Woody Allen closes “Annie Hall” with a joke: This guy goes to a psychiatrist and says, ‘Doc, my brother’s crazy; he thinks he’s a chicken.’ And the doctor says, ‘Well, why don’t you turn him in?’ The guy says, ‘I would, but I need the eggs.’
That pretty much sums up our relationship with the central banker ruling class. We know that they’re bizarrely out of touch with reality, and we’re terrified of what they might do next. But we go along with the magical thinking crew and smile at their courtiers. Why? Because we need the eggs.
It’s easy enough to rail at the Fed and the stultifying, excruciating, more-of-the-sameness that came out of Jackson Hole. But the larger problem is with us. The bigger problem is that we cannot imagine a solution for our current economic and political problems that does not rely on greater and greater government-directed spell casting. It’s time to wake up. It’s time to begin a new conversation.
Ben Hunt, “Magical Thinking”
Ben was inspired, ok – emotionally motivated by the post-Jackson Hole media parade:
What I’m saying is that we need to focus on empiricism and on what works in the real world, not theory and what “works” as an equation. What I’m saying is that usually the better course of state-directed action is to do less, not more, and the better course of individually-directed action is to do more, not less. (Emphasis mine.)
I smiled and whispered to myself, “What a creative and witty piece.” Amen Brother Hunt, amen. Ben concluded his missive saying, “The problem with magical thinking run amok and its perpetuation of a fantasy world is that sooner or later the dream of the delusional king becomes a real world nightmare for real world people. It’s time to wake up.”
I think we are waking up. Europe is waking up. Brexit moved the needle towards a better Euro solution. We don’t see that right now, but I think we will. Here too, “We the People,” are pissed off and tired of the good old boy fat cat cronyism. We are waking up. Maybe not in this election but perhaps in the next.
Perhaps it is a crisis that kick starts fiscal policy action. Perhaps not, but I believe we are turning our lights on. There are solutions. We’ll collectively figure it out.
We have a choice as to where we put our energies. My mom taught me years ago to hold joy in my heart and then focus my energies on what it is I want and then to see it as if it has already happened. Then go out and do the wind sprints, she advised — do the work, stay patient, focus on your end goal and you’ll succeed. Collectively, I believe, I mean I know… we can.
Yesterday morning, the August ISM Manufacturing Index fell to 49.4 from the prior high of 52.2. A drop below 50 suggests the economy is contracting. This morning, the odds for a September rate hike dropped after the jobs report missed expectations.
Here’s the rub: Our debt levels and entitlement promises are too large. We have crossed the debt-to-GDP thresholds at which point mucks up the growth engine — here, there and most everywhere. More debt and higher taxes is deflationary. Zero-bound interest rates are deflationary. The economic evidence we measure is deflationary. It’s not working.
We remain in the beginning of a debt deleveraging cycle. We have yet to tackle the big fiscal policy stuff (tax reform, debt restructure, infrastructure spend). For now, expect that we are going to get more eggs.
Ray Dalio sees the potential for a perfect deleveraging. Mohamed El-Erian says we are coming to the T-Juncture. We’ve come to the end of the road and can only turn left or right. One turn finds monetary policy joining hands with fiscal policy. The other turn is not the good road to go down. The better turn sees tax reform and infrastructure spending driven by a bi-partisan effort that surprises us all. Can we believe it will happen? Collectively, I think we must.
Is it the answer? Not sure, but I think so.
Here’s an idea: How about reducing the federal tax rate to zero and funding the annual government budget with newly created currency; however, the annual budget stays fixed at 20% of GDP. Or 18% or 15%. I don’t know. But hold the government size in check to a proportion of our collective annual growth. And assign to pay down the national debt over say, 50 years. That would get us going.
OK – you say… Steve, “You’re nuts.” Maybe, but I much prefer the creative power of this vision versus the destructive power of negative thought. I believe that the good news coming out of the bad stuff is that it is forcing us to “wake up.”
But that’s enough of that. Today, let’s look at valuations and see what they are telling us about probable coming 10-year annualized returns. You’ll find that I also poke some fun at Wall Street consensus earnings estimates. I believe after you see my charts, you too will distrust “consensus earnings estimates.”
Grab a coffee, find your favorite chair and dig in. Enjoy the remaining few days of summer… You’ll find a number of charts but the read is quick.
Included in this week’s On My Radar:
- U.S. Equity Market Valuations
- The Dirty Harry Jobs Report
- Trade Signals – Overvalued, Sentiment Remains in Bullish Extreme (S/T Bearish for Stocks), Cyclical Bull Uptrend
U.S. Equity Market Valuations
The S&P 500 median price-to-earnings (P/E) ratio was 23.7 on August 31, 2016. Think of “median P/E” as based on actual, reported earnings and current price, as the middle P/E (250 stocks have a lower P/E and 250 have a higher P/E).
I like it because it tends to take out the one-off accounting gimmicks. From there we can look at each month-end median P/E number and compare it to other points in time to get a sense if the market is overvalued or offering investors bargains. Further below we’ll sort median P/E into five categories that range from inexpensive to expensive. We are in the most expensive quintile today.
Note the date and small red arrow in the next chart.
Source: Ned Davis Research, Inc. (NDR)
The large red arrow at the bottom of the chart identifies price targets for the S&P 500 Index based on the median fair value since 1964. With the S&P 500 at 2170 at August month-end, the market is 28.7% above its 52-year median fair value. Rarely does a market move more than one standard deviation move above its fair value. It is 6.9% above the overvalued level of 2021.15. OK – it’s expensive but it could grow to be more expensive.
I believe, as fiduciaries, advisors are paid to understand potential risks and rewards for their clients. The above chart quantifies various levels of valuation. Are we going to get a better or worse return on our money? In this way, valuations are very telling in terms of the probable returns investors are likely to receive over a coming period in time.
The next chart is something I’ve shared in the past. Note that returns