Sell side analysts argue it is not. They use measures like future operating earnings per share, a measure that has two major flaws. First, it is based on next analyst estimates of future earnings which are always way too optimistic. The estimates are then slashed as they come closer, but never mind, it’s on to the next estimate of a brighter, better future. Second, operating earnings are not like GAAP earnings which look at actual performance and include the bad stuff…write-downs, discontinued operations…all those so-called ‘one-time’ events that seem to come around every year.
When you look at real GAAP earnings, we have had five straight quarters of declines and, according to FactSet, that’s about to go to six straight, which hasn’t happened since the Great Recession of 2008/9. So, in earnings terms, we have a recession of considerable magnitude. The first results for the third quarter released this week have not been good and the stocks have been pummeled.
There is a better indicator of value than earnings however, given how earnings can be manipulated. That indicator is the ratio of Price to Sales. It’s much harder to use accounting gimmicks to high-ball sales. This indicator tells us that the stock market is now trading at all-time never-before-seen valuations.
How did we get here? It’s all about the monetary stimulus from Central Banks—QE and zero interest rates—which have done nothing to stimulate the real economy or address its structural problems. All the Federal Reserve has accomplished is to add more debt and drive asset speculation. That’s how you get record stock prices without record revenue gains.
Free money to banks and financiers has spurred speculation, inflating asset bubbles that generate a wealth effect–households looking at their swelling IRA accounts feel wealthier and thus more enthused about borrowing and spending money they shouldn’t borrow and spend.
But wealth effects as the Fed calls them do nothing to offset the massive loss of interest income for the households that save rather than spend; nothing for the collapse of low-risk yields needed by pension funds; nothing for real investment to offset stagnating productivity and generate the cash flows required to meet the demographic time-bomb of unsustainable social welfare programs; nothing to raise the incomes of ordinary households and employ young people.
Fed policies only benefit the top 5%–the slice of households that owns 70% of the nation’s financial assets. The top .01% owning 22% does even better:
Lowering interest rates to zero simply removes the healthy discipline imposed by interest rates. With the discipline of interest reduced to zero, speculating with leveraged credit makes perfect sense if you’re a financier or corporation with access to the Fed’s free money spigot. But asset bubbles are no substitute for the expansion of goods, services and wages.
The stock market is a bubble of historic proportions. Its valuation no longer has any connection to the real economy. Stocks are supposed to represent the discounted value of future earnings by real companies. But they actually represent the distortions of free money. At some point, prices will come back to earth dear reader and earnings will matter even with ultra-low interest rates.