Digg
Forgotten this week is the sugar high the stock market got last week when the Fed suggested it would continue to keep interest rates low for about half the life-span of a Leopard frog.
The Fed's pledge to keep rates low also sparked lots of renewed chatter about “financial repression,” a term made popular of late by Carmen Reinhart and Belen Sbrancia in which market rates are explicitly or implicitly capped.
The knee-jerk reaction in the stock market, of course, has been to believe that low interest rates forever = high stock prices. The theory is that financial repression forces investors to move money to riskier investments, such as stocks.
However, Barry Knapp at Barclays Capital has been arguing for several months now that history suggests financial repression isn't necessarily a good thing for stocks, particularly from the vantage point of price to earnings multiples. Back in October, Knapp wrote:
“The late 1940s and early 1950s, noted by Bernanke as “the most striking episode of bondprice pegging [by the Fed]”. A combination of public policy uncertainty and monetary policy missteps (the unintended consequences of financial repression) coupled with a series of geopolitical events, led to extraordinary levels of price instability and uncertainty. This substantially raised equity risk premiums and compressed valuations. During the recession of 1949, S&P 500 PE multiples reached a low of 6x.
“The parallels with today are striking. We believe it is these similar factors that drove multiples to historic lows in the 1940s and help explain today's low multiples environment. Public policy uncertainty is high, monetary policy is extraordinary accommodative and negative real rates are aimed at stimulating the economy (which should provide a dose of inflation and chip away at the highest debt to GDP since 1946 (that is financial repression). While the mountain of debt in the 1940s was built up defending our country (as opposed to financing consumption), both periods, nonetheless, followed the crises. Much like the threat of another war (Korea) and another financial downturn likely influenced investors' attitude toward asset prices in the late 1940s and early 1950s, the looming threat of another financial crisis, this time in Europe, weighs on investors today.”
Beyond the history lesson, the focus of Knapp's argument is elevated risk premiums. When multiples fell last year, many were quick to point their finger at uncertainty about Europe. But Knapp says there's a more fundamental issue tied back to financial repression and questions about the short- and long-term course of inflation.
Stock market pundits generally don't talk much about inflation, but it plays an important role in multiples, in part because inflation expectations play a role in determining what investors believe future earnings growth will be. In an interview, Knapp says the connection here is between the Fed locking interest rates at zero and the volatility of inflation, which he says has an inverse relationship with P/E multiples.
“If you peg interest rates for six years (starting in late 2008), it's impossible that you won't get some pickup in inflation volatility,” he says.
Knapp says that to look for real-world examples, look no further than corporations, such as steelmakers, trying to estimate what their cost structure will be or for retailers, on what they can charge for clothes they sell.
Knapp says. “You don't know where input costs are going, you don't know where your final prices are going.”
If Knapp's correct, this is bad news for stock investors. It seems that the forward momentum in earnings growth is stalling, and without an expansion in multiples, it's going to be tough for stocks to find a catalyst for a sustained significant rise – with or without the Fed's help.
MySpace
Digg
del.icio.us
StumbleUpon
Error message
Bloomberg: Volcker Says Confidence in Financial Markets is “Broken”
The central planners (one in particular, Bernanke) have completely destroyed normally functioning markets (by manipulating and trying to artificially inflate asset prices, they destabilized the markets).
For example, stock market is having ~20% moves within a month, and EURUSD now trading like a penny stock (it used to take weeks for the currency markets to have moves like we are having nowadays within a few hours)
We are one headline away from another flash crash.
Chad, the fact that you think low interest rates help banks is completely false. Margins are falling and returns on assets are falling. Thats kinda the point of the article. easy money = bad for stocks.
Easy money (if that’s what you call it) helps only an elite of insiders. Look at the facts! Easy money has most notably helped banks and financial firms that should be bankrupt. Easy money also enabled these same firms to keep doing what they were doing because they can call for bailouts and stimulus anytime they want. Does anybody really believe that the reckless gambling that went on before 2008 has ceased? Of course not! Ben Bernanke will go down in history as the man who bankrupted America – financially and culturally. Chad in CO
Your absolutely right, the scheming, intervening, manipulating FED is about to get taken to the woodshed, once again!.
Subscriber Content Read Preview
Subscriber Content Read Preview
Subscriber Content Read Preview
Subscriber Content Read Preview
MarketBeat looks under the hood of Wall Street each day, finding market-moving news, analyzing trends and highlighting noteworthy commentary from the best blogs and research. MarketBeat is updated frequently throughout the day, helping investors stay on top of what's happening in the markets. MarketBeat lead writer Steven Russolillo spearheads the MarketBeat team, with contributions from other Journal reporters and editors. Have a comment? Write to marketbeat@wsj.com.
Read Full Article »