Some Sobering Charts
Even a traditionally optimistic Michael Darda, of MKM Partners, is having trouble discovering the silver lining among the flotsam and jetsam that is the global macro-economic ocean currently. The Japanification theme continues with five charts offering too-correlated-to-be-ignored perspectives on equities, money supply/velocity, valuations/multiples, and demographics.
An updated chart of Japan versus U.S. equities is breathtakingly grim. This chart originally ran as a Bloomberg “Chart of the Day” back in August. The chart may tell us what is in store if eurozone policymakers fail to forestall a collapse of Italy/Spain. The ECB's reluctance to even take back the errant rate hikes imposed earlier this year—the least it could do, in our view—is not encouraging in this regard.
A high ratio of liquidity doesn’t guarantee a rise in risk assets or nominal income, as Japan has found out over the last two decades. Tightening credit markets are an ongoing threat to the velocity of money.
Low long rates have not led to higher P/E ratios in Japan. Moreover, long rates tend to move with expected nominal growth prospects, which is why they have been closely correlated to movements in equity prices over the last several years.
Like Japan, the U.S. is facing demographic challenges, albeit not to the same degree (i.e., we are not headed for negative population growth). However, the Federal Reserve Bank of San Francisco has done work on equity multiples and societal age distribution (middle-aged cohort versus the old-age cohort) and has found a stunningly close relationship that does not bode well for a rise in earnings multiples from here. Indeed, the researchers note that, “the actual P/E ratio should decline…to 8.3x in 2025 before recovering to about 9x in 2030.”