Kyle Bass and the Coming Global Forest Fire

I believe that if you are a citizen anywhere in the world, this is probably the most important video that you could watch this year. Yes, the interviewer with his twirling glasses is full-of himself and really annoying, but Kyle Bass makes up for it with his genius.

 Kyle Bass Interview

Understand Long Term Valuations and Expectations

The chart you see here I original saw from the website Valuewalk.com

While I'm not going to walk through the details of the calculations, I'll summarize the conclusion: The red-line looks at 15-year returns following a given year. Hence the reason why the red-line stops in the mid-90's (It's nearly 2012, so 15 years ago ~1997). So you can see that the market since 1997 has returned about a ~4% annual return (technically ~3.66% per annum from November '07 to November '11).

The blue line, shows what the 15-year returns would have been forecasted at any given date by looking at a 10-year average multiple for the S&P, inverting it (so 20x 10-year average is a 5% return) and making some adjustments for inflation.

As you can see, over a long period of time, the returns of the market over any given 15-year period, haven't deviated too far from what a 10-year valuation would imply. This seems logical enough. After all, if you pay too much for an asset, the returns will be lower, and if you find a bargain, your returns should be higher.

The current market environment implies that over the next 15-years, the total return will likely come between -2% per year to +2% per year.

Yet another clue that after a market rally like this past week, it's good to sit on cash and wait for dramatic bargains.  It's just a matter of waiting. If the market continues to rally, the 15-year forecast will likely go negative, in which case I'll consider increasing my 13% S&P short position.

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Just as a follow up to this post. Let's say the above forecast is correct (as it has been roughly for the past several decades) and the market is set to compound at -2% to 2% per annum over the next 15-years (technically its closer to zero but let's put a range on it). If we want to assume the optimistic scenario, the upper range, we use 2% per year. This implies that the S&P can increase by about ~35% over the next 15 years, from ~1,244 to ~1,674.

This really helps justify my big S&P short position. There are all these huge macro risks that can tank the market in the coming months and if none of them play out, in all likelihood, the most I'll lose on my short is ~35% over 15 years. In contrast, all the stocks I own can compound at 8%+ per year (through shareholder returns and growth), and I think could easily increase by 50-100% in the next 3-5 years (barring a macro collapse). Feels like a the right set up, but at the same time, I don't want too much net exposure (aka if I buy a stock, I'll offset the equity exposure by shorting the S&P).