How about that? The “explosive short-term rally” we wrote about yesterday exploded overnight in New York. It’s exploding here in Australia right now. The Dow was up 2.3% and Aussie stocks are already up nearly 2% before noon.
Does this mean stocks are good value for money at these prices? Not according to the charts published in the Reserve Bank of Australia’s most recent chart book. The first chart below shows that the price-to-earnings ratio on an index of Australian stocks actually exceeded all other peaks late last year and early this. Stocks were definitely not cheap.
Now it’s not clear if the P/E ratios above are based on trailing or forward earnings. It’s most likely forwards earnings estimates. And if that’s the case, it tells you how useless earnings estimates are. If analysts get it wrong using P/E ratios to tell you if stocks are cheap doesn’t help you much. What’s more, the way modern accounting works, earnings can be pretty much whatever you want them to be.
What about dividends? Stocks are usually a buy when yields peak. For one, at bear market bottoms when no one wants to own stocks, companies forced to pay out more in earnings to attract equity buyers. Secondly, economic troughs are accompanied by higher interest rates. The higher interest rates in the real economy are usually matched with higher yields on corporate bonds and larger dividends.
But as you can see from the second RBA chart below, yields above six percent on Aussie stocks are a kind of buy signal. Of course yields DID spike above six percent last year, but this was more a function of the crash in shares than a genuine cyclical bottom. You can also see that last year’s spike in yields was much more abrupt compared to the previous peak over six percent prior to the bull run of the early 1990s. Why?
In a normal economy – one without so much interest rate intervention – the economy would move from boom to bust more gradually. With GDP and earnings growth investors would pay a premium for stocks offering capital gains. During recessions or periods of slower growth, they’d shift to more defensive yield plays.
But we live in an abnormal financial world. Interest rates are whipsawed up and down as central banks try to prevent deflation in asset markets and inflation in consumer prices (which would alert the public to the nature of the fiat money scam). In other words, last year’s spike in yields did not indicate that stocks were cheap. What would?
Well you’d have to look at something more fundamental like intrinsic value. For example, we read this paper earlier today by Societe General analyst Dylan Grice. He makes the quite compelling argument that certain risk assets are most prone to the inflationary effects of quantitative easing programs by central banks (which he assumes we’ll see a lot more of).
But which risk assets? Equities? You bet. But only equities that are relatively undervalued on an intrinsic value to price ratio (IVP). Without going into the mechanics of the IVP (which presumably includes price divided by something like net equity or net tangible asset value), it’s worth noting that many of the stocks Grice flagged up as trading at or below intrinsic value were in oil and gas or metals and mining.
Why are those stocks trading below intrinsic value? Hmm. It could be the huge uncertainty hanging over both industries as a result of new regulatory threats (the threat to offshore drilling from the BP fiasco in the Gulf of Mexico and threat to miners from other governments replicating the Rudd assault and battery on mining profits).
So there is intrinsic value at a discount. And that, as our friend Greg Canavan pointed out in his latest alert, gives you some margin of safety. But it doesn’t guarantee prices will go up. Grice adds that, “Buying expensive risk assets on the view that they’re going to become more expensive is a dangerous game to play, but since government funding crises hammer risk assets while printing money inflates them, such funding crises should present decent value opportunities to buy into beaten up assets before the inflation ride.”
Grice is essentially saying stocks are a hedge against inflation. If true, certainly puts yesterday’s market rally into perspective. But it also shows you the inherently speculative nature of investing in stocks when asset markets are rigged by central bank money printing policies. It also points out that gold has intrinsic value in the sense that it is intrinsically scarcer than paper money.
For what it’s worth, Grice’s formulation does sound right. He writes that, “With government balance sheets in such a mess across the developed world (even with yields at historically unprecedentedly low levels), government funding crises are likely to be a recurring theme in the future. Since banks hold so much ‘risk free’ government debt, those funding crises point towards more banking crises which point towards more money printing.”
When and how it stops is a good question. But arguably, it’s just begun. The money printing, that is. And if that’s the case, equities are a theoretic but highly speculative hedge against inflation. When you think about it, though, that doesn’t much sound like stocks are a fundamentally good investment now, does it? Even if they are a good trade.
Meanwhile, the debate about RuddTax continues. Last night over pasta and prawns and a bottle of beer we read our friend Dr. Marc Faber’s latest report in which he writes:
If, indeed, the Australian government increases taxes on the mining industry it will bring down new investments in the Australian mining industry below where they would have been had higher taxes not been imposed. And unless lower future investments in the mining industry in Australia are offset by higher investments elsewhere in the world, the potential supply of industrial commodities will diminish and bring about higher commodity prices than if no tax increases had taken place. And if all the countries of the world follow the “wise” measures of Australia’s Rudd government and increase taxes and royalties on the mining industry everywhere around the world, fewer commodities will be produced at higher prices, which will hurt the consumer and result in lower tax revenues for governments and lower standards of living.
Mmm hmm. It makes sense intuitively that higher mining taxes will lower production, although the government has claimed the opposite. Dr. Faber’s contention that higher global taxes on mining will also lead to lower production of commodities is arguably bullish for resource prices, but only for the companies that can afford to stay in business to produce them.
His main point, though, is that high taxes might boost short-term government revenue. But that higher taxes – no matter how good they may feel to impose if you like sticking it to the miners in the name of the people – don’t and can’t increase long-term standards of living in Australia.
Only wealth creation and increases in productivity can elevate standards of living. No amount of government wealth redistribution will change that. The more of present production the government consumes, the poorer it makes everyone over time.
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