The Burning Platform

Below is a fascinating chart. The earnings of the S&P 500 companies reached the 2007 bubble peak in 2011 and have begun to decline slightly in 2012. A critical thinking person might wonder how the earnings of the 500 biggest companies in America could be at all-time highs when the GDP of the country has barely grown at 2% for the last two years. One might wonder how these earnings could be at all-time highs when real household incomes continue to fall and the number of employed Americans is still 3 million below the 2007 level.

It’s actually pretty simple. Accounting fraud, 0% interest rates for Wall Street banks and major corporations, government doled out auto loans, student loans, food stamps, unemployment comp, and subsidies for housing, phones, cable and electricity, and the continued funding of the U.S. war machine have allowed the 500 biggest corporations in America to generate record profits. It has all been designed to convince dupes to invest in the stock market and spend money they don’t have. It is failing. What odds do you place on S&P 500 earnings soaring even higher? What odds do you place on S&P 500 earnings reverting to their long term averages? Do you feel lucky? Well do ya punk?

With fourth-quarter earnings largely in the books (over 97% of S&P 500 corporations have reported), today’s chart provides some long-term perspective to the current earnings environment by focusing on 12-month, as reported S&P 500 earnings. Today’s chart illustrates how earnings declined over 92% from its Q3 2007 peak to Q1 2009 low which brought inflation-adjusted earnings to near Great Depression lows. From its Q1 2009 low, S&P 500 earnings surged to a level that approached its credit bubble peak. Since Q4 2011, however, earnings have gone flat and have actually declined over the past two months. In the end, the latest data has inflation-adjusted earnings making new 13-month lows.

Mike Shedlock provides his view, which matches John Hussman’s:

Not Different This Time

Hussman’s message has been the same for quite some time. I am in the same camp.

For now, the market has other ideas. Yet, to bet on a sustained market advance, one has to believe “It’s different this time”.

I do not believe it will be different this time, although (and as we have seen), market valuations can remain in the stratosphere for lengthy periods of time.  However, in such instances the market will eventually take back excess gains as it did in 2000-2001 and again in 2008 through the first quarter of 2009.

What If?

Hussman wrote “If presently rich valuations were to retreat again to undervalued levels that have accompanied the start of secular bull markets, stocks would produce yet another extended period of dismal returns.”

I’ve thought about this quite a bit over the past year, and I fail to see a way the stock market does not return to low valuations seen at the end of previous long-term bear markets. Demographics, debt levels, and reversion-to-mean tendencies simply will not support the rosy scenarios of growth most advisors assume.

If so, that means a 10-year P/E at or below 10, possibly for a number of years. The impact for boomers and on pension plans will be stunningly negative.

No Hiding Places

Up to this point, the real loss from stocks could have been compensated by one’s allocation to bonds. However, from this point forward, with the 10-year treasury yield at 1.65% and pension plan assumptions at 8%, it’s highly likely both stocks and bonds will be a drag on a 50/50 portfolio’s real return, and especially on expected (needed) rates-of-return.

This reversion-to-the-mean, slow-growth dynamic, as it unfolds, seems likely to usher in the final exodus from “investing” by the boomers. It will also leave a scar on the those in their 20′s and 30′s today, which will keep them out of the markets for some time.

Need For Patience

I honestly believe the only investors, even professionals, who will make it through this exodus intact will be those who are able to hold some real assets and cash, and have the patience to wait, with the ‘patience’ part being the most critical.

There will be plenty of opportunities to buy into the stock market for a cyclical rallies, but most investors who try to trade will end up losing money because few have the patience to wait for good opportunities, while others will throw in the towel at precisely the wrong times.

That’s life in a secular bear market, and few understand bear market dynamics. Fewer still actually realize how stacked the odds are against a sustained advance and why that is precisely so.

Mike “Mish” Shedlock
 http://globaleconomicanalysis.blogspot.com