Stock Market Valuations Relative to GDP

Hussman has an excellent piece in his weekly insight letter, the following excerpt makes for an interesting read.

According to Ned Davis Research, stock market capitalization as a share of GDP is presently about 105%, versus a historical average of about 60% (and only about 50% if you exclude the bubble period since the mid-1990’s). Market cap as a fraction of GDP was about 80% before the 73-74 market plunge, and about 86% before the 1929 crash. 105% is not depressed. Presently, market cap is elevated because stocks seem reasonable as a multiple of recent earnings, but earnings themselves are at the highest share of GDP in history. Valuations are wicked once you normalize for profit margins. Given that stocks are very, very long-lived assets, it is the long-term stream of cash flows that matters most – not just next year’s earnings. Stock valuations are not depressed as a share of the economy. Rather, they are elevated because they assume that the highest profit margins in history will be sustained indefinitely (despite those profit margins being dependent on massive budget deficits – see Too Little to Lock In for the accounting relationships on this). In my view, there are red flags all around.

Lets see whether the “Insiders” get it right this time, I suspect they will. Silver may have seen an interim high for the next few months.

Forcing the count

As much as I would like to say that the top is in for the broad US indices as of the 17th September to call the final wave a truncated 5th just feels too low probability and forced due to bearish bias.

Of course this is when things get exciting as those counting the waves conventionally will start loading up at this point as we should be just completing wave C of 4 ready for one last hurrah??

Lets see what happens.

Cash on the Side – “pleeeezzzz”

“The ‘cash on the sidelines’ mantra has always been a crock of crap,” a reader writes after our take yesterday on the Fed’s Z.1 report. “The record cash and cash equivalents just so happen to coincide with record corporate debt.”

“Look it up! How could corporations possibly refrain from issuing debt at record-low interest rates? Any CFO that didn’t build a war chest of cash by issuing debt at these rates should be fired.”

“Back in 2008 when the debt window closed, many corporations found themselves cash strapped and struggling to survive. Any executive management team that forgot that lesson after only three years should have been sacked. So they issued debt hand over fist and sat on a stash of cash waiting for either for the STHTF or for things to get better. Either way, building ready cash was prudent. In fact, it would have been irresponsible not to build cash.”

“But the notion that corporations should be spending this cash hoard when 1) final demand is weak 2) higher taxes are coming and 3) we have the most business hostile administration in history manning (abandoning?) the wheelhouse… is absurd. You don’t borrow to spend, you borrow to invest, and why invest when you are running at 67% capacity?

“There is no record ‘cash on the sidelines,’ as anybody who can read a balance sheet (none of the media) has always known. It is more than offset by record liabilities.”

Yield Curve Conundrum

I am looking at the current US yield curve and saying to myself (and you) that perhaps Goldman has it wrong here. They are suggesting that the curve has met its flattening targets and is due to steepen. Putting any econometric comment aside, to me this chart looks to have a multi-year mean reversion look and more specifically it seems to display a neat head and shoulders so one would argue there is plenty flattening still to come.

Now comes my quandry I have placed a yield steepener trade on in the Aussie market, as I sense with all the uncertainty and with the weakening economic conditions, the Central Bank will be forced to pump liquidity in the system. In a more normal environment, this liquidity should be inflationary, yet we have seen in the US and parts of Europe that with record quantitative easing we are still getting decreasing bond yields. I stand by my thoughts of a steepening yield curve given all the global uncertainty and risk of default, etc. However I need to factor in the fact that we may be in a deflationary debt spiral which will mean continued lower interest rates, and due to the fact that the short end is typically bounded by ZERO (I say typically because Germany recently ran a negative yield (which is more of a unique situation as it is really trading as a cheap call option on the EUR disbandoning and Deutsche Mark coming back into the picture)) it means the yield curve is likely to become flatter.

So as per the chart above you will see the spread between the 10yr bond and 3yr bond yields in the Aussie market. I am currently trading the yield curve to steepen which is part of the current trend, however you can see that working off 10yrs worth of data we crossed over the 1.5 std deviation from the mean band and it looks like we may be flattening out. If deflation does in fact become a serious threat I believe the spread of this yield will continue down thus flattening the yield curve, which will tie up very nicely with my observation of the US displaying a head and shoulders with further flattening to come.

Oh Boy what is one to do LOL

How Low can they Go

I know we have all been saying this for some time and I guess the Japanese also said this for years, perhaps decades but lets face it, there is a bounded threshold – ZERO and we ain’t too far away.
I believe we are now in the final throws, this may last another year or two as we grind to ever more ridiculous levels but the bond market will in the end start a long trend to higher yields.

Chart of the 1929 Crash

I really like this chart.

US REITs continue higher

I have certainly said this before, so I will say it again. I think the US REITs are topping out, we may get a push to the fibonacci 68% retracement but we are certainly close.

While I am at it I feel the same way about the Canadian REIT market.

Shanghai Exchange

I believe this index is telling us there could be a hard landing coming and I see this as the canary in the coal mine for the US markets.

Greek Money Supply

This chart really tells the tale.