The mainstream media is now transfixed by the Olympic games. The USA and China are jockeying for the top slot in gold medals won. At least it only lasts 16 days, and makes a change from the interminable US presidential election. Markets seem calm, as the northern hemisphere’s money shufflers take a summer break. A reader suggests a possible reason why investors are staying in US stocks, and asks who is still buying them.
Down in Brazil, the USA and China are jockeying for the top slot in their gold medal hauls. Currently the USA has 11 and China has 10. But the US has 32 medals overall, a comfortable lead over China’s 23.
Running, jumping, swimming, chucking stuff…it makes a change from Brazil’s ongoing economic and political woes, and daily diet of violent crime.
In theory all that olympic exertion is just a bit of light entertainment. But there’s national pride at stake, especially if the nations are or aim to be superpowers. It used to all be about the USA and Soviet Union, during the days of the cold war.
Now there’s a (very) different kind of “communist” keen to display athletic prowess and take on the US of A. Chinese and American chests will collectively swell or deflate depending on the final tally of medals. Then life will go on.
The US presidential election marathon continues to grind along. It’s 16 months since Hillary Clinton announced that she was running, and 14 months since Donald Trump officially got into the game.
At last it’s entering the final lap, with less than three months until the 8th November election date. I, for one, can’t wait until it’s over. Then life will go on.
At least for a couple of years, until the next campaign gets rolling.
I got quite a few comments and questions back from readers after my last article: US stocks continue to defy gravity (and logic).
In there I wrote this: “Falling corporate profits combined with rising stock prices can mean only one of two things. On the one hand that investors are willing to accept very low future returns on their investments. On the other hand that there’s an expectation of some kind of massive profit boom on the horizon. Neither seems like a good basis for investing in US stocks.”
Victor S. wrote to me (thank you) in relation to that paragraph. He said: “You left out direct Fed manipulation via the PPT or the plunge protection team.”
I agree that the Federal Reserve – and other developed country central banks – have heavily manipulated financial markets in recent years. Actually they’ve been at it for a couple of decades, ever since Alan Greenspan was in the chair.
Post-2007 this fiddling reached a level that even the Soviets wouldn’t have dreamt of. As far as we know the Fed hasn’t been directly buying stocks – yet, or at least officially. But it’s still an attempt at centrally planned prices. It’s just that the prices are of tradable financial securities instead of everyday goods. Stocks instead of socks.
Even though the Fed maybe hasn’t been poking its fat fingers directly into the stock market machinery, a combination of ultra low interest rates and direct manipulation of the bond market have done the job well enough.
US stocks are now the third most expensive they have ever been. That’s apart from a very brief period before the 1929 Wall Street Crash, and the late 90s and early 2000s, during the heady days of the technology bubble and bust.
The result? US stocks are now the third most expensive they have ever been. That’s apart from a very brief period before the 1929 Wall Street Crash, and the late 90s and early 2000s, during the heady days of the technology bubble and bust.
Okay, technically speaking US stocks are only at the fourth most expensive level. But it’s a really close run thing. The P/E10 is 27.08 today. For three months between December 2006 and February 2007 it just scraped above 27.3 for a short time. Then the market started to slide, crashing properly in late 2008 as the global financial crisis peaked, and finally reaching bottom in March 2009.
(The P/E10 is also known as the Cyclically Adjusted P/E – “CAPE” – or the Shiller P/E. A standard P/E uses just one year of earnings as the “E”. The P/E10 uses the average of the last ten years of earnings, each adjusted for inflation. The idea is to build in the ups and downs of the earnings cycle. As such, the P/E10 is a more reliable indicator of market valuation than most other measures.)
So it’s hardly auspicious that the market is at a valuation level associated with bubbles that were followed by massive crashes. The median, or mid-point, P/E10 since 1881 is 16.04. That’s 41% below today’s level. So if things got back to “average” the S&P 500 would be trading around 1,290.
Put another way, the P/E10 is in the top 6% of its 135 year historic range. Excluding the really extreme late 90s technology bubble it’s within the top 3% of the range.
In other words US stocks have very rarely been more expensive than now. You’d need a lot of optimism or pharmaceuticals to think that makes it a good investment prospect.
But what that “plunge protection team” that Victor highlighted to me? What is it, and can it save the day? Does its existence mean people should still own US stocks, even at these elevated levels?
The plunge protection team is the colloquial name for something called the Working Group on Financial Markets. It’s made up of the Secretary of the Treasury (finance minister), Chair of the Board of Governors of the Federal Reserve (head of central bank), Chairman of the Securities and Exchange Commission (head of a big regulator) and Chairman of the Commodities Futures Trading Commission (head of another big regulator).
It was set up in March 1988 as a response to the 1987 market crash. The nickname was coined by the Washington Post in 1997. A lot of people think it exists to manipulate stock prices, and especially to prevent crashes.
Well, if that’s the case then it hasn’t done a great job. We’ve had two major collapses in the markets since it was established, from 2000 to 2002 and then in the period 2007 to 2009.
Of course the PPT does scrabble about to get things back on track when crashes occur. But occur they still do. As the Soviets and others have found to their cost, central planning always fails. Markets will have their wicked way in the end.
Even if the PPT could prevent another crash in future – which I sincerely doubt, short of the Fed directly buying trillions of dollars of stocks – it’s not a good reason to own US stocks today.
Even if the PPT could prevent another crash in future – which I sincerely doubt, short of the Fed directly buying trillions of dollars of stocks – it’s not a good reason to own US stocks today. The returns are still likely to be very poor, as I explained last time (see here if you missed it).
Victor S. also asked who is doing the buying to keep this market propped up, and whether it’s the central banks. Another reader, Paul T. says that “The smart money has already divested”.
Paul could be right. But that leaves an awful lot of “dumb” money still invested. The market capitalisation of the S&P 500 index is US$19.1 trillion dollars, according to Siblis Research.
To put that into perspective it’s around 8% of total global wealth of about US$250 trillion, as calculated by bank Credit Suisse. Or 16% of net financial wealth of about US$125 trillion, which is savings and investments net of debt, and excluding non-financial wealth such as real estate.
In other words a lot is at stake. A market fall of 40% would wipe out US$7.6 trillion.
So we know there are still a lot of investors holding US stocks – whether directly or through fund managers. The question is who is still buying at these levels? Where is the new “dumb” money coming from?
Look no further than the corporations themselves. The dumb money comes from management teams wasting company cash – often borrowed – on buybacks of overpriced stocks. This achieves little, except lining the pockets of the management teams, which are stuffed full of stocks and executive stock options. (For more see: The S&P 500 is being looted by management.)
One day this over priced market will head down and back to reality. Then it will be worth investing again. But until then it’s best to stay well away.
Stay tuned OfWealthers,