The fundamental consequence of 30 years of Fed fueled financial asset inflation is that the prices of stocks and bonds have way overshot the mark.
That’s why what lies ahead is a long stretch of losses and investor disappointment as the fat years give way to the lean.
These will hit hard the bullish investor herd and aggressive buyers of calls who can’t imagine any other state of play. They will be shocked to learn — but only after it is way too late — that the only money to be made during the decades ahead is on the short side of the market by buying puts on any of the big averages: the FANGMAN, S&P 500, NASDAQ 100, the DOW and any number of broad-based ETFs.
The reason is straightforward. The sluggish, debt-ridden Main Street economy has been over-capitalized, and it will take years for company profits and incomes being generated to catch up to currently bloated asset values. Accordingly, even as operating profits struggle to grow, valuation multiples will contract for years to come, owing to steadily rising and normalizing interest rates.
We can benchmark this impending grand reversal on Wall Street by reaching back to a cycle that began in mid-1987. That’s when Alan Greenspan took the helm at the Fed and promptly inaugurated the present era of financial repression and stock market coddling that he was pleased to call the “wealth effects” policy.
At the time, the trailing P/E multiple on the S&P 500 was about 12X earnings — a valuation level that reflected a Main Street economy and Wall Street financial markets that were each reasonably healthy.
The US GDP in Q2 1987 stood at $4.8 trillion and the total stock market was valued at $3.0 trillion, as measured by the Wilshire 5000. Back then, Wall Street stocks were stably capitalized at 62% of Main Street GDP.
Over the next 34 years, a vast unsustainable gulf opened up between the Main Street economy and the Wall Street capitalization of publicly traded stocks.
During that three-decade period the Wilshire 5000 market cap rose by 1,440% to $46.3 trillion. That’s nearly four times the 375% gain in nominal GDP to $22.7 trillion.
Accordingly, the stock market, which was barely three-fifths of GDP on Greenspan’s arrival at the Fed, now stands at an off-the-charts 204% of GDP.
If we assume for the moment that the 1987 stock market capitalization rate against national income (GDP) was roughly correct, that would mean that the Wilshire 5000 should be worth $14 trillion today, not $46 trillion. Hence, the $32 trillion of excess stock market valuation hangs over the financial system like a Sword of Damocles.
In fact, we believe that the gulf between GDP and market cap has been growing wider and more dangerous since the Fed sped up money printing after the Lehman meltdown. To wit, since the pre-crisis peak in October 2007, the market cap of the Wilshire 5000 is up by nearly $32 trillion, while the national income to support it (GDP) is higher by only $8 trillion.
The stock market’s capitalization should be falling, not soaring into the nose-bleed section of history. After all, since the financial crisis and Great Recession, the capacity of the US economy to generate growth and rising profits has been sharply diminished. The real GDP growth rate since the pre-crisis peak in Q4 2007, for instance, is just 1.5% per annum, which is less than half its historical trend rate of growth.
Back in October 2007, the stock market’s capitalization was 106% of GDP and in just 14 years it has soared to the aforementioned 204%. So even as the growth rate of the US economy has been cut in half, stock market capitalization has doubled.
Given that the stock market has gotten way, way ahead of the economy, the longer-range implication is a long spell during which financial asset prices will stagnate or even fall until they eventually recover the healthy relationship to national income.
Looking at this from a different angle, the current $46 trillion market cap of the Wilshire 5000 would not return to 62% of GDP until US GDP reaches $75 trillion. At an average of 3.3% per annum increase in nominal GDP since Q4 2007, it would take 38 years to get there!
That’s right. The massively over-valued stock market is currently capitalizing an economy that might exist by the year 2060… if all goes well.
Editor’s Note: Did you know that that United States government has unleashed the most dangerous experiment in its entire history?
In fact, what’s been unleashed is trillions of dollars of stimulus with no end in sight.
When any government goes on an uncontrollable money printing spree it impacts everyone.
That’s precisely why, NY Times best selling author Doug Casey just released this urgent new video on the biggest imminent threat and what you can do about it.
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If you still have a 401k are they invested in pharmaceutical companies? My guess is yes since they’re doing so well.
My son, the millennial rocket scientist told me I should invest every dime I can spare in Gamestop and some company designing NFTs for them called Luperin or something.
That’s my informed investing advice.
My husband says I can’t spare any dimes.
P.S. I told my son “look around we have everything we need here” I explained that even if something were to stop the government from paying retirement to Nick, we had saved enough we think we’d get by and perhaps thrive with all the prepper stuff I “invested” in longagoandfaraway.
(I already told Geneva to NEVER buy sugar, dried potatoes or carrots or bourbon again. She said she doesn’t need the bourbon but she does like those big Mormon cans for storage, so she’ll take the sugar, potatoes and carrots. In return, I get three big sheets of plywood her husband had in his shed when he passed away. Gold for gold.)
Don’t forget to add toilet paper to the prepper list recalling the toilet paper caper not long ago. I’ve seen toilet paper listed as high as #25 on some top 100 lists of essentials for preppers. Fortunate you on the plywood. I don’t know what thickness the plywood you received. Prices have come down a bit I believe after seeing some retailers pricing it as high as $90 for a 4x8x 3/4″ sheet. I use to staple paper targets to smaller pieces of leftover plywood. Not anymore. And who can afford ammo now for recreational shooting? I’ve switched to .22 ammo for the recreational target shooting. While many may know this whether they hate or like Wal Mart, in my area since stocking .22 ammo again the retail giant offers .22 high velocity solid nose and hollow point ammo from Federal and Winchester in the 300+ round boxes for what calculates out at 6 cents per round after tax. Not a bad price all things considered.
I grabbed a couple of cans of 22LR and 9mm. We decided we got plenty of 30 aught 6.
Lots of new house construction going on around the suburbs of Memphrica and I go dumpster diving for the OSB they cut out from the windows, doors and roofs. I find lots of uses for it around the place. Also, regularly find pretty decent 2X4’s and 2X6’s in shorter than 8′ lengths and all you have to do is pull a couple dozen nails.
Nick tore down the old balcony from our treehouse and rebuilt it. I donated all the old lumber to my pig-raising hillbilly friend Larry and he built the most amazing shed. I’ll take a picture next trip to Larry’s.
He may be a bit slow witted, but he is industrious and now has a shed for his rabbit food!
Waste not.
Ain’t easy being cheap.
A coworker once dubbed me The King of Cheap and I took it as a high compliment.
In old times, it was a virtue.
Nice. My twin brother and I built half of our first cabin, in Alaska, from an old school. I made a built a beautiful table from a Douglass fir board, with no knots, using a chainsaw, rasp and plane. Almost a work of art. The legs and connectors were logs and branches. This was before the days it was cool to be a homesteader. Not bad for a city boy from Bucktown Chicago. Our first greenhouse was made from alder branches, easy to bend. I never saw anybody do anything with alder except cut and burn it.
One of my favorite shows to watch is Homestead Rescue. the Raney’s are homesteaders from AK and Marty is mighty handy with a chainsaw.
I’ll bet your table is beautiful. My Dad built furniture when he was a young man and I still have a couple of pieces that need some refurbishment. Alder smoke and salmon go together quite well.
Yes. It’s an awesome show. I had heard about that crazy Marty guy who climbs Denali with his guitar. But I never met him. They’re skills are incredible. The Alaska shows are all fun to watch. I used to hear a story about a 12-year-old girl who yodeled at the bars. But never saw her. It ended up it was Jewel.
The Fed doesn’t know how to taper a Ponzi scheme.
We are all screwed.
Merry Xmas.
Well said. The only thing that ends a Ponzi scheme is a gun.
Good stuff, David …just remember that ” normalized interest rates ” will hug zero for the rest of our lifetimes.
I don’t like it any more than you do.
Merry Christmas !!
Macro economics: Quote from the end of the article for a summary of cause and effect in the banking world.
“There can be no doubt that with interest rates around the world rising from negative and zero rates, credit conditions will be changed substantially,
And with a preponderance of zombie corporations the world over, bankers will become acutely aware of the risks.
It will not be long before loans are called in, and collateral sold into the markets.
This article concludes that with rising interest rates now inevitable, they will lead to a bear market in financial assets, which can only accelerate the contraction of bank credit.
The operational gearing in global G-SIBs is at record levels and is truly alarming.
There must be no doubt that higher interest rates and the scramble to contain the fall-out will make the collapse of Austria’s Credit-Anstalt in May 1931 seem a relatively minor failure in comparison.”
https://www.goldmoney.com/research/goldmoney-insights/the-credit-cycle-and-zombies-downfall
David Stockman may know the truth about the stockmarket but he is not telling us about it. He was a leading Neo-Con economist pushing “fair trade” way back in the Reagan days. He was instrumental in the exporting of the guts of the American economy to Mexico and China. He is a Uniparty economist screw him. I don’t presume to be an economist or investment guru but this guy is a liar that does not have Americans interest at heart. Beware.
I know. I read his early life.