WASHINGTON – When it comes to US higher and higher stock prices I am struck by something truly odd, in fact frightening. There is an obvious disconnect between all time Wall Street highs and relatively weak economic data.
The US economy is doing OK, but not especially well. After the weakest recovery in recent history, America is growing at 2% a year, may be a little better. However, unemployment around 6% is still too high. Labor participation is at historic lows. Real incomes have not grown for decades. A new generation of college graduates is coming into the labor market saddled with the heavy burden of gigantic student loans. These huge financial obligations prevent even the lucky ones who find decent jobs to spend, buy homes, etc. All in all, I would not call this a booming economy.
Forget about the BRICS
Add to this not particularly inspiring US picture the obvious fact that the global economy is doing poorly. Remember the BRICS? Not even one of them has met expectations. Brazil was all about its short-lived commodities export boom. Now it is in poor shape. Forget about Russia and sorry-looking South Africa. India, now under new management, may hold some promise. China’s economic miracle story is over. The spectacular 30 year export-led model has run its course. At this time China is desperately trying to meet inflated growth targets by pumping more cash into a so-so economy already suffering of a serious case of “too much bad debt”, coupled with massive overcapacity is some key sectors, like steel.
Europe and Japan are in decline
In all this, Europe and Japan are in seriously bad shape. Simply stated, these are old, in fact exhausted societies with way too much public debt, negative birth rates, too many old people, negligible investments, bloated public sectors, and huge entitlement programs no longer supported by a large active work force paying into the system.
These old countries, mostly run by mediocre political leaders, simply cannot keep up any more. Italy has zero growth, an unemployment rate of 12%, with youth unemployment in the South up to 60%, and a national debt now equal to 130% of GDP. Japan is once again in a recession, while its national debt is 230% of GDP. None of this is fixable.
Now, let’s point out the obvious. These are America’s main trading partners. How can it be that the US economy is doing so-so, the rest of the world, including those who buy our goods ans services, is in mediocre to bad shape and the US stock market is booming? It used to be that stock prices reflected basic fundamentals. Well, not any more.
Stock valuations driven by Central Bankers
These days stock prices have little to do with the real economy. They are determined by the presumed positive impact of supposedly benign monetary policies implemented by Central Bankers. And what kind of magic are they doing? Well, the Central Bankers throw more and more invented money into the system while purchasing assets in order to ignite growth.
The evidence is that this does not increase the volume of productive investments; but it pushes up the valuation of stocks. Indeed, since real interest rates are kept below zero by the monetary authorities, where else will you put your money? Therefore, all the smart people buy more stocks, counting on Fed or ECB policies to push valuations higher and higher, no matter what the fundamentals may be. Japan’s economy is not growing, but its stock market valuations doubled. Have we gone totally mad? The answer is “Yes”.
David Stockman’s analysis
Here is how David Stockman sees it. Writing in his own www.davidstockmancontracorner.com he says:
“The global financial system has come unglued. Everywhere the real world evidence points to cooling growth, faltering investment, slowing trade, vast excess industrial capacity, peak private debt, public fiscal exhaustion, currency wars, intensified politico-military conflict and an unprecedented disconnect between debt-saturated real economies and irrationally exuberant financial markets.
Yet overnight two central banks promised what amounts to more monetary heroin [bold added] and, presto, the S&P 500 index jerked up to 2070. That is, the robo-traders inflated the PE multiple for S&P’s basket of US-based global companies to a nose bleed 20X their reported LTM earnings.
And those earnings surely embody a high water mark in a world where Japan is going down for the count, China’s house of cards is truly collapsing, Europe is plunging into a triple dip and Wall Street’s spurious claim that 3% “escape velocity” has finally arrived in the US is soon to be discredited for the 5th year running. So it goes without saying that if “price discovery” actually existed in the Wall Street casino, the capitalization rate on these blatantly engineered earnings (i.e. inflated EPS owing to massive buybacks) would be decidedly less exuberant.
In truth, nothing has changed about the precarious state of the world since yesterday. Except….. except the Great Bloviator at the ECB [President Mario Draghi] made another fatuous and undeliverable promise—- this time that he would do whatever he “must to raise inflation and inflation expectations as fast as possible”; and, at nearly the same hour, the desperate comrades in Beijing administered another sharp poke in the eye to China’s savers by lowering the deposit rate to by 25 bps to 2.75%.
Let’s see. Can it possibly be true that European growth is faltering because it does not have enough inflation? Or that China’s fantastic borrowing and building boom is cooling rapidly because the People Bank of China (PBOC) has been too stingy?
The answer is not on your life, of course. So why would stocks soar based on two overnight announcements that can not possibly alleviate Europe’s slide into recession or the collapse of China’s out-of-control investment and construction bubble?”
This boom is unsustainable
Well, there is no valid economic reason for these incredibly high stock valuations, except for the crazy belief held by most investors that Central Bankers have magic wealth creation powers.
As long as the monetary authorities of the US, Europe, Japan and now China can keep their magician tricks going, (buying assets while keeping interest rates at zero), everybody in America will continue to believe that the stratospheric Wall Street valuations are justified.
I do not know when, but there will be a point when the Central Bankers will run out of tricks, and therefore this whole Wall Street boom will unravel, because it is based on nothing real.