We’re about to look at a dashboard of indicators that make the case that the market sits late cycle. How do we know? When we compare the current valuation level to periods throughout history, the dashboard is flashing red: “extreme overvaluation.” A number of the data points go back to the 1920s.The latest readings sit in the top 20% of all readings. Some sit in the top 2% of all readings.
Chart 1 – Price-to-Sales
It’s easy for a company to keep track of its sales. When sales are good, everyone in the company sleeps well at night. This next data set looks at the combined gross sales of all the companies in the S&P Industrial Average from 1954 to December 31, 2019 and plots the sales data relative to the price of the Industrial Average. The data is updated quarterly.
Chart 2 – Median P/E
Median is the price in the middle. If you have 500 stocks in the S&P 500 Index, this next chart plots the price-to-earnings ratio of the stock in the middle. What I like about this process is that it removes a lot of the accounting games that some companies play.
Further, when you look at all of the data going back to 1964, you can get a good feel for “fair value.” Think of “fair value” as the straight line that moves from lower left to upper right in the first cycle chart I shared. Again, that straight line is a return of about 10.01% per year.
The green dotted line in the middle section is the “fair value” line.
Chart 3 – Market Cap-to-GDP
Warren Buffett said this is his favorite valuation chart. So if it’s his favorite, it is certainly one of mine. Simply look at the current level: 145.4%. Compare it to the high at the top of the great tech bubble in 2000. And note the better buying opportunities that occurred in 1982, 2002 and 2008-09.
Chart 4 – Shiller P/E
The following chart captures the Shiller P/E level over time. As you can see, it sits at the second highest level in history. Prices are high relative to smoothed ten-year earnings. What’s important is what the data tells us about coming returns.
Chart 4 – Duration – The current US bull market has been the longest in a century.
Why Americans are Attracted to Socialism
Thoughts by John Mauldin
The fact that so many Americans (especially young Americans) support Bernie Sanders ought to tell us something. A Quinnipiac poll out this week showed Senator Sanders with 54% support among Democrats age18–34. Meanwhile, 50% of adults under 38 told the Harris Poll last year that they would “prefer living in a socialist country.”
I don’t believe they really want socialism. Few even understand what it is. What they want is change. They see little hope for improvement in their situations, no matter how hard they work and sacrifice. They don’t see anyone in authority trying to help them. So, when someone offers what sound like easy answers, they jump aboard.
Until we fix it, desperate people will keep making desperate choices.
Because of the frustrations of so many, both left and right, I think volatile swings between radically different political choices could become normal for at least the next three election cycles, if not longer.
To my generation, “socialism” is the second “S” in USSR. We grew up being taught the Soviet Union was a mortal foe bent on world domination. We didn’t have to wonder if this adversary had nuclear weapons; we knew it could drop them on us any time.
The new definition of Socialism involves various degrees of collectivizing property and redistributing wealth. That can sound pretty attractive if you have no property or wealth, and threatening if you do.
If the US economy is performing so well, and the rising tide is lifting all boats, why is socialism getting any traction at all? Public opinion data says this shouldn’t be happening. Polls from Gallup and others find solid majorities saying their financial condition improved in recent years, or at least got no worse.
I see two answers to that. One is in the question itself. Your financial condition can be better than it was but still not where you think it should be. If you are no longer drowning and are instead treading water with no lifeboat in sight, then yes, your condition has “improved.” But you’re still looking for answers.
The broad “better or worse” responses are heavily weighted by political affiliation. Republicans say both their own condition and the economy are better. Democrats say both are worse. They can’t all be right.
Polls that ask more specific questions find a considerably less rosy scenario.
For instance, a December 2019 Bankrate.com survey found half of US workers didn’t get any kind of pay raise in the last year. Gains in average hourly earnings may have been heavily weighted toward a smaller number of workers who got much larger raises.
Another survey by Salary Finance of 2,700 US adults working at companies with 500+ employees found 32% saying they ran out of money between paychecks. That’s consistent with the Federal Reserve’s annual “SHED” survey, which last year found almost 40% of US adults would need to borrow money to cover a $400 emergency expense. It also found an additional 18% of Americans considered themselves “just getting by” and 7% “finding it difficult to get by.”
Perhaps not coincidentally, the Fed reported this month that household debt balances hit $14 trillion, an all-time high. This was actually low as a percentage of disposable income, but disposable income is again highly weighted toward the top. Many at the bottom are in debt up to their eyeballs. And we’re not even in recession yet.
Since 2007, the ONLY group that has seen an increase in net worth is the top 10% of the population.
Bottom line: In one of the best decades the American economy has ever recorded, families were bled dry by landlords, hospital administrators, university bursars, and child-care centers. For millions, a roaring economy felt precarious or downright terrible. Urging people who live paycheck to paycheck to save more is not realistic. They have no money left after those fast-growing expenses. Almost all saving occurs in the top 20% and certainly in the top 40%.
More than half the country is in various degrees of trouble, and they are open to anything they think might help them, including what they think of as socialism.
The Fed’s Quantitative Easing (QE) Tool
The effectiveness of QE, and zero interest rates, is based on the point at which you apply these measures.
In 2008, when the Fed launched into their “accommodative policy” emergency strategy to bail out the financial markets, the Fed’s balance sheet was running at $915 Billion. The Fed Funds rate was at 4.2%.
If the market fell into a recession tomorrow, the Fed would be starting with a $4.2 Trillion balance sheet with interest rates 3% lower than they were in 2009. In other words, the ability of the Fed to ‘bail out’ the markets today, is much more limited than it was in 2008.
It has taken a massive amount of interventions by Central Banks to keep economies afloat globally over the last decade, and there is rising evidence that growth is beginning to decelerate.
Furthermore, we have much more akin with Japan than many would like to believe:
- A decline in savings rates
- An aging demographic
- A heavily indebted economy
- A decline in exports
- Slowing domestic economic growth rates.
- An underemployed younger demographic.
- An inelastic supply-demand curve
- Weak industrial production
- Dependence on productivity increases
The lynchpin to Japan, and the U.S., remains demographics and interest rates. As the aging population grows becoming a net drag on “savings,” the dependency on the “social welfare net” will continue to expand. The “pension problem” is only the tip of the iceberg.
While another $2-4 Trillion in QE might indeed be successful in keeping the bubble inflated for a while longer, there is a limit to the ability to continue pulling forward future consumption to stimulate economic activity. In other words, there are only so many autos, houses, etc., which can be purchased within a given cycle. There is evidence the cycle peak has been reached.
If the effectiveness of rate reductions and QE are diminished due to the reasons detailed herein, the subsequent destruction to the “wealth effect” will be larger than currently imagined. The Fed’s biggest fear is finding themselves powerless to offset the negative impacts of the next recession.
If more “QE” works, great.
But as investors, with our retirement savings at risk, what if it doesn’t?
At year-end 2019, the futures-implied probability of three rates cuts this year was only 20%. Now it’s up to 90%.
As far as the Coronavirus and the Fed? The Fed will be in full-on stimulus mode, akin to 2008–2009. But it probably won’t have the same kind of effect. Monetary policy tools just aren’t designed for this situation. All they can do is stimulate demand, and virus containment measures will make any such demand hard to fill. Fiscal stimulus might help but would also increase the already massive deficit.
The Federal Reserve and other central banks can’t bail us out this time.
Corona Virus Update
The number of coronavirus cases in the U.S. has jumped to 53, most of them connected to the Diamond Princess cruise ship. Moving east, Hong Kong extended school closures till mid-April, a cabin crew member of Korean Air tested positive for the coronavirus, and the CDC raised the U.S. travel advisory alert for South Korea, where cases have risen to 893. Japan’s health minister also said it’s too early to talk about canceling the 2020 Olympics, while China fully banned trade and consumption of illegal wildlife.
- China’s small/medium private sector (SME) is notoriously undercapitalized, with most companies risking bankruptcy if they miss 6-8 weeks of cash flow.
- The government has suddenly made credit readily available to these companies. The question is whether help comes too late.
- Reports indicate some SME companies are releasing 20% of their workforce and cutting pay for the rest.
- Hunt calculates at-risk consumer spending could be RMB 3 trillion, or about $450 billion. This would be 2% of China’s GDP.
- Worse, the infections may not be over. Thousands fled Wuhan before the lockdown and spread all over the country.
- The fact that schools are not reopening suggests the government still sees significant risks.
- South Korea cases have jumped
The Coronavirus is an income statement crisis. It doesn’t attack the assets on the balance sheet like the mortgage crisis did. Instead, it attacks a company’s ability to generate revenue and earn profits.
Companies like United Airlines (UAL) must pay tens of thousands of employees, maintain hundreds of airplanes, and more… no matter what happens. But if the company’s planes can’t fly to China because of the virus, it will have much less revenue to pay all those bills.
United recently reported a roughly 100% decline in near-term demand in China.
What if that near-term decline becomes longer term and requires the airline to radically alter the way it flies customers around the world? Can anyone guarantee it won’t happen?
Of course not.
The virus could create a significant problem for long enough that it damages the business models of big companies around the world… forcing them to do a major retrenchment.
Other companies, like consumer-electronics giant Apple (AAPL), make and sell a lot of products in China. (Apple has 42 stores in the country.) So these companies might see a double-whammy of lower demand in a key market and difficulties in manufacturing the products for all the markets that they serve.
In the simplest terms… if your business depends on keeping your manufacturing costs low by making everything you need in China, you have a serious problem right now.
How long will this last? That’s the BIG question! If I had to guess, I believe the coronavirus will last longer than anyone currently expects.
In my opinion, you can’t really compare the current “COVID-19” coronavirus with severe acute respiratory syndrome (“SARS”) and Middle East respiratory syndrome (“MERS”).
The SARS outbreak in 2002 and 2003 only resulted in around 8,100 cases, and it was mostly all over in eight months. We’ve seen a higher fatality rate with MERS (roughly 35%), and it’s still ongoing after six and a half years. But there are only 2,527 total cases.
Meanwhile, with COVID-19, the numbers are much higher…
To date, roughly 84,000 people have been infected. That’s already more than 10 times the amount of SARS cases. And the number of deaths is rapidly approaching 3,000.
In my mind, it’s also hard to compare the coronavirus with the regular flu… Yes, millions of folks get the flu each year. And it has killed many more people than the coronavirus.
But you can get a flu shot. And we know much more about the flu than we know about the coronavirus. As it stands right now, no coronavirus shot or vaccine exists. And we have no idea how many people will get it… how many will die… or when a vaccine will be available.
For the last 3+ years, I have maintained it would take an “exogenous” event to send the United States into recession. Historically suboptimal growth? Sure, but sub-3% growth isn’t a recession.
The coronavirus obviously qualifies as an exogenous event. But that doesn’t mean a textbook two-quarter recession, although it certainly may. Financial markets aren’t waiting to find out what COVID-19 will do. Much of the selling is fear of the unknown. The modern world hasn’t faced anything quite like this, and it’s coming at a time when the economy is vulnerable for other reasons.
Investors aren’t convinced of the Trump administration’s response to the virus outbreak; Besides risks to global supply chains, travel restrictions and profit warnings, many are seeing other dangers as part of a worsening economic picture. The risk to the global consumer is the real problem. Starbucks and Apple can reopen their stores in China, but few people will go into them. Uncertainty about the U.S. presidential election’s outcome is also starting to drive markets, while even before the selloff this week, equities were being measured at lofty valuations.
“U.S. companies will generate no earnings growth in 2020,” wrote David Kostin, Goldman’s chief U.S. equity strategist, despite a consensus from Wall Street that still calls for earnings to climb 7% this year. “We have cut our 2020 global growth forecast to 2.8% (from 3.2%). This would be the lowest reading since 2009,” economists at Bank of America added, saying it would also be the first time since the financial crisis that it was expected to be under 3%.
Chinese manufacturing saw a HUGE drop in February:
China’s economy is seriously damaged even if the virus is under control. Much of the lost time is unrecoverable. For instance, a hotel room that sits empty for a night is a permanently lost opportunity. Government can provide credit and activate infrastructure projects to absorb excess labor, but recovery is likely delayed until next fall – at best.
0.01% of people who get the flu die from it. That’s 1 out of every 1,000.
Roughly 2% of the people who contract the coronavirus die from it. That’s 2 out of every 100.
In addition to a higher mortality rate, the virus is three times more infectious than the normal flu.
The Good News on the Corona Virus response:
Last week, only a few US labs could test for the coronavirus. Clearly, we were massively unprepared, but that is changing fast. As you read this, already 93 labs should have testing facilities. A bedside diagnostic is coming, too, as 70 companies are working on it. The FDA is changing its procedures to allow confirmation at labs other than at the CDC’s main headquarters. This will ease concern by quickly separating actual COVID-19 cases from common colds and flu.
The CDC has estimated up to 41,000 people in the U.S. have died from the flu and up to 41 million people have gotten sick this flu season alone. Where’s the market sell-off attributed to that?
Market Data
- General Electric shed almost 78,000 employees in 2019, or more than a quarter of its workforce, as divestitures left the conglomerate with the same number of personnel as it had in 1951.
- Breadth last week was among the worst we’ve ever seen.
- Even gold, which some consider to be a safe haven, did not fare well. Such across-the-board selling has only occurred a few times since 1988. As you may guess, this typically happens around a bear market, recession, or major correction (1998, 2001, 2008, 2010)
- Quick pullback. Stocks were on the verge of one of their quickest corrections from an all-time high in history.
* The McClellan Oscillator – a popular breadth indicator based on advancing vs. declining issues – is truly at an extreme. Such levels of selling have only been matched 3 other times in history:
- August 8, 2011: the bottom of a major -20% correction
- October 19, 1987: biggest one day crash in market history, near bottom of a massive correction
- October 20 and 27, 1978: towards the end of a -15% correction
Boeing’s aircraft orders:
The Yield Curve has inverted….again.
All content is the opinion of Brian Decker.
