The markets seem to think so. Here’s what hundreds of bullish analysts are saying: the price-to-earnings ratio (P/E ratio) is roughly 20 today and they are projecting earnings to grow an astounding 30% by the end of 2017. Therefore, a forecast of 2500 on the S&P is not unreasonable. And so you get a lot of predictions of a big S&P 500 bull market in 2017.
I call this ‘fun with numbers’.
These ‘analysts’ are using operating earnings in their calculation. If they used reported GAAP earnings, they would find that today’s P/E is actually 26.79—already at their inflated target– using the cyclically adjusted P/E ratio (CAPE) created by Professor Robert Shiller. Using CAPE, you can compare the market’s P/E going back in time. The current PE is at the top of its 2007 range, exceeded only in the irrational markets of 2000 and 1929.
It boggles the mind that people take these estimates seriously. But that is the problem. A very large number of people and market advisors do. That is why you hear that you’ve got to be bullish and stay in the market.
The underlying rationale for all this is the Trump election victory. Republicans are now in control of over 67 per cent of state legislative chambers. Republicans have won more total seats than they have since 1920. Starting next year, the GOP will control both legislative chambers in 32 states, an all-time high. Analysts tell us that means Trump will have his way. This assumes Republicans agree on the huge deficit spending that Trump has proposed. I doubt it. This also assumes that politics can ‘trump’ the laws of economics and finance. They can’t.
I applaud Trump for wanting to deregulate the economy but I don’t think his economic plan can succeed in reviving growth.
Trump Repeats Reagan?
We’re now into the third decade of monumental debt creation. Debt has increased more than three times faster than the economy. It’s way too late for a Reagan renewal.
When President Reagan came into office, the Fed’s balance sheet was at $174 billion; today it’s $4.524 Trillion (T).
Total Debt Securities issued were $2.0 T; now they are $40.581 T.
Outstanding Treasury Securities have grown from $736 billion to $15.385 T.
Agency Securities (guaranteed by the U.S. Treasury) have mushroomed from $191 billion to $8.324 T.
Total Mortgages have increased from $1.458 T to $13.974 T.
Corporate Bonds have expanded from $511 billion to $12.030 T.
Reagan inherited a 14 year bear market in stocks and 34 year bear market in bonds. He came to power at the beginning of a new credit cycle. There was nowhere to go but up. Government debt/GDP had continually fallen since WWII to just 30%. The baby boomers were moving into their productive years. The IBM PC was just launched. The Soviet empire was on the verge of collapsing. It was the perfect time for Reagan’s ‘morning in America’.
Trump is inheriting asset bubbles in stocks, bonds, and commercial real estate. Total debt/GDP is at record highs exceeding 100%, at the end of an historic debt cycle with interest rates at all-time lows (much of the world’s sovereign debt actually dipped into negative yields not long ago). Boomers are just moving into retirement which will swamp an entitlement system that was never reigned in. Bonds appear to be on the verge of a multi-decade bear market. The government’s interest costs will explode because the politicians cleverly structured its debt on the short end of the curve to understate the deficit, assuming rates would stay low forever.
What’s Really Going On?
When analyzing today’s markets, we need to keep a few things in perspective. Global central bankers continue to provide market liquidity (QE) to the tune of about $2.0 TN annualized. Chinese Credit is expanding at a record pace of about $3.0 TN annualized, with significant ongoing capital flight. Years of this unprecedented liquidity backdrop have fundamentally altered the way markets function. Investors no longer drive markets, speculators do. According to TrimTabs, on the day Donald Trump won the presidency and the two days following, investors poured the most money into stock-based exchange-traded funds that they have in nine years. In the week leading up to the election, short-term money was scrambling to hedge (short) against a Trump victory which was assumed to be a negative for the markets. When the unexpected happened, with Trump winning and the markets responding positively, frantic short covering and equally frantic new longs drove stocks wild. Equity-based ETFs took in $22.6 billion from election Tuesday through Thursday. According to Bloomberg, in the week following the election, the Financial Select Sector SPDR exchange-traded fund amassed a record $4.9 billion of inflows, more than it accumulated in the previous three years.
This is a mania. Do you think it can continue?
There are very few apt comparisons to today’s extraordinary backdrop. Certainly, the Reagan election of 1981 is not one of them. Late in the “Roaring Twenties” offers a far better parallel with similar economic disparities, globalization, cheap and plentiful credit, debt spiralling out of control, financial innovation and unending speculation. By 1929, it was deeply embedded in the speculators’ psyche that an enlightened Fed would never allow a market or economic collapse. Of course, we know how that ended.
Thanks to Doug Noland for finding this wonderful quote from the President of that time.
“One trouble with every inflationary creation of credit is that it acts like a delayed time bomb. There is an interval of indefinite and sometimes considerable length between the injection of the stimulant and the resulting speculation. Likewise, there is an interval of a similarly indefinite length of time between the injection of the remedial serum and the lowering of the speculative fever. Once the fever gets under way it generates its own toxics.” “The Memoirs of Herbert Hoover: The Great Depression 1929-1941”
President Trump may not like the comparison but to me it’s not Reagan, it’s Hoover.