What was it Dickens wrote in the opening paragraph of A Tale of Two Cities? Not that ‘it was the best of times and the worst of times’. That ‘it was the epoch of belief and the epoch of incredulity’. So true. People today are willing to believe anything at all, or nothing at all. Why is that?
I’ll come back to that in a moment. But first, did you know that between 1997 and 1999, the S&P 500 made 127 new all-time highs? I remember that epoch of belief well. It was the first coming of the Internet revolution. Every week it was a new story, a new world-changing technology, or a new business model that, miraculously, didn’t involve making any money.
The S&P 500 closed at a new all-time high on Friday. It’s the 117th time that’s happened since 2019. And even more impressively, the blue chip benchmark has nearly doubled from the March 2020 pandemic lows. That would be the fastest double from a low since the 1940s, according to Dow Jones Market Data.
That makes sense from a psychological point of view. If you can hold your nerve when everyone else is losing theirs, if you can be greedy when others are fearful (as Warren Buffett famously says), you can get some great results. Of course, there’s no real science to knowing whether you should be afraid too, or whether everyone else has simply got it wrong.
The simplest thing of all to do is to follow the money. We knew a wall of liquidity would hit financial markets and the economy once the fiscal and monetary policy responses to COVID got underway in earnest. Those responses have yielded two specific things: inflation in consumer prices and even greater inflation in asset prices (stocks and negative-yielding government bonds).
Which brings me to another aspect of Buffett, his famous market capitalisation-to-GDP indicator. Thanks to the huge expansion in global central bank balance sheets, the total market capitalisation of the world’s equity markets is now just under US$119 trillion. That’s 140% of world GDP.
Source: Wilshire Associates
That’s a lot. But compared to the Buffett Indicator for just the US alone, it’s peanuts. The mcap/gdp ratio for the US is now over 200%. Its long-term average is 86.82%. Conclusion? US stocks are massively overvalued, relative to the economy. World stocks too, for that matter.
Buffett’s indicator is based on a simple observation which would seem to be logically foolproof: the value of publicly traded stocks can’t be permanently greater than the value of the goods and services traded in the real economy. How can companies infinitely generate earnings greater than the underlying economic transactions in the economy?
The answer is: they can’t. But investors can value those earnings at whatever multiple they see fit. And since last March, they’ve seen fit to value those earnings richly. Yale Professor Robert Shiller’s cyclically adjusted price-to-earnings ratio is 38.81. The only time it was higher was in December 1999, when it peaked at 44.19.
Why do people become the most optimistic precisely at the moment of maximum danger? Is it because they’re drunk with euphoria? Do they cease to be rational? Or are they so emotional that they can no longer accurately perceive real risk, even when it’s about to punch them in the nose?
Who knows? Maybe it’s because investors are sitting at home in front of their screens during lockdown with nothing to do but buy and sell stocks (mostly buy). Or maybe it’s just simple liquidity.
The total assets of the four major central banks — the US Federal Reserve, the Bank of Japan, the European Central Bank, and the People’s Bank of China — are now over US$30 trillion, according to Yardeni Research. The first three alone have increased their assets held on the balance sheet by US$10 trillion since the COVID crisis began.
With central bankers pushing down official interest rates so low that real rates (adjusted for inflation) are negative in many bond markets, it doesn’t pay to invest for income. Go for growth! Go for stocks! In a momentum market driven by liquidity, it pays to keep things simple.
But simple isn’t the same as safe. Which brings me back to being fearful when others are greedy. Wall Street hasn’t been this bullish in almost 20 years, according to Bloomberg. It found that 56% of S&P 500 stocks are rated as a ‘buy’ by analysts. Which makes sense. Wall Street is in the business of selling stocks. The more, the merrier.
Beware analysts bearing buy recommendations. Things can change faster than the Greeks can bring you a gift horse. Just look at the unfolding strategic collapse of the US’ military industrial complex in Afghanistan.
After 20 years, trillions of dollars, and thousands of lives, the military is leaving. The country has fallen to the Taliban in less than two weeks. US helicopters hovering over the embassy in Kabul to evacuate personnel look eerily similar to photos from Saigon in 1975.
What’s worse, you can expect the US Air Force to begin bombing supplies left behind when ground forces evacuate. That’s what you get when you run an empire on borrowed money and deficits. You get a massive waste of blood and treasure.
The entire American foreign policy and national security establishment failed. It’s a bipartisan strategic failure backed by the Bushes, the Clintons, the Cheneys, the Bidens, CNN, Fox, and The New York Times. It would have been cheaper to take US$10 trillion, pile it in the desert, pour gasoline on it, and set it on fire. It would have saved thousands of American lives and tens of thousands of Afghani lives.
Instead, the contractors and defence companies got a world-historical gravy train. And now we have a world-historical mess. And a whole generation of American servicemen and women who left blood, limbs, and friends behind in Afghanistan but brought back with them physical scars and mental trauma that will last a lifetime.
Here’s another fact. The Soviets left Afghanistan in February of 1989. By the end of 1991, the Soviet Union itself no longer existed. This is a subject I’m looking at in the next Bonner-Denning Letter. The point? When things collapse, it can happen a lot faster than you think.
Editor, The Rum Rebellion
PS: Why are people willing to believe anything? Or conversely, why do they doubt everything? It’s partly because our growing addiction to mobile phones and television has flooded our brains with more information than they are evolved to process into a story that makes sense. Most of the information is irrelevant anyway. But there’s a lot of it. And it’s very loud.
That is, there are many stories to choose from that might turn random noise into a pattern that makes sense, a story we can tell ourselves. Hence the term ‘narrative’. Different people look at what are, objectively, the same set of facts, and then walk away with a different story that makes sense. Another way of saying it is that people see what they want to see.
Or, as Bill has often said, people come to believe what they believe when they need to believe it. When enough of them believe in something — like a bull market or the conquest of Afghanistan — you get one set of ‘facts’. When they come to believe it is necessary to cut losses and quit wasting lives and money, you get a bear market, a strategic retreat, and a new set of ‘facts’. Of course, it’s not the facts that have changed. It’s our perception of them, and the conclusions we draw.
PPS: Did you celebrate the anniversary of the event that unofficially marked the beginning of American decline? That criminal Richard Nixon ended the gold standard in the US on 15 August 1971. The US was hemorrhaging lives and money in another war of conquest (Vietnam). International holders of dollars (mostly the French) began trading them for real money (gold).
Nixon put a stop to that. It’s been a fiat money world ever since. The world money system, not anchored to a reserve currency backed by a real money, has floated along on a sea of fake dollars.
Here’s the big question: How long will THAT monetary regime last, now that the government backing it has shown how feckless, incompetent, and bankrupt it is?