The S&P 500 has fallen 7.37 percent so far this year. What to make of it? Naturally, some people find falling stock prices to be unpleasant. Others find them distressing. Another way to look at falling stock prices, however, is like a high-fiber diet. The effect is necessary to a healthy functioning system.
The simple fact is that stock prices, fueled by speculative liquidity, have long since outrun the real economy. The disconnect between the two has been widely observable. The economy’s lagged, incomes have stagnated, yet stocks have soared.
Wilshire Total Market Index vs. GDP since 2009 (01/01/2009 = 100). The market’s capitalization vs. GDP has been soaring ever since the adoption of the full-fledged fiat money system – and the gap between the two has never been wider than at the 2015 stock market peak – click to enlarge.
Thus the present, ever so slight reduction in liquidity, and the subsequent lowering of stock prices, has a cleansing influence. For it will serve to eliminate marginal businesses, and trim the fat from larger businesses. Consequently, business owners, managers, and workers of marginal undertakings will have to redirect their efforts into something new…something that’s of greater value.
For example, Walmart recently announced it would be closing 269 stores and laying off 16,000 workers. Obviously, we don’t wish any harm to hard working Walmart employees. But we’re also confident many of these 16,000 people will now find a new, more meaningful, and more prosperous purpose in life.
Though it can be painful at times, eliminating and minimizing wasteful activities is how the world becomes more affluent. On the other hand, propping up negligible endeavors with cheap credit ultimately subtracts wealth from the world.
How much more stocks will fall, no one really knows for sure. Perhaps they’ve already fallen as far as they will. But we wouldn’t bet our life savings on it.
This is merely conjecture, of course. But we do recognize that even with the 7.37 percent drop year-to-date, the S&P 500’s Cyclically Adjusted Price Earning (CAPE) Ratio is 23.97. We also recognize that the CAPE Ratio’s mean, going back to 1881, is 16.65.
In terms of the P/10, this is one of the most overvalued markets since 1880 (in fact, it is in the 92nd percentile of the entire data series – only the peaks of 2007, 1929 and the tech bubble were even more overvalued) – click to enlarge.
On top of that, we understand that valuations always revert back to their mean eventually. Similarly, we know that when reverting back to their mean, valuations often overshoot not only to the upside; but to the downside too. This is how an average is formed.
Certainly, there are countless ways for valuations to come down. One obvious way is for corporate earnings to increase. Another way is for share prices to decrease.
From what we gather, fourth-quarter earnings for S&P 500 companies are expected to fall 6 percent year over year. What’s more, this is the third consecutive quarter that earnings have fallen on an annual basis. Thus, it seems likely, that for stock valuations to get anywhere near their historical average, share prices will need to go down much, much more.
These are some simple facts regarding stock valuations as we understand them. Don’t listen to us, if you don’t agree with them. For there’s plenty out there that we don’t agree with.
Something’s Gone Horribly Awry
For instance, we don’t agree with the illusion and degradation of prosperity that’s readily visible to us as we make our way through our daily rotes in downtown Los Angeles. There are tall shiny buildings, sleek new cars, and chic restaurant fronts up 5th Street and Grand Avenue.
Then, several blocks down 5th Street, at San Pedro Street in Skid Row, there are sidewalk tents, concrete ruble, and multitudes of empty stomachs outside the collection of of rescue missions.
A part of skid row in downtown LA
Photo credit: Lawrence K. Ho
Clearly, something’s gone horribly awry. Hard work, perseverance, and ingenuity likely have something to do with the shiny streets. Conversely, sloth, drug abuse, and mental defectives likely have something to do with the blighted streets. But we also have an inkling that 20 years of activist Fed policy has left its marks all over both.
No doubt, the collection of shiny skyscrapers has sprouted up over the years thanks to the fertilizer of cheap credit. At the moment, Korean Air / Hanjin Group is financing construction of The Wilshire Grand Tower. When it opens its doors in 2017, it will be the new tallest building in Los Angeles and the tallest building west of the Mississippi.
Our friend Pater Tenebrarum of Acting Man, recently explained how the construction of marque skyscrapers coincides with the late stages of an artificial, central bank induced, boom. The Wilshire Grand Tower will forever be a monument to ZIRP.
At the other extreme, it may be unclear upon first glance how the Fed’s artificially cheap credit has wrought abject poverty. Ironically, John Maynard Keynes, the godfather of modern day economic intervention by governments, provided one of the better, succinct explanations of this hidden and insidious relationship. Thus we’ll close with an excerpt of Keynes from The Economic Consequences of the Peace, written in 1919.
Before Keynes became a Keynesian, he wrote this….
“Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security, but at confidence in the equity of the existing distribution of wealth.
“Those to whom the system brings windfalls, beyond their deserts and even beyond their expectations or desires, become “profiteers,” who are the object of the hatred of the bourgeoisie, whom the inflationism has impoverished, not less than of the proletariat. As the inflation proceeds and the real value of the currency fluctuates wildly from month to month, all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless; and the process of wealth-getting degenerates into a gamble and a lottery.
“Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”
Charts by St. Louis Fed, Doug Short/Advisorperspectives
Chart and image captions by PT
M N. Gordon is the editor and publisher of the Economic Prism.
It is that time of the year again – our semi-annual funding drive begins today. Give us a little hand in offsetting the costs of running this blog, as advertising revenue alone is insufficient. You can help us reach our modest funding goal by donating either via paypal or bitcoin. Those of you who have made a ton of money based on some of the things we have said in these pages (we actually made a few good calls lately!), please feel free to up your donations accordingly (we are sorry if you have followed one of our bad calls. This is of course your own fault). Other than that, we can only repeat that donations to this site are apt to secure many benefits. These range from sound sleep, to children including you in their songs, to the potential of obtaining privileges in the afterlife (the latter cannot be guaranteed, but it seems highly likely). As always, we are greatly honored by your readership and hope that our special mixture of entertainment and education is adding a little value to your life!
Bitcoin address: 1DRkVzUmkGaz9xAP81us86zzxh5VMEhNke
Most read in the last 20 days:
- Gold Price Skyrockets in India after Currency Ban – Part III
When Money Dies In part-I of the dispatch we talked about what happened during the first two days after Indian Prime Minister, Narendra Modi banned Rs 500 and Rs 1000 banknotes, comprising of 88% of the monetary value of cash in circulation. In part-II, we talked about the scenes, chaos, desperation, and massive loss of productive capacity that this ban had led to over the next few days. Indian prime minister Narendra Modi – another finger-wagger, as can be seen in this...
- Gold Price Skyrockets in India after Currency Ban – Part II
Chaos in the Wake of the Ban Here is a link to Part 1, about what happened in the first two days after India's government made Rs 500 (~$7.50) and Rs 1,000 (~$15) banknotes illegal. They can now only be converted to Rs 100 (~$1.50) or lower denomination notes, at bank branches or post offices. Banks were closed the first day after the decision. What follows is the crux of what has happened over the subsequent four days. India's prime minister Nahendra Modi, author of the...
- Gold Price Skyrockets in India after Currency Ban – Part IV
A Market Gripped by Fear The Indian Prime Minister announced on 8th November 2016 that Rs 500 and Rs 1,000 banknotes would no longer be legal tender. Linked are Part-I, Part-II and Part-III updates on the rapidly encroaching police state. The economic and social mess that Modi has created is unprecedented. It will go down in history as an epitome of naivety and arrogance due to Modi’s self-centered desire to increase tax-collection at any cost. Indian jewelry...
- A Note on Gold and India – What is Driving the Gold Price?
Hidden Motives It is well-known that India's government wants to coerce its population into “modernizing” its financial behavior and abandoning its traditions. The recent ban on large-denomination banknotes was not only meant to fight corruption. Obviously, this very bad Indian has way too much cash. Just look at him, he looks suspicious! Photo via thenewsminute.com In fact, as our friend Jayant Bhandari has pointed out, fresh avenues for corruption ...
- India's Currency Debacle – An Interview with Jayant Bhandari
A Major Crisis Last week Jayant Bhandari related the story of the overnight ban of certain banknotes in India under cover of “stamping out corruption” (see Gold Price Skyrockets In India after Currency Ban Part 1 and Part 2 for the details). Banned 500 rupee banknotes The problem is inter alia that the sudden ban of these banknotes has hit the Indian economy quite hard, given that 97% of all transactions in the country are cash-based. Not only that, it has...
- Will the Swamp Swallow Trump?
Permanently Skewed TRUMP HOTEL, New York – Trump’s rambling army – professionals, amateurs, camp followers, and profiteers – is marching south, down the I-95 corridor. There, on the banks of the Potomac, it will fight its next big battle. Lieutenants in Trump's army: Bannon, Flynn & Sessions Photo credit: Drew Angerer / AFP Here at the Diary, we do not like to get involved in politics. But this is a special time in the history of our planet – a...
- There Are Two Types of Credit — One of Them Leads to Booms and Busts
Stumped by the Bust In the slump of a cycle, businesses that were thriving begin to experience difficulties or go under. They do so not because of firm-specific entrepreneurial errors but rather in tandem with whole sectors of the economy. People who were wealthy yesterday have become poor today. Factories that were busy yesterday are shut down today, and workers are out of jobs. What has caused the bust? The modern-day economic orthodoxy continues to be unable to provide...
- All Aboard! Trump’s Express Train to the Future
Free Money! BALTIMORE – Last week, the Dow punched up above 19,000 – a new all-time record. And on Monday, the Dow, the S&P 500, the Nasdaq, and the small-cap Russell 2000 each hit new all-time highs. The last time that happened was on the last day of December 1999. Ironically, two events that were almost universally expected to trigger large stock market declines were followed by quite rapid and strong gains. Would the market have fallen if Hillary Clinton had won...
- Attaining Self-Destruct Velocity
Bad Monday Some Monday mornings are better than others. Others are worse than some. For one Amazon employee, this past Monday morning was particularly bad. No doubt, the poor fellow would have been better off he’d called in sick to work. Such a simple decision would have saved him from extreme agony. But, unfortunately, he showed up at Amazon’s Seattle headquarters and put on a public and painful display of madness. Good-bye cruel world! On this our planet,...
- Gold Bull Market Remains Intact – Long Term Fundamentals Outweigh Short Term Market Gyrations
A Strong First Half of the Year, Followed by Another Retreat In early 2016 gold had a big bull run. The precious metal rose close to 25% this year, pushed higher in a summer rally that peaked on July 10th. Gold experienced a bumpy ride over the remainder of the summer though, as investors became increasingly concerned about a potential rate hike by the Federal Reserve. Uncertainty returned to gold market and has intensified further since then. Initially, gold rallied sharply...
- Too Early for “Inflation Bets”?
The Trump Trade After 35 years of waiting... so many false signals... so often deceived... so often disappointed... bond bears gathered on rooftops as though awaiting the Second Coming. Many times, investors have said to themselves, “This is it! This is the end of the Great Bull Market in Bonds!” The long bond's long cycle – red rectangles indicate when the post 1980 bull market was held to be “over” or “over for sure” or “100% over”, etc. We have...
- About that Economic Inequality
Illusory Riches, Obvious Impoverishment I address this essay to two groups. One group is those among the liberty movement, who believe that there’s nothing wrong with inequality. These are often Objectivists, who unknowingly defend a regime that artificially suppresses working people. And suddenly, you feel much lighter... The other group is those among the Left who still call themselves liberals. They say they don’t like inequality, but nevertheless...