Why The Casino Is Dangerous: There Is Nothing Below
Submitted by David Stockman via Contra Corner blog,
The algos and chart traders are making another run at 2000 on the S&P 500, attempting to convince the wary investor one more time that buying on the dips is a no brainer. And in that proposition they are, ironically, correct. To buy this utterly manipulated market at these nosebleed valuation levels is about as brainless of an undertaking as is imaginable.
Now we even have it in a back-handed way from Deutsche Bank. Its chief strategist, David Bianco, claims that the S&P 500 is now trading at 17X reported trailing earnings and that historically when the multiple has gotten into that zone after three years or more of market gains (we have had five) good things do not happen. But, yes, this time is different according to perma-bull Bianco because even though above 17 PEs are rare after many years of EPS growth, very low interest rates are even more rare and support higher PEs:
Thus, powerful global structural trends appear at work and we find ourselves more accepting of long-term risk free real interest rates staying well below historical norms through the cycle. The completion of a good earnings season, improved confidence in decent US growth and S&P EPS growth for at least the rest of the year, and these still exceptionally low interest rates is shifting risk firmly to the upside for our longer-term fair value S&P 500 targets. We increasingly see the currently observed PEs as fair with upside at Tech, Healthcare and Financials, partially offset by Energy, with further overall S&P price gains fueled by EPS growth.
Now that is non-sensical Wall Street drivel. Honestly measured earnings have been growing only at a tepid rate, and have no prospects for acceleration given the sharp slowdown in both the global and domestic economy. And, please, how can we discount a distant stream of corporate earnings based on utterly artificial and unsustainably low interest rates that simply can’t be sustained over time without destroying the monetary system. That is, to keep the money market at zero and the ten-year at today’s 2.40% on a permanent basis in a world where inflation plus taxes turn these rates into deeply negative returns is virtually impossible. So sooner or later, and probably the former, there will be a normalization of interest rates, and that will cause a sharp downward re-pricing of equities.
In fact, LTM reported S&P 500 earnings after Q2 results and adjusted for the pension accounting change that is not embedded in the historical data were about $100 per share. That represents less than a 3% annual growth rate since late 2011, and implies a 20X multiple—- if the algos do achieve there target of 2000 on the S&P 500.
So with corporate profit rates off the charts, tepid earnings growth, sky-high actual PE multiples and a central bank pegged interest rate structure that has nowhere to go but up, it is evident that Wall Street stock peddlers like Bianco are doing nothing more than calling the sheep to another slaughter.
And a slaughter is what it will be. As shown below, there has been a thunderous collapse in stock market volume since the financial crisis, and trading is down by 60% on the NYSE and 75% on NASDAQ. Where has it gone? Into ETFs and the fast money driven options market, that’s where. And what is the central characteristic of these venues in a market crisis? The answer is lack of liquidity and a violent unwind of the implicit leverage in the massive hedge fund driven market in stock options.
And then what happens when the Wall Street casino experiences a significant break and the options/ETF un-wind gathers force? Quite simply, the massive stock repurchase spree of corporate America comes to a halt as the C-suite hunkers down. As has been evident for several Fed cycles now, and as is quite clear in the chart below, corporate America buys strenuously at the top and lapses into paralysis at the bottom.
In short, the Fed and other central banks have ruined the internals of all capital markets, but especially the stock markets. The short interest has been destroyed; one way trade based on zero carry costs rules the day on Wall Street; and corporate America is plundering its own balance sheets in order to feed the fast money and fuel artificial winnings in the stock options racket.
But when it comes to real investors there is really no one home in the casino. Accordingly, when confidence in the central bank con game breaks, markets will gap down drastically, suddenly and violently. And this time there will be no Bernanke style rescue. Were the Fed to attempt to go back to massive QE and thereby substitute its own liqudity for the crisis-driven collapse of corporate stock-buying, it would actually exacerbate the panic and compound the selling.
The reason not to buy the dips is thus a no brainer. There is a yawning gap below!
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