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Last week the Dow Jones Industrial Average (DJIA) stood at a price to earnings ratio (P/E) of 20.70. That’s insane. From 1929 to 2010, the average P/E ratio for the Dow has been around 15, which means that investors were willing to pay $15 for a return of $1. Think about it. Currently, the Dow sits at 38% higher than its historical average.
And it’s not just the DJIA. Every single index is well above its historical average, with tech stocks hitting new highs regularly. After the 2016 election, the highs were being hit in specific industries seen to benefit the most from a Presidency that would be deregulating just about everything. Now it is just about everything that is up.
The markets have not been deterred by Fed Funds rate increases or even global geopolitical risk, of which there is now plenty. The VIX (the measure of volatility traded on the Chicago Mercantile Exchange) finished last week at $10.70, which is incredibly low. Essentially markets think risk is almost non-existent and only upside exists.
It’s just pure greed and greed never results in good outcomes. Ever.
I have been a market bear for several years now. Early? Yes, but always better than late. It’s never a sin to miss upside if you avoid the massive downside. This market has been inflated for far too long and a crash is due.
What is causing this and what does it indicate for us average people?
For years now companies have been showing record profits. Much of this profitability hasn’t come from innovation, productivity or record sales. It has come from undercutting the consumer base with low wages and longer work hours. Even scandal and unethical corporate behavior has had little impact.
Even Wells Fargo (WFC) stock is over 10 points off its low after being found to open 2 million fake accounts. Its account openings have fallen precipitously with year-over-year quarters as much as 40% lower in credit card openings. Profits are still very high for them as they lay off thousands, close over 400 branches, and cut severance packages by over a third. In other words, the employees get screwed and the investors do well.
Banks overall have done exceedingly well due to the expectation that regulations designed to protect the American people are soon to be gone. Even the agency (the CFPB) that caught Wells Fargo will have their power degraded under new proposals.
It isn’t just banks. A one-page tax plan from the Trump administration outlines massive tax cuts for corporations and even entities such as LLCs and subchapter S corporations. Wall Street calls it pro-growth. No. It is pro-investor and that is it.
About half of Americans own stocks. The clear majority do so through 401ks with their employer and pay high fees. Direct ownership of stocks is often relegated to the wealthy who will most benefit from current proposals. Disparity will increase and is nothing but a negative for an economy that depends on 70 percent of its GDP from consumer spending.
Since the financial crises companies haven’t reinvested their record profits or increased wages. In fact, wages haven’t seen growth anywhere near commensurate with profits. Even a low unemployment rate has only reflected more people working for less. A job in retail will never have the economic impact and social mobility of the manufacturing jobs of old. Even those retail jobs are now threatened by the retail apocalypse.
So why are the markets so high?
Two words: stock buybacks. While companies have kept wages stagnant, automated jobs away, tucked profits away overseas, and invested little back into their core businesses, they have bought back tons of stocks to provide gains to investors through stock price increases.
Based on that silly one-page proposal from the Trump administration that dramatically cuts corporate taxes, investors are expecting greater corporate profits and even more stock buybacks. It’s enough to keep stock prices at unreasonable highs.
While summer can typically be a stock market drag after the completion of earnings season, it so far has not with new highs being hit regularly. Yet, multiple risks exist right now that have not been priced in. It’s pure greed.
What’s ahead?
The debt ceiling could lead to a showdown. That is beyond damaging to the economy.
Geopolitical risk exists in a President that is a loose cannon and potentially mentally ill. Allies are being pushed away, North Korea is more belligerent than ever, retail is in meltdown, trade wars are a threat as protectionism looms and automation continues to push out non-information economy workers. These things are sitting right in front of us, yet Wall Street is booming as it expects new gifts from the administration. It’s pure greed.
Most likely tax reform won’t happen this year. The power of the President is being diminished daily. As Trump’s favorability ratings continue to fall, the governing party faces a backlash they don’t know how to handle.
Another Fed increase is ahead. Bitcoin has exploded to amazing heights and gold has continued to rise, which indicates a strong contingent that believes in the overvaluation of the markets as well. The proposed budget destroys social programs that benefit the poor yet it is the lower rungs of the economic ladder that create a stimulus to the general economy, as every dime is reinvested back into it.
Essentially, massive headwinds are ahead but utterly ignored by markets right now. In normal times, markets like stability. None exists. It’s pure greed.
What happens when greed reaches its tipping point? It comes crashing down. This author expects it. That it is this long-overdue has reached the point of surreal.
Staying away will continue to be the espoused strategy. Missing the crash will always be better than the marginal gains.
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