As the market continues to grind higher each and ever day it’s useful to gain some perspective on just how much Bernanke is impacting valuations and generating disequilibrium in the market. In order to do so we’ll review a number of long-term valuation indicators.
The first is Warren Buffett’s self proclaimed favorite valuation tool (see here for more). He uses the total market cap of the US stock market compared to GNP. He has generally maintained that levels below 80% are bullish. The latest reading of 106% is well below the levels seen at the last two market peaks, but well above the historical average levels. You will notice that the permanently high valuations coincide with the Greenspan Put which has now morphed into the Bernanke Put.
John Hussman’s latest piece succinctly describes the current market environment in which Ben Bernanke continues to encourage speculation and malinvestment. As we all know by now it is Bernanke’s goal to keep asset prices “higher than they otherwise would be” in an attempt to generate a self sustaining economic recovery through asset prices. This is the insane notion that nominal wealth will lead to real wealth. In fact, Ben Bernanke has this quite backwards. Fundamentals drive real wealth – not nominal price increases. But two bubbles in one decade doesn’t teach this man a lesson. Hussman elaborates:
“Last week, the S&P 500 Index ascended to a Shiller P/E in excess of 24 (this “cyclically-adjusted P/E” or CAPE represents the ratio of the S&P 500 to 10-year average earnings, adjusted for inflation). Prior to the mid-1990′s market bubble, a multiple in excess of 24 for the CAPE was briefly seen only once, between August and early-October 1929. Of course, we observe richer multiples at the heights of the late-1990′s bubble, when investors got ahead of themselves in response to the introduction of transformative technologies such as the internet. After a market slide of more than 50%, investors again pushed the Shiller multiple beyond 24 during the housing bubble and cash-out financing free-for-all that ended in the recent mortgage collapse.
And here we are again. This is not to say that we can rule out yet higher valuations, but with no transformative technologies driving the economy, little expansion in capital investment, and ongoing retrenchment in consumer balance sheets, I can’t help but think that the “virtuous cycle” rhetoric of Ben Bernanke is an awfully thin gruel by comparison. We should not deserve to be called “investors” if we fail to recognize that valuations are richer today than at any point in history, save for the few months before the 1929 crash, and a bubble period that has been rewarded by zero total return for the S&P 500 since 2000. Indeed, the stock market has lagged the return on low-yielding Treasury bills since August 1998. I am not sure that even members of my own profession have learned anything from this.”
Using his expected returns methodology Mr. Hussman is looking for annual returns of just 3.15% in the coming decade:
Dshort brings us the Q Ratio which has now hit “nosebleed” territory again. This is consistent with the other metrics which all showed relatively stable ranges until the Fed began its unusual policy of propping up markets following the 87 crash. The latest reading of 1.17 is well below the Nasdaq bubble peak, but is higher than any other historical peak. “Nosebleed” could be an understatement.
As I mentioned in December, we have to ask ourselves if any of this matters as long as the Fed is directly involved in promoting speculation. It’s now clear that the Bernanke Put is well ingrained in every investor’s head. Never has the Federal Reserve been so explicit about propping up asset prices and it has created a speculative frenzy that has every investor trying to front-run the Fed. The problem for the Fed will be letting their foot off the gas. They have created a beast that they likely no longer control. When and if the Fed ever ends QE it is likely that markets will begin to revert to the mean. This will likely force the Fed’s hand to stabilize markets. So what we’ve created with this explicit backstop is a positive feedback loop. Can the Fed ever get out of the market now? And if they don’t it’s likely that markets will spiral higher until they cannot control the inevitable collapse.
The foolishness of current Fed policy cannot be downplayed. Let’s hope for the sake of US citizens that they are as quick to take credit for the inevitable market decline as they have been about taking credit for the rally. For once they admit to having contributed to malinvestment and misallocation of resources we can likely begin mounting a case that closes this horrible chapter in American history where the Central Bank attempted to turn our economy into a financialized ponzi scheme.
“Faith in the FED is the last bubble”….
I thought this was the last bullet in the chamber,QE2, but now I realize there are no bullets left after tech bubble, Greenspans put, Glass/Segal,CMO,Housing bubble. Its really to stop the bleeding.
No bullets left? What’s the chart show? The Fed has been capable of engineering permanently high valuations. Their bullets are infinite and history now proves they can indefinitely keep the ball in the air. Additionally, there is ZERO political will to stop them…
Brandon the charts, or at least the GDP v S+P and CAPE charts, show the market collapsing at lower high valuations over time, suggestive of the Fed policy having reduced impact over time.
Why blame Bernanke? It’s the American peoples’s fault (along with the leadership that the few that vote elected). All of a sudden everyone cares now if he inflates everything so the people can continue to drive around in their rented cars, live in their borrowed houses and complain on their computers. The USA mindlessly achieved one of its most important goals…to export capitalism and democratic ideals. The communists fell apart (a la Karl Marx) and their people are adopting our ways. Soon they will be eating plenty of meat (a la McDonalds) while driving their rented cars back to their borrowed houses. The rest of the world won’t be able to afford the buns for the burgers…but the USA and most of its people never cared anyway…
Its an alarming picture!
The Bulls will argue that the graph is meaningless as “Margins” are considerably higher than the average over the period of that graph and that interest rates are also alot lower than the average, affording higher valuations etc etc
Naturally, they ignore the following;
Margins are cyclical. Aided with cost cutting / job cutting etc. But at some point one companies costs becomes another companies revenue. That isn’t obvious now with all the stimulus spending papering over the cracks
So I guess
if you are bullish you say we have reached a “permanent plateau of higher margins and lower interest rates” allowing us pay a higher % of GNP than before. This time it is different!!
If you are bearish, you argue that Margins are cyclical. Govt stimulus will hit a brick wall at some point… you cant have ever growing deficits and low interest rates forever. Once the stimulus rug is removed (either by choice or by the market), GNP, Margins etc etc are all vulnerable to serious correction…Thats when stocks markets halve
hey mikie, i’ve liked your posts in past. with this one, i would simply say that context should matter to an investor. hussman is a little too rigid.
of course the shiller pe will look high when you come out of a recession. but the period when you come out of a recession is the time to buy (context) as opposed to the time to sell or hold.
so when hussman says, “We should not deserve to be called "investors" if we fail to recognize that valuations are richer today than at any point in history, save for the few months before the 1929 crash, and a bubble period that has been rewarded by zero total return for the S&P 500 since 2000″, he is talking like an academic, not an investor.
what would he recommend, wait for valuations to increase so the shiller pe goes down and then invest?
oops, replace valuations with earnings.
my point is that if you wait for earnings to increase to lower the shiller pe, you are already on the sliding slope of the cycle.
if you wait for valuations to decrease, then that’s ok is suppose, that just puts you on the bench until the next cycle, and there is money to be made in the interim.
Chris,
Your criticism applies to traditional P/E ratios, not Shiller or Hussman. Those ratios are specifically designed to adjust for the business cycle.
“Soon they will be eating plenty of meat (a la McDonalds)”
…you have a vey loose definition of “meat” I see…..:)
we have the DOW bubble, next the gold bubble.
ride the bubbles in a bubble world.
Yes, ride them…. for small amounts of time, and disembark before the ‘POP’
I thought QE was largely ineffective, both because of the reasoning you have posted before (Treasuries are “near money” and therefore in a low interest rate world, asset swaps don’t increase M2) and because of the subsequent real world experience where interest rates have risen. Unless you are talking about the Fed successfully changing inflation expectations through moral suasion.
This is my issue as well, with Cullen placing blame on the Fed.
He has taught me why QE2 does nothing to fundamentals.
In a recent blog he has admitted Ben has never said “go buy stocks because I said so.”
In recent Fed press releases, I have not read language that would be any reason for investors to be so bullish. If anything, the opposite.
So I still am wondering what the rhetoric is that Cullen speaks of. Though he may think the markets are so unthinking in this environment that they interpret any Fed action as proof enough for a future recovery; and thus the only good Fed policy right now is no policy.
I am not sure what you guys have been reading. Bernanke has taken credit for the equity rally in numerous recent speeches….
Uh, I have never said that Ben didn’t want higher stock prices. That has been his goal for months now and his commentary has been consistent for months on end.
http://www.nytimes.com/2010/11/07/your-money/07stra.html
I never said you said that. I said exactly what I said. Word for word from a post a couple days ago (http://pragcap.com/three-things-i-think-i-think-21):
“You've clearly misinterpreted how the Fed intended to raise equity prices. The goal is to reduce int rates and increase the relative value of equities. Bernanke described this several months ago:
"Thus, our purchases of Treasury, agency debt, and agency MBS likely both reduced the yields on those securities and also pushed investors into holding other assets with similar characteristics, such as credit risk and duration."
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