't want to watch the whole video.

video


Well, the bullish market rally is too irresistible not to own it.

Another good example is how this Trump Rally isn't entirely due to Trump because the failure of the health care plan vote haven't accompanied by a large drop (anything > 8%). No big drop implies no big discounting of Trump policies in the 1st place.

If we have a bigger drop in the coming weeks, is it a coincidence once again that we will say that this is due to Trump's failure to repeal the health care plan that happened at the same time as crude price going south. Deja vu ! I think this is because the so-called Trump Reflation Trade, or Trumpflation looks a lot like the Long Crude Trade.


 The Silver Lining 

So with IWM and along with commodities, which fuelled by Trump's pro-growth fiscal policies, are fading while the tech stocks are advancing, this suggests that even the 20% of Trump's factor is being removed from the "Trump" Rally. At this point in time (late March 2017) the Trump Rally is in name only.

This repricing is a good thing. Because if little or zero of Trump's pro-growth polices are being priced into a rallying market, then when they're actually implemented, it will put extra fuel into the stock market. In other words, we have this strong rally in Trump's name only, and when the actual Trump Rally starts - i.e. when his policies are being implemented - it's quite a sight to be behold. But of course, Trump policies don't exist in a vacuum. We need to curb our enthusiasm for the development, however. The Fed, for example, may act in a counterproductive way. It may raise rate to kill wage rise pressure, and kill any rally. This could be 2 or 3 years away. Will have to wait and see how all this plays out.

If Trump couldn't deliver on any of this pro-growth policies (which is highly unlikely. He should able to deliver at least a small part of his plans), it's ok because the rally has started without him, and got a boost when he got into the office, and then being repriced once again when his health care bill failed. The Trump Honeymoon is over. We're now pretty much back to pre-Trump rally mode. Anything Trump can deliver on his promise in the future is an icing on the cake. If not, that's okay. Just eat the cake, it's less fattening.


In summary, if prices stay inside the purple channels, the rally is intact (that doesn't mean that we're going into a bear market when prices fall below these channels. We'll just have to reevaluate the whole bullishness of the rally). But i think it's unlikely.

For the next few weeks, the market may traverse further below the centre-line. It may even visit the bottom of the channel to test 200d MA. Maybe. I'll likely do some company shopping all the way down to the bottom channel. 3 weeks ago, my cash level was 20%, today, its 55%. I've been saving for a market rainy days like the coming weeks. There will be plenty of high quality companies to pick up at the discount bin. "Bring your truck, bring your wife, and save!"




Thursday, 23 March 2017

OPEC Vs Central Banks: The Battle of Global Inflation and Deflation

 For Every OPEC Action, There's a Central Bank Reaction 

The U.S. economy and equity market was cruising along in 2014. The global economies weren't strong then, but they were still hanging on the cliff by their fingers. They were slowly crawling up to the cliff to safety. Along came OPEC, who decided to push the price of crude oil down a precipice and taking global economies along with it. The reason? To kill the U.S. oil frackers and regain market share. And they were successful.

Weekly WTI prices from 2014 to 2017
Weekly WTI prices from 2014 to 2017
Source:  tradingview.com

By 2015, both the the world economies and S&P 500 also started to lose their finger grips on the cliff. When crude price dropped from $110 in 2014 to $60 in early 2015, it was still okay for global economies and equity market. In fact, lower crude price is good for the economy. But if crude oil is continued to move below $60, world economies faced a problem that had been plaguing them since the Great Recession of 2008: deflation. So you can have too much of a good thing.

Cast your mind back to the 1970s, it was OPEC who created the rampant inflation that rattled world's economies. Like them or hate them, OPEC pulls the lever on global inflation and deflation via the oil prices. Of course, it's not their intention or interest to change global inflation landscape (however, it's their intention to exercise the immense power that they have in getting what they want). Because energy cost is such an integral part of the modern economies that crude oil prices are part and parcel of inflation calculus. So when crude prices spiked like those in the 1970s, 1990 or 2005 to 2007 period, inflation ticked up. And when crude prices dived like those in 1986, 2008, or the 2014 - 2015 periods, inflation declined.


Crude oil price from 1960 to 2017
Crude oil price from 1960 to 2017.
Source:  macrotrends.net


Source:  macrotrends.net

So it's up to central banks around the world to fight OPEC induced inflation or deflation by pulling their levers of official interest rates as the OPEC turning their oil field's sprockets.

So next time when you blame central banks around the world for money printing, you should spare a thought that they're simply reacting to OPEC's inflationary or deflationary pressure.

If you look at the 2 charts above (crude price and CPI charts, which measures inflation), every peak in the crude price chart (1970s, 1999 or 2005 to 2007) corresponds to a spike in CPI figures (years in black), and every trough in the crude price chart (1986, 2008 or 2014 to 2015) corresponds to a low bar in CPI chart (years in red).


During these periods of outlier inflation or deflation, central bank like the Fed would need to counteract these forces accordingly. Just look at how similar the charts of US CPI above and the US Fed Fund Rate below.

US Fed Fund Rate from 1960 to 2017
Source:  macrotrends.net
So the chain of events are clear. OPEC move prices up or down, this transmits to higher or lower CPI, meaning inflation or deflation, and the Fed (and global central banks) increase or decrease official interest rates accordingly. In other words, OPEC creates storm and wreaks havoc, and the central bankers would need to clean up the mess afterwards.

While crude oil isn't the only driver of inflation or deflation, but it's the singular most dominant force. I shouldn't sound like that OPEC is the only boogieman. It all gets to the economic basics of supply and demand at the end of the day. But OPEC, collectively as an oil cartel could exert more influence on oil price than any individual group (at least for now. But their influence is declining. This will be the topic for my next article). US oil frackers would soon give OPEC a run for their money.




Friday, 17 March 2017

Puerta del Sol (Sun Gate), Madrid

It's not a large public square, but it's the arguably the most important square in Madrid for locals, and for that reason, it's a good place to visit to get a glimpse into the local culture and tradition.


Real Casa de Correos, Puerta del Sol, Madrid, Spain
Real Casa de Correos

Real Casa de Correos (or the Royal House of Post-Office) is the main edifice that you'll see in the square. Today, it's the office of the President of Community of Madrid.

So what makes this plaza so special? For one thing, this square isn't just considered the centre of Madrid, it's therefore the centre of Spain. D'uh! Well, there's a little bit more than that...

Real Casa de Correos, Puerta del Sol, Madrid, Spain
Dunno if the square is always so busy or because it was around the festive season.

In front of Real Casa de Correos is a plaque that is called kilómetro cero (Zero Kilometre, also "0 km"). It's not hard to find. Just walk to the main entrance of the building and you'll see people pointing their cameras at the ground (which isn't the typical camera angle). I dunno why i didn't take a photo of it. It's a mystery to me. This is one reason why i still haven't got bored with myself because there's much about me that i don't know and want to find out as much as the world out there. I'm a mystery wrapped in a enigmatic outfit inside a riddled diseased body. Ok, that's enough about nothing about me.

This "0 km" is the symbolic centre of Spain, and marks the physical centre of the Spanish road network. This is what i meant by the centre of Spain. A number of capital cities in the world have such plaques. E.g. there's one such "zero kilometre" plaque in Tinanmen Square in Beijing.


Clock Tower, Real Casa de Correos, Puerta del Sol, Madrid, Spain Clock Tower, Real Casa de Correos, Puerta del Sol, Madrid, Spain


Another importance of this square is the clock. No, there's nothing special physically about this clock. But on New Year's Eve, locals would gather here waiting for the clock to strike 12, and stuffing their mouths with 12 grapes with each striking of the bell for good luck for the rest of the year.

We left Madrid just 2 days before New Year's Eve. So didn't get to see the grapes stuffing spectacles. Of course, you can do so at the comfort of home as the whole event is broadcast live on TV.

Despite its name - Puerta del Sol, or Gate of the Sun - there's actually no gate. Trust me, i looked high and low. Unless it's a few inches tall, i had to say i couldn't find it.

No, there's no gate. But it still has a few things to look at. Another thing that supposed to be here, but no longer here is The Fountain of Hapies. Instead, it has been replaced by a modern fountain.

Fountain and statue of Charles III, Puerta del Sol, Madrid, Spain
Fountain with statue of Charles III behind it

While the original fountain is no longer there, but you can still have an idea what it looks like on the tiled street sign in Puerta del Sol.

Tiled street sign, Puerta del Sol, Madrid, Spain
Street sign showing the historical fountain.  Pretty impressive fountain (if it's still around)



Pigeons on fountain, Puerta del Sol, Madrid, Spain
"Look! A bird having a bath at the fountain !"
"Oh...a pigeon! I thought you said a 'bird'..."


Pigeons on fountain, Puerta del Sol, Madrid, Spain






statue of Charles III, Puerta del Sol, Madrid, Spain
King Charles III on a horsie, holding a scroll in his right hand (not a sword).
Often described as an enlightened despot (a few other come to mind).


Another iconic statue in this square is statue of the Bear and the Strawberry Tree, which is in the coat of arms of Madrid city. This is actually a modern work that was installed here in 1967.

Sculpture, The Bear and the Strawberry Tree, Puerta del Sol, Madrid, Spain



Another statue that's at the opposite side of the square is the statue of Roman goddess La Mariblanca. Take note of the coat of arms (with the Bear and The Strawberry Tree) at the bottom of the photo.

Statue, La Mariblanca, Puerta del Sol, Madrid, Spain
Madrid's city coat of arms on the pedestal


Some well known advertisement is closely associates with a site, like the Coca-Cola sign in Times Square in NYC. Or in the case of Puerta del Sol, the Tio Pepe billboard. You could say Tio Pepe to the Spanish is what Coca-Cola is to American.

Billboard of Tio Pepe and statue of Charles III, Puerta del Sol, Madrid, Spain


Toruist police car, Puerta del Sol, Madrid, Spain
Tourist cop car that tells you the main countries of origins of the tourists:
Italian, Japanese, German, Chinese, Arabic, and Russian.
The order is probably sorted by the relative size of the tourists' countries of origins.
Nice stats !!!


Lottery kiosk, Puerta del Sol, Madrid, Spain
It's almost new year,
and so let's get lucky...
go buy some lottery...
from here to eternity !

Lottery stand, Puerta del Sol, Madrid, Spain
Why not buy it here,
with queue all empty ?
You'll get it quickly...
no need to line up like bees !


Metro entrance, Puerta del Sol, Madrid, Spain
The iconic peanut (or bowling pin) shaped metro entrance.


The square is family friendly. Here are some street artists.

Street artist, Pooh Bear, Puerta del Sol, Madrid, Spain
Peeka-pooh !!!    Now i c u !


Street artist, Pooh Bear and Micky Mouse, Puerta del Sol, Madrid, Spain
Coming up / out for air...

Street artist, Child's Play, Puerta del Sol, Madrid, Spain
Girls really love their dolls...Smile, and say "Chucky!"
Is child labour illegal here? Wait. it's Child's Play (1988)
I hope the knife isn't rusty. It can lead to nasty infection.
Street artist, Pikachu, Puerta del Sol, Madrid, Spain
Peeka-chu!  I'm right behind you !
Eeeeew! Lucky! He's not Chucky !



Shoe shine, Puerta del Sol, Madrid, Spain
Catching up on world events and stock prices between shoe shine...
Thought bubble:  "Apple's up $8 today! Better eat less... Should i sell all 5000 of my Apple's shares today ?"

Speaking of apples, if you're a little hungry and hankering for some snack, or simply have a weakness for croquette, you can head to Casa Labra. It's a restaurant tucked behind Puerta del Sol. Expect long queue. At least when we were there.

We bought a fish croquette. It was a little disappointing. The filling is quite creamy, and there wasn't so much fish, just fish paste or prawn puree. We prefer pieces of fish fillets. But if you don't mind that, you can give it a try. There're other stuffs too.

Casa Labra restaurant, Puerta del Sol, Madrid, Spain
Casa Labra with long queue




Wednesday, 15 March 2017

Is the Shiller PE Ratio a Good Valuation Tool for the Stock Market ?

 Shiller CAPE Ratio 

I have seen the Shiller PE Ratio chart making the rounds in the internet lately. It has been used as evidence that the stock market is overvalued. I have even seen prof. Robert Shiller - a Nobel laureate in economics - appeared on CNBC a few times lately pointing out that the stock market is overvalued based on the chart that bears his name.

I reckon that chart is evaluating the stock market without the most important context of all: interest rates (Fed Fund Rate or bond yield, to be exact). Surely, we can't measure the stock market in any meaningful way without comparing it to its interest rate environment.

During 2016, there is the much talked about topic of TINA (There Is No Alternative) condition in the investment landscape. I.e. the stock market kept going up while the earnings are declining, and the GDP growth was slowing to a crawl. This is attributed to the fact that when bond yield is negligible (and in some parts of Europe and Japan, bond yield is negative). In this environment, what's the point of putting money in bond when you're guaranteed to lose money?

Hence, there's no alternative but putting money into shares. For this reason, share prices would benefit a higher p/e ratio because of lower bond yield. (No, i don't think the Fed lowers FFR (Fed Fund Rate) to lift asset prices. Maybe partly for the Wealth Effect. Mainly, the Fed drop rates to reflate the disinflation / deflation since the Great Recession of 2008 (actually this occurred long before 2008). Asset price rises is just a side effect. Not the cure).

In summer, woolen sweater are cheap, but the same woolen sweaters could double in price, and we still need to buy it. You've no alternative (the alternative is hypothermia. Or in the case of investment, erosion of wealth).

Earnings are important (it's the "E" in PE ratios), but it must also be priced in relation to interest rates (directly influenced - if not controlled - by FFR), and not just its historical context. In other words, both earnings and bond yields affect price (the "P" in PE ratios).

Shiller PE and Cape ratio, and fed fund rates
Source: Shiller PE Ratio comes from multpl.
(Click chart to enlarge)

Let's compare the charts of Fed Fund Rates and Shiller PE Ratios side by side (or top and bottom). Here are a few things of note.

* The 2 peaks in Fed Fund Rates (~1920 and ~1980) correspond to 2 bottoms in Shiller PE Ratios. Not surprisingly, a trend of increasing FFR lead to contraction of PE ratios. This makes sense. That's the whole point of increasing rates.

E.g. The market topped with a p/e = 7 ! Yes, single digit. But the inflation was 14%! Yes, double digit. While this is an anecdotal evidence, but it fits in everything in this article. So today we have historical low inflation, we should expect historical high p/e.


* The 2 rate hike cycles (~1900 - 1920, and  ~1970 - 1980) lead to declining PE ratios.

* Life is never so simple. We can have period of rate hike and increasing PE ratios at the same time such as those in ~1940 - 1970. The red line that denotes pivotal rate (~5%). We're in this zone right now where we can have a growing PE ratios and increasing FFR at the same time. Once we're above this pivotal rate, we're starting to kill the PE ratios, as seen from the chart. This is because our economies can't handle high FFR (and high is defined as anything over ~5%).

Another way of looking at the 2 distinct periods between 1950 to 1980 is this: in the 1st period from 1950 to 1970, the Fed performed normalization of rates, which tends to steepen the bond yield curve, and this is good for economy and market (expansion of market p/e). In the 2nd period, the Fed tried to rein in inflation, which tends to flatten the bond yield curve, and that's bad for economy and equity market (contraction of market p/e). We're clearly in the 1st period now with the Fed normalizing rates.


 Fund Flows Between Bond and Stock Markets 

Clearly, one can't just look at PE ratios alone. Remember that the bond market is more than twice as big as the equity market, its fund flow to the equity is therefore quite significant.

The rise and fall of bond yield leads to the fund flows between the bond and share markets, and contributing to the the fall and rise of the share market. The bond yield in turns is greatly influenced by Fed Fund Rate.

Therefore FFR determines the flow of money between bond and stock market. Or more accurately, money are seeking the best returns for the investment money, or best bang for the bucks. Surely, that has to be the most important gauge for all investments.

Fund flows model between Bond and stock markets
When Fed Fund Rate is low, fund will flow from bond to share market, leading to increased liquidity
in the share market, thus causing its prices (and p/e) to rise.


So, let's look at the Shiller PE Ratios right now in the context of Fed Fund Rates. We have the lowest Fed Fund Rate on this chart going back for more than 100 years, and yet we don't have the highest Shiller PE Ratios today.

To put it another way, if the Shiller PE Ratio that we have today is the same value (~43) as the Tech Bubble top of 2000, our stock market is still cheaper because the FFR is considerably lower today than year 2000. Of course, i'm not saying a PE ratio of 43 is cheap. I'm saying that if we have Shiller PE Ratio = 43 today, it's considerably undervalued when compare to the days of the Tech Bubble. Since the Shiller PE Ratio is under 30 right now, is it cheap or expensive?

Well, the price of 10 Year U.S. Treasury Note is about 43 times its annual interest payment, which happens to be the Shiller PE Ratio for the Tech Bubble peak of 2000. In other words, if today's p/e ratio is the same as the S&P 500 p/e ratio of the peak of 2000, the market is fully valued. Since we're well below that, the market p/e is cheap because of the high 10-year treasury bond price (or historically low yield).


In summary, both the bond and stock market are competing for the same investment money. They're competitors just as shoes companies competing for our money. To compare the p/e ratios of a stock market with its past records is like comparing the price of brand X shoes with its past prices.

What you really want is comparing the price of shoes of brand X with the price of brand Y today. Not the past. Of course, one can compare the price of brand X shoes with its past to get some idea of what prices are considered expensive in the past, but it's much more relevant and useful to compare brand X shoes with its main competitor of brand Y in the same timeframe.

If the price of brand Y shoes are expensive (read bond prices), then even if the prices of brand X shoes (read stock prices) are more expensive now than its historical prices, we still want to buy brand X shoes because we don't want to pay for higher priced brand Y shoes.

Bond markets have been in bull market in the last 30 years while stock markets have bear markets with severe corrections. Bonds are therefore much more expensive than stocks. Or to put it another way, if the yield of 10 Year T Note today is, say 8% (which is lower than the 1980s), why would Wall Street even want to hold equity? Unless S&P 500 has a low single digit PE ratio.

It would make sense to look at the Shiller CAPE Ratio if share market exists in isolation. In other words, no significant competitor for money in the equity market from other market. Not only this is simply not the case, the stock and bond markets are in fact joined at the hips (shown in my drawing above).

I've seen countless articles that put up the Shiller CAPE Ratio chart without questioning its validity, and stating it as 'proof' that the stock market is very overvalued, and as if all matter are settled, end of discussion. That has to be the most dangerous thing one can do. If i can place a slither of doubt in them (or more importantly their readers), i've done my job.

For those who keep insisting in showing this chart that the market is soon to correct based on the high Shiller Cape Ratio, they should read what the professor said about the usefulness of his chart as a predictive tool here. He questions the usefulness of Shiller Cape Ratio as a timing tool (but people are using it for that exact purpose). If the bond market (and gold market to an extent a lesser - much lesser - market) is an important competitor for money, then why not just use bond market (brand Y shoes) as gauge of stock market (brand X shoes) valuation model?



 The Low FFR Normal 

We're in a goldie locks period that's more similar to the period between ~1950 to 1970 with increasing Fed Fund Rate and inflation from a low base. As long as the Fed kept the Fed Fund Rate well below 5%, the market should benefit from it (assuming the economy isn't running into some spanner in the works like Sub-prime bubble).

I have a feeling that the Fed will keep FFR considerably lower than 5% for sometimes to come. I don't think the share market can withstand even a 3% FFR. We're living in the Age of Disinflation causing by the 3 megatrends of globalization, aging demographics, and most of all, technology (which leads to lower prices of energies, goods, and services). These megatrends won't go away any time soon, and the Fed and central banks around the world will have to contend with low FFR to combat those powerful drivers of disinflation.