Friday, 12 February 2021 The Crack-Up Boom Is Here
It’s nothing new on Wall Street that stock prices sometimes dislocate from conventional economic and corporate fundamentals.By definition, it’s a hallmark of the latter stages of major bull-markets and, for what by now seems permanent, since 2014.But as monetary politics have become evermore interventionist and volatile, so too has the stock market cycle.In the last 15 years alone, we’ve had three major booms.
And with economic fundamentals tanking on an unprecedented scale during the past twelve months, some might still watch and wonder in bemusement why the prices of major U.S.
stock market indices have not only risen, but surged.
This has culminated in a dislocation between stock market indices and past and current fundamentals which, at first glance, appears stretched beyond any reasonable explanation.But the answer to why is perhaps easier found not in why stocks are so expensive, but why cash is so cheap.
The last twelve months have been extraordinary since the stock market has, uncharacteristically, been more concerned about the longer term rather than current and next quarter earnings.
The market has behaved as if nothing negative at all has happened to the economy during the lockdowns.Which begs a question – why this shift to a focus on next year’s earnings and beyond? Part of the explanation for why stock market valuations are high is of course found in the apparent expectation that the dip in earnings is temporary.And, naturally, the deluge of liquidity created by the US treasury and the Fed in tandem sends a clear signal to markets to buy stocks.But it’s still the sum of what a company has already accumulated in net worth and future excess cash generated that matter from a valuation perspective.
The earnings decline therefore should have pushed valuations down unless offset by improved expectations longer term.But are there any good reasons to expect long term corporate earnings prospects to be any better today than they were at this stage last year? Surely, the answer must be an unreserved no.Rather, the contrary – we should expect economic growth to be lower now, since both production and employment have shrunk.
As a result, the economy has consumed wealth, evidenced by rising debt levels and a surge in money supply growth, not least relative to the already overstated private saving rate.Any sound theoretical valuation of the stock market ought to conclude that stock market prices today should be substantially lower than a year ago.So why are valuations instead substantially higher? We should not forget of course that there are factors pulling in the opposite direction.Negative real returns on high-quality corporate bonds and treasuries make equity investments more attractive and hence valuable than before.It’s also reasonable to expect interest rates to remain lower for longer now than pre covid given the weaker economy.
But given the highly elevated level of stock market valuations even before covid, I’m not convinced we can justify even higher valuations because of even lower interest rates expectations.
Bad economic fundamentals have not only remained good news for stocks, but become even better news on a scale that mocks the previous six years.Something must be wrong.Which begs another question; if longer-term economic fundamentals have not improved post covid and interest rates expectations could not possibly be much lower today, what fundamental factors are then driving this racket? Before I continue, I must point out that so-called fundamentals frequently have little to do with stock prices, though many of us, including myself, once upon a time became brainwashed to believe the two are hand in glove.
Informed investors learned generations ago that the combination of monetary- and fiscal policies, and the so-called “stimuli” they provide, or the more potent version – in tandem – fuel stock market prices.Simply put, “don’t fight the Fed” and its undoing of the great American economy – that has dominated the globe for more than a century – remains a solid buy and hold strategy, especially for the uninformed and those that should never have invested in the stock market.It must be a sign of an undoing of some sort, when economic policies lure even the most novice of speculators to invest their money in this stock market mania.The “Fed put” has by now become permanent, rather than the less predictable interventionist policy it was in the past.The only question remaining today is how long this put can remain “in the money” as both the will and ability to try are unquestionable.Everyone that assumed the Fed put to be permanent or simply piggy-backed on ever-higher stock market prices, happily unaware of fundamentals and Fed policy, has won not only this year, but for at least the last seven years.
Even a novice, too lazy to place a sell order since 1982, can declare himself a genius today if he bought an index fund or bought some long-term treasury bonds that he occasionally rolled over.Stocks for the long-term indeed Jeremy Siegel, but not for the reasons you based your theory on.But fool’s gold has been abundant for generations, and especially since Nixon closed the gold window in 1971.As a result, ignorance and buy-and-hold strategies followed blindly have hence been a path to success for at least a generation in the stock market.This does not however mean stocks and other risk assets will replicate these nominal returns in the coming decades.And now we get to the crux of the matter.
Stocks are not ridiculously expensive because fundamentals are poor.Stock prices are high because cash is extremely cheap as it offers nothing but a continuous loss in purchasing power.Cash has been offering negative returns for years, and notably since the 2008 banking crisis in the US and many countries in Europe.Even unsophisticated investors have noticed this (as their neighbours have been making a killing in stocks and cryptos) and thus have all the incentives to abandon cash savings accounts to the extent possible.Whom in their right mind would lend their excess cash to fragile banks at 0 % interest rate these days? The answer is probably fewer than in the last decade and most decades preceding it.The only option left to acquire any return at all with an ever-depreciating fiat currency backed by absolutely nothing, other than the bad faith of the Federal Reserve and the US government, is none other than to move much further out on the risk curve.
And that is exactly what investors and speculators have done for years and more recently since the covid lock-downs were implemented.This desperate chase for yields has push valuations ever higher.To put it bluntly, investors are scrambling to flog unnecessary cash holdings to protect the purchasing power of their savings.
This is the very hallmark, and a confirmation of everything which is wrong with the monetary system and economic policies these days, of the crack-up boom.M2 money inflation is today running at around 26 % annually.Meanwhile, 10-year treasury bonds are offering little more than 1 %.This leaves the ratio between the two at a staggering 24x.
The extremeness of this ratio reflects an observation, the importance of which shouldn’t be understated; treasury bonds are highly valued relative to cash, to an extent perhaps never seen before in the US.And when cash is trash compared to even so-called safe government bonds, cash will be trash compared to most other financial assets that grow at a slower pace than the quantity of US dollars does.Money is whatever we commonly accept in exchange for any good or service.
Today we know money as currencies, being it the U.S.dollar or the Yen.But when a currency loses a most distinguishing feature of being sound money, namely a store of value, there are few limits to what anything priced in that very currency should be valued at.That’s the stage we are at now, as people need to move out of cash in a desperate attempt to maintain the purchasing power of their savings.
Worse yet, they might depend on capital gains to make up for the dwindling purchasing power of their incomes.This is all distinguishing features of a failing currency and monetary system.Throwing more money at a failing currency, as is now customary across all countries with a central bank since the remaining link to gold ended in 1971, will serve to further undermine the dire state the US dollar and other currencies are already facing.Investors have noticed this, not because they are experts at money and monetary politics, but because they have figured out cash is no longer king, but an asset to avoid as much as possible.They have discovered this out of a necessity to protect their savings the best they can.This action by itself reflects the failure of a currency as people need to either become experts or hire such expertise to protect their savings (little wonder investment banks the financial services sector at large love monetary inflation).Little wonder Bitcoin and other cryptos have gained tremendous interest and traction in recent years.
The Federal Reserve’s monopoly on money is under attack.
Its last and only defense to protect it from failing will eventually be to raise interest rates and limit the issuance of additional money.But if it ever were to do that, the economy would collapse.
Alas, the Federal Reserve and everyone involved will continue kicking the can down the road for as long as they can.The crack-up boom in the stock market, one of the historically most accurate indicators of inflation, indicates the kick-the-can tactic cannot last much longer.For those believing the US dollar will be converted into something else, for example, a crypto currency should know that owners of US dollar will lose purchasing power and realise their already accrued losses.If they did not, why in the world would a government replace a currency? Posted by EcPoFi at 21:05:00 No comments:.
