It is hard to dispute, even to the most ardent bull, that US stocks are anything but severely overvalued. Most analysts have their favourite metric for stock ratios, mine is price/revenues. The legendary investor Warren Buffett likes total market capitalisation/GDP.
One of the simplest and widest used methods is the CAPE (Cyclically Adjusted Price Earnings) but even then, there is a favoured CAPE, the Shiller CAPE, devised by Nobel Laureate American economist, Robert Shiller. It uses the price earnings based on average inflation-adjusted earnings from the previous 10 years.
The average ratio over the last century is around 16 times. At times the CAPE has been over double this, 1929, 2000 and over the last year. Ominous, yet? Even at the high in 2007, before the Great Financial Crash, the CAPE was lower than here. The optimists will remark that earnings will continue to grow and that zero interest rates justify sky-high multiples, but, historically, earnings never grow when unemployment is at cyclical lows with wage inflation biting into profit margins.
If earnings are unlikely to grow and we are double the average CAPE level, you don’t need a Fields medal in Mathematics to understand that US stocks could lose AT LEAST half their value to revert to the mean.
John Hussman’s weekly market comment often comes with a historical quote and the below seems worth repeating.
“There are three principal phases of a bull market: the first is represented by reviving confidence in the future of business; the second is the response of stock prices to the known improvement in corporate earnings, and the third is the period when speculation is rampant – a period when stocks are advanced on hopes and expectations.” -Robert Rhea, 1932
We are sure Robert Rhea would have something to say about the current state of the market, probably turning in his grave. At the top of all manias, when speculation and hope is paramount, you invariably have an event that in hindsight seems poignant. Today, we give you, the long-awaited IPO of the taxi-riding service Uber, with an opening valuation close to $100bn. The fact that Uber has never made a profit, lost almost $2bn last year, and many suggest it may never make any money is currently irrelevant. Maybe, in years to come, people will look back on this with incredulity.
Since the 2009 stock market lows, financial assets have soared, far outstripping real assets. Our good friends at Variant Perception, one of the top macro research companies in the world have just published a report, ‘The Next Generation Of Monetary Policy’ which is a must-read. They acknowledge the failure of QE, the last decade of extraordinary monetary policy that has ‘failed’ in their eyes, to increase the general inflation level. As we wrote about recently, the most obvious effect of QE, has been to produce tremendous wealth inequality which can’t really have been the plan, but it an unfortunate outcome, for the masses. Heads-in-the-sand central bankers who believe they ‘saved’ the system, do not seem to appreciate the extreme perils of soaring debt and budget to GDP ratios. Economics 101, says that above 100% and 5% on those ratios is not a good place to be at all, and most certainly not for the stock market investors.
By decade, it was the 1970s, that saw real assets benefit the most versus their financial counterparts. It was a similar time of rising debt and deficits, which led to galloping inflation. It is our belief, we look into the same abyss as then.
CRY Index – The TR/CC CRB Excess Return Index is an arithmetic average of commodity futures prices with monthly rebalancing.
While the typical commodity index tends to be too heavily weighted in oil, we can see that generally all real assets and commodities are distinctly cheap in their cycles relative to financial assets.
We have observed an eerie silence in many economist peer groups in recent months. They know full well, that 3.8% unemployment should not be accompanied by a market belief in Federal rate cuts, later in the year. They know that at peak economic activity, the budget deficit to GDP, should not be over 5% and rising. But, they are quiet. For now.
We believe they know as we do, it is not a question of, IF, the stock market crashes, possibly, the largest in history, at a time, when the recognised monetary policy has ‘failed’ but, WHEN?
While oil might be the commodity index heavyweight, gold has always been the king of the commodities. Its place as the asset of last resort in the financial markets as well as a commodity, has seen it historically, be one of the best portfolio diversifiers.
We urge investors, to seriously consider, proper rotation out of equities, especially US equities, into gold, at this time to avoid a potentially catastrophic wealth reduction.
Glint, with not just an ability to hold physical gold, but also to spend it with a Glint card, offers one of the best ways to prepare your portfolio for the changing world before its too late.