Juggling Dynamite

A December 2020 paper entitled The Big Bang:  Stock Market Capitalization in the Long Run, confirms that we have been living through a highly unusual period in financial markets.

While advanced-economy stock market capitalization to GDP ratios were pretty constant between 1870 and 1990s, they tripled in what the authors call a “big bang” in the 30 years since.   This structural break’s key driver was a policy and profit shift in favour of publicly listed larger firms along with stagnating economic growth.  No free lunch, the authors find that these trends do not bode well for future investment returns or stock market stability from here:

The existence of this profit shift is consistent with the broader trend of increasing market power of large firms at an increasingly uneven distribution of corporate earnings in the US and globally (De Loecker et al.,2020; De Loecker and Eeckhout, 2018). Because these high market values reflect a distributional shift within current income rather than a high future growth potential, they do not generally signal favourable near-term prospects for the economy.

On the contrary, we show that high levels of market capitalization are typically a sign of brewing trouble, predicting low returns, low growth, and a high probability of a stock market crash.

Persistently high inflation can reduce buying power for households when comparable increases in wages do not offset it, and wage growth has been flat for years.

However, the greater fear for central banks is that persistently low inflation, disinflation, and outright price deflation leave much less room for monetary policy (at near-zero interest rates) to prod spending, economic growth, and capital flows into corporate securities.

While pandemics of the magnitude of COVID-19 have been historically rare, they’ve tended to be deflationary, reducing consumers and consumption in their aftermath.

That said, in the near term, there is no question that year-over-year comparables look inflated from depression readings in the first half of 2020 (base effects), on top of recent supply chain disruptions and some pent-up demand, mostly for services.

On the demand point, it is important to realize that consumer spending through the 2020 pandemic/recession has already been extraordinary, thanks to record government assistance. Bank of America credit/debit card data (charted beside) shows that March 2021 household spending (in orange) was significantly higher on key goods than February of 2020 (in black) and only lower on lodging and airlines.  The elevated consumption of goods is unlikely to continue indefinitely.

Much of the jump in prices we see in the first half of 2021 is not so much inflation as reflation from depression levels in early 2020.  This chart captures the relative change well.
While central banks and the finance sector continue to tout an inflation narrative, the case for non-transitory effects (and much higher interest rates) remains sketchy thus far.

A few recent charts, courtesy of DailyShot.com, offer clarity on where we are in the present financial cycle.

According to data from BofA, central bank and government injections (backed by taxpayers) encouraged more than half a trillion dollars to flood into global equity funds over the past 5 months–exceeding the total inflows recorded over the previous 12 years.
The rising liquidity and risk appetite enabled corporate mergers and acquisitions (shown below by sector since 2000) to reach a new all-time high in the first quarter of 2021, surpassing the prior peaks in 2000 and 2007.

It also allowed companies and their investment bank underwriters to sell a record amount of new equity issues to the public in the first quarter of 2021.
At the highest price to forecast-sales ratios in at least 20 years…

And allow zombie companies –those not making enough money to pay the interest on the debt they’ve already accumulated–across the OECD, to borrow even more.

While paying lenders the lowest interest compensation ever–less than 4%.
Whatever buyers may think they’re doing here, it’s certainly not ‘investing’.