“they can’t keep monetizing the public debt at the egregious rates of the last few years…”
CNBC’s Fed fanboy, Steve Liesman, accidentally knocked one out of the park yeserday when he lured Janet Yellen into a quip that will surely go down as the signature insanity of her baleful tenure. Liesman thus queried:
“Every day it seems the stock market goes up triple digits… is it now, or will it soon become a worry for the central bank that valuations are this high?”
After a bit of double talk interspersed with gobbledygook, Yellen uttered the money quote:
”There is nothing flashing red there or possibly even orange,” on asset valuations…
Surely our soon to be pensioned-off Keynesian School Marm was not thinking about the fact that the S&P 500 stood at 2662 as she spoke, which amounts to 24.9X the $107 per share of earnings posted by America’s leading companies for the LTM period ending in September 2017.
That’s at least a flashing bright orange light given certain undeniable realities. For instance, by any historic standard 24.9X is a super-growth PE multiple. Yet the most recent $107 per share earnings figure represents a microscopic 0.3% annual rate of gain since the $106 per share posted by the S&P 500 companies three years ago in September 2014.
OK, accomplished facts and actual history (as opposed to hockey stick projections) apparently don’t matter any more—so looking at the tepid growth of earnings in the rearview mirror apparently doesn’t count, either.
Still, we do mean “tepid” and not just in the last three years. During the last cycle, S&P 500 earnings peaked at $85 per share in June 2007. And that was at a point when the unemployment rate had declined to 4.5%, implying that macroeconomic setting was roughly similar to the present.
Stated differently, we are looking at a ten-year peak-to-peak macroeconomic cycle, but during that span the nominal earnings growth rate of the S&P 500 has been just 2.3%—or barely above inflation and with the benefit of massive stock buybacks, to boot.
How do you get a 24.9X hyper-growth multiple out of that?
Apparently, you ignore the past and present and, instead, get all bulled-up about the future. Even then, however, the forward looking outlook embedded in the Fed staff forecast—which Yellen took great pains to describe and endorse—- isn’t all that.
For the next three years (2018-2020) the Fed projects nominal GDP growth of only 4.0% per annum. So, again, how do you get the robust, sustained double-digit earnings growth trend implied in current PE multiples unless you assume that the already peak profit share of GDP will just keep on growing indefinitely—- like some kind of macroeconomic cookie monster?
Beyond that, however, is the elephant in the room called the business cycle. This expansion is now 102 months old; is already 70% longer than the average expansion since 1950 of 61 months; and is not far from matching the all-time record of 118 months which was achieved under the far more benign environment of the 1990s.
That is to say, the appropriate PE multiple is never some grand average extracted from decades or centuries of business cycle apples (recessions), oranges (recoveries) and cumquats (old age); it depends on where you are in the cycle and whether the world ahead looks—broadly speaking—more benign or more challenged than that of the most recent cycle or two.
As to the latter point, even Yellen has taken to worrying about the fiscal outlook recently, and well she might.
The historical fiscal profligacy already embedded in the budget baseline amounts to $12 trillion of new deficits over the next decade (adjusting for phony spending expirations and tax breaks). So now, with the GOP/Trumpian borrowing orgy on top of that to fund tax cuts, defense increases and much else—-the 10- and 20-year fiscal outlook has never, ever been this bad.
That is, even if there is not another recession before 2027 and the US economy experiences a miraculous 207 quarters of continuous growth, the public debt will be upwards of $35 trillion or nearly 140% of GDP by 2027; and that also assumes no new disasters or wars beyond the present and that Congress operates for a whole decade without adding one new program or one incremental dollar to the programs already on the books.
We’ll take the unders on that fairy tale—-all day and night!
At the same time, the Fed and other central banks have never been so out of dry powder. After a $20 trillion money printing orgy since the late 1990s, even the world’s Keynesian central bankers recognize that they can’t keep monetizing the public debt at the egregious rates of the last few years, especially.
At least, not when the world economy is allegedly operating on all cylinders, but there is still— as of the most recent reckoning—$9.7 trillion of debt trading at negative interest rates. Or when quasi-bankrupt welfare states like Italy are still taking down 2-year money at negative yields.
So with US fiscal deficits already above $1 trillion per year on an objective “baked in” basis and the global central banks embarking on an epochal pivot into QT (quantitative tightening), interest rates and bond yields have nowhere to go except up—and by a lot over time.
Moreover, it can not be denied that the now fading era of ultra-low interest rates is still fully “priced-in” to stocks and other risk assets. For instance, to maintain a “bid” for stocks at current nosebleed levels the casino fundamentally depends upon massive share buybacks funded with cheap borrowed money and also the relentless liquidation of existing shares through mega-mergers—also mainly financed with cheap debt.
Indeed, the chart below, which tracks 17 consecutive years of negative net equity issuance by US companies, is one of the “unseen” consequences of the aggressive monetary central planning regime of the Fed. But it’s not the natural state of affairs, and certainly the function of stock exchanges on an honest free market would not be to function as a killing field for equity capital.
Needless to say, Yellen and her posse have never bothered to examine these “unseen” consequences of their systematic financial repression and falsification of financial asset prices. But that doesn’t mean that the pattern below will not be heavily impacted by the impending pivot to QT.
In a word, the Fed has been the nursemaid for the Big Buyer of stocks—-corporate treasurers and Wall Street leverage artists— during the extended bull run since Greenspan arrived at the Eccles Building in August 1987. Yet the impact of the Fed’s unavoidable and long overdue plan to shrink its elephantine balance sheet—-which Yellen affirmed during yesterday’s swan song—will be to take away the punchbowl of cheap debt on which that Big Buyer has completely depended since the late 1980s.
So when Yellen averred that valuations were still within “historical ranges” (albeit “elevated”), just exactly what history was she talking about? Surely the last three decades of easy money and falling yields—capped off with massive QE and practically zero yields since 2008—are not the right historical benchmark at all.
In short, what happens to earnings when the interest cost on the $13 trillion of debt now carried by US businesses (corporations and pass-throughs combined) begins to rise significantly? And what happens to the rate of corporate share repurchases when borrowing costs escalate?
Yellen had no views on these matters because the truth is she has never really thought about corporate finance and the manner in which massive Fed intrusions into the money and capital markets have distorted the information flows and signaling systems on which accurate pricing of financial assets ultimately depends.
And that gets us to the implicit Eternal Life of the current business cycle that is “priced-in” to today’s stock market. Yet as Yellen was taking her bows for steering the US economy to the Keynesian nirvana of Full Employment, even she did not go so far—-like Bernanke in his Great Moderation speech of March 2005—as to suggest that the business cycle has been abolished for evermore and that no recession will ever again darken the nation’s door.
Then again, Yellen did express confidence that real GDP would grow by better than 2.0% per year through the end of 2020. But that would reach to month 138 of the current expansion—-a place where there US economy has never been in all of recorded history!
So perhaps our school marm implied that the grim reaper of recession would be held-off until 2021.
If so, why would you want to value the S&P 500 at nearly 25X earnings that are destined to fall by 30-40% during the next recession, as they always do?
Or purchase the Russell 2000 index of domestic small and mid-cap companies which will bear the full brunt at 110X?
Or most especially, buy some Amazon shares (or its momo ilk) at 280X—even though AMZN is already losing gobs of money on its $140 billion E-commerce business, which will be a lot bigger and be losing far more when Yellen’s implicit recession strikes in 2021.
In short, even as Yellen espied no flashing red or yellow warning lights in today manic financial markets, she did admit to the fact that valuations are “elevated”. We are not sure what she actually meant by that term, but we are quite certain that “elevated” is an understatement when it comes to the likes of the three charts below.
And the dozens more just like them available at the click of a mouse.
Janet Yellen’s incorrigible bubble-blindness, of course, is not for want of information about the stock market. For crying out loud, the massively inflated PE ratios we cited above are all printed daily in the market data section of the Wall Street Journal.
Instead, Yellen is so maniacally committed to her bathtub model of the US economy and groundless supposition that 2.00% inflation is the essential key to economic growth and prosperity that she simply cherry-picks valuation ratios that are convenient—that is, consistent with ultra-low interest rate policies which she believes are essential to achieving the Fed’s inflation goal.
But folks, the entire 2.00% inflation preoccupation of Yellen and the other central bankers is just plain nuts. There is absolutely no correlation historically and across countries between the rate of real growth and whether inflation clocks in at 1.4% or 2.2% or 3.1%—or even 0.0% or less.
Moreover, there are solid reasons for today’s so-called “low-flation” that have nothing to do with the Fed’s endless attempts to generate more of it.
To wit, the world has been flooded by cheap capital emanating from decades of central bank financial repression, and that flood of tools, plants, trains, trucks, ships and technology has mobilized tens of billions of peasant labor hours that were not previously generating output in the world commercial economy.
That is to say, the main cause of so-called low-flation is the China Price for goods, the India Price for Service and the Technology Price being spurred by endless amounts of venture investment and speculative capital.
In short, Janet Yellen has spent the last 13 years on the Fed beating the tom-toms for more goods and services inflation when it was not needed in the slightest, while fueling a massive, unstable, unsustainable and destructive financial asset inflation about which she has remained completely oblivious.
On that score, the legendary hedge fund trader, Stanley Druckenmiller, summed it up as well as any:
Bitcoin as well as art, wine, equities and credit are all “one way up.” There are huge distortions in markets, he said, “all in the name of this 2 percent inflation target.”
Yet at the end of the day, even Yellen’s chronic yapping about insufficient inflation turns out to be a crock. From the time of her appointment as San Francisco Fed chief in 2004, the CPI has increased by 33% or at a 2.15% annual rate.
So what, exactly, is so deficient about that—even if inflation is good for prosperity, which it isn’t?
Almost ten years after the financial crisis we still have some of the lowest interest rates in the history of mankind. We have some of the highest asset values ever recorded or imagined. And when that combustible anomaly unravels, were are quite sure that Janet Yellen’s name will incur the vilification by historians that it so richly deserves.
As Jim Grant recently put it so cogently:
We have depression level interest rates, we have boom time equity and real estate values and we have graveyard level volatility – and this all at the same time. That’s rather perplexing, isn’t it?
The trouble with Yellen and her peers is that they have robbed the money and capital markets of vast amounts of information and assessments that would come from participants on the free market in their tens of millions.
And for what reason?
Apparently to achieve an inflation rate to the second decimal place on the shortest measuring stick they can find. And they surely looked hard.
The fact is, over the last 21 years, the regular old CPI inflation rate—with all its defects related to hedonics and many other statistical shenanigans designed to make it read lower—has exceeded2.00% per annum more than two-thirds of the time, as shown in the chart below.
And its once again above 2.00% now!
On the other hand, the Fed’s short ruler—the PCE deflator less food and energy—has fallen below the magic 2.00% about 80% of the time. And that’s not due to some kind of post-financial crisis hysteresis; it was well below 2.00% from 1996 through 2004.
But one thing you can be sure of. The difference between the blue bars and the orange bars over the last 21 years is entirely due to index construction and weightings, and the associated unresolvable academic debates about how y0u properly measure the general inflation rate. And those technical differences and arguments are no more relevant to the real world than the 12th century debates on how many angels can sit on the head of a pin.
Stated differently, the variances between the blue and orange bars are utterly irrelevant to real growth, jobs, wages, living standards and wealth of the American economy.
So when all is said and done, Janet Yellen has spent a lifetime on the Fed fostering destructive financial bubbles and an egregious redistribution of wealth to the top of the economic ladder.
For that we say, Good Riddance!