Listening to the leaders at the Fed these days is like hearing the best students in the class arguing with the teacher over a grade. Much of the media seems like parents arguing on their child’s behalf. For the guys at the Fed, who mostly know academia and nothing else, low grades would be crushing if they were not delusional. The class in this case is Real Economy 101 in which the Fed has helped guide the labor participation rate to thirty-year lows. Too many twenty-something’s reside in their parents’ basements for lack of a good job and older workers have given up looking for work in droves.
Nonetheless, our brave students at the Fed are just certain as can be that money velocity will rise sooner or later, as their printed money finally gets put to productive use in the real world. Doubters like us must prove the “counterfactual” (a popular word among the FOMC acolytes these days) that things would be worse without the heroes at the Fed who have rescued us every five years or so from the popping of the bubbles they helped blow.
The FOMC swears it deserves an “A+” because stock prices are so elevated and speculation is rampant again. Numerous pundits praise the wisdom of Chairman Bernanke. However, for the first time we can recall, a number of significant money managers and captains of industry have voiced concerns that a bubble has formed in many asset classes. But the Fed supposedly knows better! Though there is so little real world experience within its ranks, somehow the central bankers’ good grades in school and fancy research papers replete with indecipherable squiggly lines trumps the wisdom of people who really do not have a vested interest in sounding cautious.
We will give them their coveted A+ in one subject: Bubble Formation 101. They have been receiving that grade for over twenty years. Equity bulls are now running over 3.5 to 1 versus bears according to sentiment surveys. Margin debt and mutual funds flows are at euphoric extremes. Tech companies with no earnings are priced into the stratosphere. A++! We also give them an A+ in Capital Misallocation Strategies 101. The FOMC is causing money to flow into markets and not into productive capital. They openly sell the “sizzle” of their magic trick. However, does the Fed think that business decision makers are so naïve as to believe anything in the current environment is real or sustainable? Will higher stock prices lead to job growth?
Why you may ask are we so hard on the Fed. It is because their policies at these extremes help so few and penalize so many, especially savers. Even some from the inside the Fed are beginning to recognize the shortcomings and unintended consequences of current policies. In a recent piece in the Wall Street Journal Andrew Huszar, the man put in charge of the Fed’s mortgage purchase program wrote:
“I can only say: I’m sorry, America. As a former Federal Reserve official, I was responsible for executing the centerpiece program of the Fed’s first plunge into the bond-buying experiment known as quantitative easing. The central bank continues to spin QE as a tool for helping Main Street. But I’ve come to recognize the program for what it really is: the greatest backdoor Wall Street bailout of all time.”
Better late than never we suppose.
By the most important measures, U.S. stocks are the most richly valued that they have ever been in about 100 years of history, in spite of the underlying economy needing life support and pain killers for five years now. We predominantly use normalized earnings to value equities in an effort to adjust for cyclical earnings variability and typical profit margin behavior, but a more direct and less “geeky” way to get to largely the same answer is to compare stocks to annual revenue figures. On that front, data-centric fund manager John Hussman recently wrote:
“While the valuation of the S&P 500 Index itself was higher in 2000, it’s notable that the overvaluation of the S&P 500 was skewed in 2000 by extreme overvaluation in very large-capitalization stocks, while smaller capitalization stocks were much more reasonably valued. In contrast, we have never in history observed the median stock as overvalued as we observe presently. Indeed, the median price/revenue ratio of stocks in the S&P 500 now exceeds the 2000 peak. Likewise, as Damien Cleusix has observed, if we examine valuations by quartiles (25% of stocks in each bin), the average price/revenue ratio of the two middle quartiles also exceeds the 2000 extreme.”
Yet comically, former Chairman Greenspan had the audacity to recently argue stocks are cheap.
The next Fed Chair, Janet Yellen, just told us today during her confirmation hearing that there is no “over leveraging in the markets” and no “misalignment in asset prices.” Why worry?
The views expressed on this blog are the opinions of the authors. This information is not intended as investment advice or to recommend the purchase or sale of securities. More information on Strategic Balance, LLC may be obtained by contacting investor relations.