US stocks fell slightly overnight. It appears as though investors are hungry for more…stimulus news.
I mentioned yesterday just how expensive the S&P 500 is now. On a price-to-sales measure, the S&P 500 is 20% higher than it was at the 2000 dotcom peak.
Back then, the economy was healthy.
Now? Not so much.
Which is why there is such an appetite for more…always more stimulus. From the Wall Street Journal:
‘“The economy needs another fiscal booster,” Ms. Boussour said. “If it doesn’t get it, we run the risk of activity stalling and the labor market losing steam again.”’
What Ms Boussour really means is that the stock market needs another fiscal booster.
Because when you’re priced for perfection, you need everything to go right.
The problem for the economy and the stock market, is that it is trying to recover from the biggest economic shock in history. And making matters worse, it was deteriorating even before the coronavirus shock.
What do I mean by that?
Wasn’t the stock market all-time highs just before the virus hit?
Yes, but the bond market was telling you otherwise.
The chart below shows the nominal 10-year US Treasury yield. From mid-2016 to October/November 2018, yields rose. Rising yields are an indication of an expanding economy and increasing returns on capital. In such an environment, there is less need to own ‘safe and secure’ US treasury bonds.
But that was as good as it got. The bond market turned lower and kept falling throughout 2019. This was despite the Fed halting its quantitative tightening program in late 2018 and reintroducing quantitative easing in 2019.
Falling bond yields are a sign of an expectation of slowing economic growth and declining returns on capital across the economy.
The stock market ignored that though and powered higher as 2020 got underway.
Then the virus hit an already fragile economy.
And while the bond market is saying there is no recovery in sight, stocks are already celebrating a recovery.
It is truly bizarre.
The chart above is the nominal 10-year bond yield.
To get a better understanding of the message the bond market is trying to give us, it’s better to look at the real yield. You get this buy subtracting the yield on TIPS (Treasury Inflation-Protected Securities) from the nominal yield.
This is what it looks like:
This shows real yields since the 2008 bust. While a recovery kicked in pretty swiftly, yields couldn’t move sustainably higher.
In other words, the economy was not able to generate, or sustain, higher returns on capital following that bust. And it’s been that way ever since.
After peaking in late 2012/early 2013, the US/global economy began to deteriorate all the way through to 2016.
You’ll recall at this time that is was particularly rough for Aussie commodity stocks.
Then another reflation/recovery kicked in, but like I said, it gave way in late 2018.
Now, I haven’t mentioned the Fed in all this.
So let’s bring it in…
Prior to 2008, the Fed’s balance sheet was as flat as a tack. But after four ‘QE’ programs, it’s just under US$7 trillion.
What has it done for the economy?
The real yields in the bond market tell you it has done nothing. The Fed is either useless, or its efforts are only just managing to prop the economy up and avert outright deflation.
It’s not a stock market, but a market of stocks
I thought the Fed was producing inflation with all its ‘money printing’, and destroying the dollar?
Well, that’s certainly what the stock market believes.
Maybe that’s all it is. A belief.
And while the bond market is pricing in rising inflation following the collapse in inflation expectations from the shutdown, it’s still low based on post-2008 history. That is, the average inflation rate expectation over the next 10 years is just 1.67%.
And for all the Fed’s work, and the increasing debt load of the US government, since 2008 the US dollar has been in a structural uptrend.
The monthly chart of the US Dollar Index shows you this trend clearly.
Yes, it’s fallen recently, but it could well be simply forming a ‘higher low’ on the chart, before moving higher again.
The overall message here is that the bond market (and the US dollar) are telling you that the ‘system’ is not fixed. The trend is to lower growth, and lower returns on capital.
Telstra Corp Ltd [ASX:TLS] admitted it yesterday when they cut their target on newly invested capital from 10% to 7%. Decent returns on capital simply aren’t available on aggregate.
The biggest risk for investors right now is that the stock market (especially in the US) is refusing to believe this.
More than ever, it’s important to understand that it’s not a stock market, but a market of stocks. There is good value out there. But there are also lots of stocks with unrealistic expectations priced in.
It’s time to monitor your portfolio closely. Where you’re playing in the speculative space, make sure your stop-losses are set and adhered to.
I could be completely wrong. Bit it feels like we’re getting close to a turn in the market here.
Editor, The Rum Rebellion