by Matthew Piepenburg, Gold Switzerland:
It should and will come as no surprise that fundamentals like valuation basics and sane credit levels have left the building (and securities markets) for some time.
Today, we literally invest (i.e. buy and sell) in a veritable market Twilight Zone beyond sight, sound, reason and, well…earnings, profits and cash-flow.
But that’s what happens when a central bank produces fiat money like this…
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That is, gobs and gobs of printed dollars (of which the FOMC has promised more this week) keep banks artificially liquid, bond prices artificially bought/high, yields artificially repressed and thus rates (i.e. the cost of borrowing) stapled to the floor of history.
But as the Austrian School reminds, cheap debt leads to debt binging, and debt binging leads to very bad things…
Cheap Debt = Crappy Bonds & Zombie Enterprises
Smelling cheap rates, U.S. companies will borrow (i.e. binge) like this…
Corporations chase cheap debt almost as much as college kids seek discounted beer, and use it just as dangerously—i.e. to buy-back their own shares or issue dividends with borrowed dollars, make no profits and then call themselves “recovered” as their stock prices fly, literally, on borrowed wings.
Many, in fact 15%, of these debt-drunk enterprises are walking dead “zombies” who borrow at advantaged rates just to pay yesterday’s interest and have no chance at all of ever repaying the principal.
These zombies, however, are just one member of an over-all embarrassing club of U.S. corporate bond issuers, 67% of which are rated at or just a pinch above junk, high yield or levered loan status—namely the very bottom of the credit barrel.
From Bad Bonds to Inflated Stocks: Just Do the Math
But when not issuing IOU’s to stay alive, many of those same enterprises are passively riding a stock market wave above jagged rocks of broken balance sheets hidden just beneath the waterline.
And as for modern balance sheets–do they or any other rule of math and common sense even matter anymore in this new Twilight Zone?
Toward that end, I’m thinking of those pesky items of the ancient past like earnings, profits, cash flow, book value etc.
As Doug Cass recently reminded, nearly every traditional and once-respected measure of sound stock valuation—i.e., PE ratios (27.9), Cyclically Adjusted PE multiples (32.9), Price to Earnings ratios (27.9), Price to Sales (3.0) or even Buffet’s favorite, the classic Total Market Cap to GDP (170%)—are all at record high levels of over-valuation today.
And yet buyers are crowding in for more, buying at (and chasing) frothy tops like sheep following a mad herdsman.
Speaking of mad crowds and their even madder herdsman, Citigroup is forecasting an S&P at 3800 for 2021 while JP Morgan and Kantor Fitzgerald are anticipating 20% surges from current stock valuations for the coming year–pandemics, recessions and unemployment levels be damned.
Price to What?
But let’s pause and consider (for the sake of brevity) just one of the many 100th percentile metrics of market overvaluation—the infamous price to operating earnings ratio.
It’s worth noting that current PE ratios for the S&P are now where they were just before the infamous bubble-popping of 2001 and even higher than where they stood before the great rise of 2008 made history as the Great Financial Crisis of that same year:
Look a little scary to you?
Now look even closer.
What’s particularly eerie is just how fast those ratios (i.e. metrics of gross over-payment) have climbed since the market tanked in March of this year.
Folks, it’s not as if earnings were rising by double digits because valuation was rising at the same pace.
If we look at actual earnings per share data, they confirm that earnings today are where they stood in 2018 when the market was valued much lower.
This means today’s (and tomorrow’s) investors are literally riding such an optimistic high that they are openly (and likely unknowingly) paying 35% higher prices for the same companies whose earnings have not risen for the same period.
Furthermore, earnings per share data has been totally distorted by trillions in corporate stock buy-backs, which means investors are paying far more than even these staggering percentages confirm.
So, what gives? What’s going on? How did things get this crazy?
Mania and Market Psychology
In simple terms, we are witnessing a mania, and manias, like viruses, can last for a long time.
Mania’s moreover, have less to do with valuations and math—i.e. PE ratios and bond yields—and more to do with psychology, a topic absent from most Wall Street (and even Main Street) reading lists.
Looking at past manias and bubbles, we know that maniacal investors always pile in together on the buy-side, ignoring valuation sobriety until they are forced to—i.e. when it’s too late.
We also know that market manias often have no correlation to underlying economic conditions, and thus markets can thrive while economies (as now) are literally gasping for air.
In fact, manias typically gain speed rather than tire out as markets pierce resistance levels and reach new, record-highs, seemingly, with each weekly headline and despite every red flag from traditional valuation metrics.
Confidence follows headlines, and headlines create crowds, and crowds follow each other (and the sell-side)—right up to, and then eventually, right over a market cliff.
This is true of all bubbles and maniacal markets, from Revolutionary France (1793), the roaring 20’s (1929), the bloated Nikkei (1989), the irrational NASDAQ (2000), or the sub-prime S&P (2008).
Overestimating Skill While Underestimating Humility
Psychologists, for example, would remind that a cognitive bias often occurs in bull markets wherein individuals of a low ability at a given skill begin to overestimate their abilities due simply to an “inability to face their inability.”
This often takes place when investors are enjoying a trend (or mania) rather than genius or fair price discovery.
The fancy lads call this psychological phenomenon the Dunning-Kruger Affect, and I’d contend that many self-smug Fed Chairs and wealth advisors, as well as many investors, are suffering from it now as they passively enjoy (and take credit for) a maniacal market rise.
This disease of false confidence spurred by false (i.e. artificial markets) is particularly the case for Janet Yellen, who is now heading from the Fed to the Treasury with much applause.
Ah, how the ironies do abound. When it comes to monetary discipline, Yellen at the Treasury makes as much sense as Madoff at the SEC.