Like a ‘Closing Out Sale’ that never seems to end, people are beginning to think that this ‘Stock Market Surge’ may not be totally on the level.
Unlike an honest bull market, it may never end…
But in many ways, it looks more and more like a classic top.
Stocks keep going up…and more and more investors, getting in the mood, think they will go up forever.
The last time we saw anything comparable was at the end of the 1990s.
Then, it was the tech-heavy NASDAQ that had caught fire. It burned hot from 1995 to 2000, with prices up five times.
But then, when there was no more furniture to throw onto the fire, it quickly went cold.
The NASDAQ fell 80%; the ashes remained cold for the next 10 years.
The flames were only rekindled after the Fed and other central banks added $15 trillion to the world’s supply of dry tinder.
No ordinary market
This was one of three incidents over a 20-year period that reshaped popular attitudes to money, investing, and the markets.
First came the ‘Black Monday’ crash of 1987. Then there was the aforementioned collapse of the NASDAQ in 2000. Finally, the crisis of 2008–09 further drove home the point: This is no ordinary stock market.
Until 1987, the best way to make money in the stock market was to do careful research and find good companies selling for less than they were worth.
After 1987, the value of this kind of fundamental analysis fell. It didn’t matter anymore how much something was worth.
The stock market was no longer functioning as a market for stocks, carefully discovering what each and every one was worth. Instead, it was reacting to something else.
And by 2009, fundamental analysis was no longer helpful; it was, in fact, counterproductive. The more research you did — to identify value-rich companies — the worse your portfolio would do.
This may seem impossible. But that is what happened. Value-rich companies with low price-to-earnings (P/E) ratios and little debt underperformed the go-go leaders of the growth genre.
Mr Luskin’s maths
This phenomenon was inadvertently described in last Friday’s Wall Street Journal.
Donald L Luskin, a macroeconomic forecaster, wrote an enthusiastic editorial in which he argued that stocks may be high, but they are going much higher because ‘policy changes augur much better earnings in the coming years’:
‘[A]s in 2009, the economy is facing a fundamental turning point driven by profound changes in economic policy. Once again, it’s policy, not valuations, that is determining stock prices.’
Mr Luskin did the maths.
At a corporate tax rate of 35%, a dollar of corporate earnings turns into 65 cents after Washington takes its cut. At the new 21% rate, the same dollar becomes 79 cents. That’s earnings growth of 21.5%.
If we were advising Mr Luskin, we would suggest he put his calculator down and put on his thinking cap. Out of whose pocket cometh that extra 14 cents?
You will say, ‘It comes from the tax cut.’ But since the feds won’t forego a single penny in spending, we must assume they will get it from somewhere else, right?
Corporations, as proponents of the tax cut were quick to point out, do not pay taxes. They just collect them. The money either comes from their employees, their shareholders, and/or their customers.
So if the shareholders and/or the employees get 14 cents more, it is almost a dead certainty that the customers will get 14 cents less.
Then who will buy the corporations’ products and services?
(Yes, we are aware of the Laffer Curve…and the theory that there is an ideal tax rate out there at which the feds maximise their income, often by lowering tax rates. But first, there is no evidence that it is true. Second, even if it were true, there’s no reason to think the new tax rate is any better than the last one. And third, it seems unlikely that further stimulus, at this point in the business cycle…after $10 trillion of Fed stimulus since 2009…will produce much of anything…except, maybe, more money for shareholders and corporate insiders!)
Rockstar central bankers
So yes…Mr Luskin could be right…as far as his maths and his logic take him.
But transferring wealth to shareholders and bondholders is what the feds have been doing for the last 30 years, ever since former Fed chief Alan Greenspan invented the ‘Greenspan put’.
By slashing interest rates and talking up the market, Mr Greenspan guaranteed that stocks wouldn’t go down too much, or stay down too long.
The Greenspan Era represented a fundamental and dramatic turnabout for the Fed.
America’s central bank was meant to be — and had been — a mostly passive institution. Few people knew who the chairman of the Fed was; few cared.
The Fed was not meant to guide the economy…and surely not to enhance it. Instead, it was supposed only to guard against excesses, as Fed chairman William McChesney Martin put it, by ‘taking away the punchbowl’ when the party got too hot.
But Mr Greenspan was determined to be a rock star. Instead of taking the punchbowl away, he added more booze!
Stocks went up for the next three decades…as more and more alcohol got dumped into the punch.
And now, look around: The world has $233 trillion in debt. Interest rates are barely off the floor. And as much as $11 trillion of debt trades with negative yields.
So when the current tightening cycle causes the next crash…the feds will panic, as usual.
And, as usual — having learned the lesson over the last 30 years — investors will buy the dip, confident that the feds will come into the market with their cheap sauce.
But this time, the bottles will be empty.
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