The Stock Market: For Those of You Keeping Score at Home

Since stock prices had fallen for a few days before a partial recovery on Friday, some might think they are now low.  They are not low. They are sky-high, having been inflated to bubble levels by a decade of near zero percent interest rates.

The Federal Reserve has been trying to normalize interest rates, and as a result the 10-Year U.S. Treasury Bond now yields a still-low but closer-to-typical 3.16%.  When interest rates were rock bottom, there was a lot of talk about the “Fed Model,” which holds that stocks are fairly valued when the dividend yield – the actual cash return on stocks – equals the yield on a 10-year U.S. Treasury Bond.  Well, the dividend yield on the S&P 500, after the recent price declines, was 1.92%.  To get that dividend yield up to 3.16% to match the current U.S. Treasury Bond yield, the stock market would have to fall by 39.2% from current levels.   But the historic average dividend yield is much higher at 4.35%.  To get the dividend yield that high stock prices would have to fall 55.9%.

Are high stock prices good?  They are good for rich people and older people who have lots of stock and are selling, but really, really bad for young people buying stock to save for retirement.  If they buy at these artificially high prices, they become locked into a future cash return that is so low that it falls below inflation, so they would actually be getting poorer.

Similarly, are high housing prices good?  They are good for older sellers, their lenders, speculators and flippers, but bad for younger buyers seeking an affordable place to live.  They end up locked into decades of house poverty, during which they might not be able to sell for the value of their mortgage.

It isn’t too far fetched to say that for nearly 20 years the goal of U.S. economic policy has been to keep asset prices high, so older and richer Americans can sell to poorer later-born Americans at high prices, but the wages of later-born Americans low, to prevent “cost push inflation.”

Remember that when everyone panics about falling stock and housing prices.   When the press reports high stock and housing prices as good and falling prices as bad remember this question – “good and bad for whom?”  If you are under 50, you’d probably be better off with a stock market crash.  If you are a millennial, you would probably be better off with a housing market crash.  Even if you already bought, at least it might put a lid on your property taxes.

Stock prices are too high to be justified by the income businesses are actually earning, even given that profits are taking a record share of the economy relative to wages.

And too much of those profits are going to executive pay, not shareholders in the form of dividends.

The current level of profits, meanwhile, is itself unsustainable as a percent of the economy, because it requires American workers paid less to nonetheless spend ever more, borrowing the difference.  Eventually they go broke, or retire into poverty, and that spending stops.

Moreover, the recent trend in stocks and bonds reminds me of the situation before the “Black Monday” stock market crash in 1987.  Take a look.

Huge federal budget deficits, as a result of tax cuts.

Rising interest rates at the end of a long expansion that was heading for a recession, which should have led to falling stock prices.  But instead stock prices soared more than 33 percent in the first eight months of 1987, before reversing and crashing back lower than they started.

In this case stocks were overpriced and heading for a fall on November 4, 2016, before Trump’s election, as even he had said during the campaign, but had since soared 37.8% to the recent peak of just a few days ago.

Lots of automatic trading by computers based on algorithms.

The next step for a step by step repeat of 1987 is for increasing stock market selling in the run-up to the weekend, because everyone is afraid to be holding stocks when they can’t trade.   That’s what had just happened prior to the video above, which I watched at the time it aired 32 years ago.

Followed by a stupid statement by an administration official that is a dog whistle that tells everyone it’s time to get out, before everyone else does.  God knows there are lots of candidates to make such a statement in the Trump Administration, staring with Trump.

Stocks soared after Trump was elected because Wall Street figured Trump would throw one more big party on the credit card, and then they’d cash out before the bill came due.  All them figure that – their high frequency trading computers will get them out first.  And the richest generations in U.S. history are now in retirement, and they’ll all feel they need to sell as well if things get hairy.

The broader economic and fiscal disaster goes back a long way, and is a social tsunami of future-selling that goes far beyond Federal Reserve policy, the Obama Administration’s economic policy, the Bush II economic policy, or The Donald’s economic policy.

But if the final meltdown happens on The Donald’s watch and he nonetheless gets all the blame, well, well it couldn’t happen to a nicer guy. And if it doesn’t? That just means it will be worse later.

If it does happen you’ll hear all kinds of people blaming all kinds of other people and things for the decrease.   But here is one you might not hear, but one that is true. If stock prices plunge, the main reason will be that they were too high to begin with.

2 thoughts on “The Stock Market: For Those of You Keeping Score at Home

  1. larrylittlefield Post author

    A chart showing the same idea as this put another way.

    Debt bubble equals wealth bubble? Not real wealth. A small number of people and interests have a whole lot of pieces of paper that say they own our future. Do they?

  2. Stevie

    Reminds me of an editorial cartoon I saw around that time that had a fellow looking at the headline of new stock market high, saying to himself: do I invest and cause a market crash, or wait and watch the market soar even higher? As I recall, by the late 1980’s the market was considered overvalued by traditional measures, yet kept rising anyway. Go PE ratio!

    There can be no question that FED intervention caused huge inflation: on Wall Street, not Main Street. As most have little or no stock, irrelevant to ordinary folks. Profits have been a little wobbly lately. Still no clue what the trigger would be for the next downturn, probably something unexpected and unforeseen, as usual.

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