I have long appreciated Ed Easterling’s excellent and detailed historical data, some of which can be seen at Crestmont Research. At the end of June he updated the valuation measurements for the S&P 500 and notes that while stocks gained 5% in the second quarter, normalized earnings increased just 1% over the same period.
In fact over the past 24 months, 80% of the gains in stock prices have been driven by the willingness of buyers to pay a higher and higher premium for each dollar of expected earnings. At the end of June that premium had ballooned to more than 26 times 10 year average earnings and nearly 19 times consensus forward expected earnings. Easterling reminds us:
“historically (and based upon well-accepted financial and economic principles), the valuation level of the stock market has cycled from levels below 10 times earnings to levels above 20 times earnings. Except for bubble periods, the P/E tends to peak near 25…
The peak for P/E generally occurs at very low and stable rates of inflation. When inflation falls into deflation, earnings
(the denominator for P/E) begins to decline on a reported basis (deflation is the nominal decline in prices). At that point, with future earnings expected to decline from deflation, the value of stocks declines in response to reduced future earnings—thus, P/Es also decline under deflation.”
He also stresses that secular bears (where PEs mean revert from above 25 to below 10 again) are measured in distance not time.
They either get to the end zone via a period of sharp, steep declines from here (as in -55ish total return over the next 5 years, or -45ish total return over the next 7, or -26ish over the the next decade–want to see the Sharpe ratio on any of these outcomes?), or through a long, slow slog sideways of 2% nominal total returns annually over the next 20 years as earnings move up and prices stay flat long enough for PEs to finally grind lower. Pick your poison (aka strategy) accordingly.
In any of these outcomes, it requires suspension of reason to justify holdings stocks at present valuations and calling them “investments”. See: The PE Report.
Investment grade bond yields have been falling in tandem with global growth forecasts over the past 7 months again, leaving the consensus, who are expecting a pick up in inflation, on the wrong side of the trade.
This segment offers a good summary of some of the reasons that present inflation expectations are likely to continue to over-estimate as demand and growth continue to slow. Here is a direct video link.
The largest factor not mentioned in the clip however, is debt. Debt is future consumption denied, and the world has tried to borrow its way out of the debt crisis of 2007-08 by adding on trillions and trillions of more debt every year since. The weight of this debt at all levels of the economy now from households to governments and large cap business has left a large hole in potential demand over the next few years. This means, slower growth and disinflation, not to mention necessary deflation in financial assets as markets finally recouple with the reality that the world economy is driven by customers not central bankers.
Danielle was guest today with Kerry Lutz on The Financial Survival Network talking about recent trends in the world economy and markets. You can listen to an audio clip of the segment here.
It was one thing when the world was in love with high tech shares in 2000 or with US banks, home-builders and construction materials in 2007. Those were extremely dangerous times to be sure and many oblivious and greedy “investors” deservedly learned brutal lessons of loss. But seniors and risk averse people still had a reasonable investment option back then. Interest rates at both of these prior market peaks were still within the normal range and savers could still earn 5% in guaranteed bank deposits and investment grade bonds without facing high risk of loss.
Today cash rates are less than 2% and even locking into 20 or 30 year government bonds will earn less than 2.7% interest. The madness of zero-interest rate central bank policies the past 5 years, has increasingly corralled gullible throngs into the arms of investment “advisers” who have sold them over-valued bank shares, sector ETFs and mutual funds at the most extreme valuations seen to date (see chart below of the Canadian bank index ETF).
Since these “conservative, dividend-paying” bank shares lost 50% in both of the last down cycles, the carnage this time threatens to be even deeper and more wide spread than in 2001-02 or 2008-09. Only this time, victims will be even more exposed, that much older and less able to recover or make ends meet.
We rented this film on iTunes last night. It is one of the most entertaining and thought-provoking works I have seen in a while. Film maker Margarethe von Trotta made some brilliant choices in telling this story of the real life events that found German philosopher and writer Hannah Arendt reporting for the The New Yorker on the war crimes trial of Nazi Adolf Eichmann. The real life footage of Eichmann’s testimony is skillfully interwoven into this narrative focused on friendship, love and thought.
This film examines the thinking and rationalizations after World War II rather than the war crimes themselves. As a concentration camp survivor and world-renowned political theorist, Arendt begins her attendance and coverage of Eichmann’s trial looking for understanding of human behavior. In the process she finds not the simple black and white of monsters and heroes, but a complex web of culpability that divides and infuriates many of her contemporaries. Here is the trailer.
In the end Arendt concludes that it is each individual’s ability to think for ourselves that defines our humanity. Good reminder amid the intense spin and pull of mainstream thinking and consensus views in our own time.
I love Stuart McLean’s Vinyl Cafe and yesterday had the good fortune of being stuck in weekend cottage traffic long enough to enjoy his entire Sunday show. The inspiring true story read from Michael Gallagher of Hope, Main is one for the ages. You can hear it by advancing the playbar to 11:30. Here is the direct audio link.
Senators Elizabeth Warren (D-Mass) and John McCain (R-Ariz.) continue as forceful advocates for the intelligent and obviously necessary return to a Glass-Steagall-like division preventing banks from levered speculating backed by the American taxpayer. This clip from 2013, is a good reminder of some of the history of this fight and why congress and the business media continue to oppose this return to reason with all of their bank-sponsored might. Here is a direct video link.
As more and more people move into cities, the demand for access to fresher, more nutritious foods continues to rise.
Brooklyn-based Gotham Greens builds greenhouses on urban rooftops. Inside the greenhouses, the company grows vegetables that don’t have to make the long journey most food makes from rural farms to cities…
This high-tech solution, though costly and subject to space limitations, is one of many approaches to urban agriculture now being explored around the globe. And on a per-square-foot basis, its product yields could potentially eclipse those produced by traditional farming methods.
Here is a direct video clip.
In 2013, $10.832 trillion of the $15.942 trillion GDP produced in the US went toward household purchases. This means that consumer spending from US households–the wealthiest in the world–while diminished since the credit bubble peak in 2007-08, still accounts for more than two-thirds of U.S. economic demand, and remains the most dominant cohort driving global demand. In Q1 the growth in this key sector was lowered to a 1.0 percent rate compared with the long-term average growth trend of more than 3% a year.
While corporations have borrowed trillions at the lowest interest rates in at least 3 centuries and then plowed the funds into buying back their own shares on the open market to increase reported profits (per share) and use their sky-high stocks as the “free” currency for mergers and acquisitions of other over-valued companies, the aging and indebted western consumer continues to slip further below historic consumption trends.
The great equalizer persists however: just as neither labor nor management get their way indefinitely in the interdependent ecosystem of a consumer-led economy, corporate profits remain the most mean-reverting economic series ever plotted as shown below. The glaring overshoot of corporate profits as a percentage of GDP the past 5 years has some re-coupling to do. And when that happens, those owning stocks today valued at 26 times average 10 year earnings, are likely to feel the financial pain of excessive optimism.
Complacency and aggressive risk taking has been intentionally encouraged by Central Bank policies the past 4 years. But since the Fed is only bluffing that it has control, reality will eventually hit as a dramatic shock and punishment to followers.
Investors should be paying more attention to the uncertainty being created by the turmoil in Ukraine and the Mideast, Mohamed El-Erian told CNBC on Monday.
“Because the Fed is standing by the markets, there’s [been] a reason to fade any sell off.”
“But the problem is if you step back the process is getting worse. It involves nonstate actors, which means it’s much harder to contain,” he said. “Unlike the old days, there is no outside power that inform, influence, or impose outcomes.” Here is a direct video link.
Today’s processed foods industry is more powerful than the tobacco industry was in the 1950′s and ’60′s. Not everyone smokes, but everyone eats. The other magnifying feature in terms of social impact, is that unlike tobacco, processed foods are being pumped into our children from birth. The long-term health of next generations is being insidiously compromised before they even get a chance to be young and strong. It is a tragedy being perpetrated both through the inadvertent neglect of parents and caregivers as well as the media-spinning power of big food conglomerates and the captured politicians that assist them. Healthy eating is one of those rare foundational choices where individuals either make a conscious decision to be part of the solution or they are part of the problem.
This is the movie the food industry doesn’t want you to see. FED UP blows the lid off everything we thought we knew about food and weight loss, revealing a 30-year campaign by the food industry, aided by the U.S. government, to mislead and confuse the American public, resulting in one of the largest health epidemics in history. Here is a direct video link.
Danielle was a guest today on Talk Digital Network with Jim Goddard talking about recent trends in the world economy and markets. You can listen to an audio clip of the segment here.
To clarify the comments on Buffett, investors in his Berkshire shares made zero nominal returns (negative real returns after inflation) for 6 years from 2007 all the way to 2013. Over the past 12 months as QE mania lifted all risky assets, Berkshire shares went along for the ride mirroring the gains in the S&P 500. This also means that when the S&P enters the next bear market decline, the tightly correlated Berkshire will go along for that ride as well. For the chart and more see: Buy and hold Buffett necessarily perpetually bullish.
Notwithstanding the usual heavy gold-mongering by the sponsor, this interview offers some worthwhile macro and financial risk analysis.
The central banks of the world are massively and insouciantly pursuing financial instability. That’s the inherent result of the 68 straight months of zero money market rates that have been forced into the global financial system by the Fed and its confederates at the BOJ, ECB and BOE. ZIRP fuels endless carry trades and the harvesting of every manner of profit spread between negligible “funding” costs and positive yields and returns on a wide spectrum of risk assets. Here is a direct link to his latest audio interview.
Today the US 10 year treasury has dropped to 2.5%, down from a yield of 3% at the start of the year. If it does close through 2.50 the next downside test area is 2.3% as shown in this updated chart.
Of course throughout, as usual, stock-floggers have been perpetually forecasting treasury bond prices would tank and 10 year yields soar to 4%+ every moment now. Fascinating that they always see rates moving higher for investment grade bonds (prices lower), but never the commensurate repricing lower that deflation would imply for risk assets like corporate bonds and equities.
But then they are stock-floggers after all, and so hope springs eternal on their asset class and future growth. Most especially as prices move to all time highs. This next chart of consensus GDP forecasts since the start of every new year since 2009 offers some perspective. The consensus led by the inept US Fed has forecast US GP growth of 3%+ every year only to ratchet it down in retrospect every disappointing quarter. 2014 has been no different (black line below), with expectations from near 3% in January now down to maybe 1.5% half way through.
For those who remain mystified as to how North American bonds could be still attracting large buyer interest at present yields, this chart from Hoisington Investment Management, second quarter review and Bloomberg offers a comparative view of present US and Canadian government bond yields relative to the rest of the developed world. So far, North American bonds are offering the highest yields by a significant margin.
How low can North American treasury yields go? If the slowing global growth theme continues as we suspect it will over at least the next year or two, the answer is quite a lot lower, with the US 10 year potentially moving back below 2% and the 30 year well below 3. Believe it or not.