Marginal Activities

The S&P 500 has fallen 7.37 percent so far this year.  What to make of it? Naturally, some people find falling stock prices to be unpleasant.  Others find them distressing.  Another way to look at falling stock prices, however, is like a high-fiber diet.  The effect is necessary to a healthy functioning system.

The simple fact is that stock prices, fueled by speculative liquidity, have long since outrun the real economy.  The disconnect between the two has been widely observable.  The economy’s lagged, incomes have stagnated, yet stocks have soared.

 

1-Wilshire and GDP from 2009Wilshire Total Market Index vs. GDP since 2009 (01/01/2009 = 100). The market’s capitalization vs. GDP has been soaring ever since the adoption of the full-fledged fiat money system – and the gap between the two has never been wider than at the 2015 stock market peak – click to enlarge.

 

Thus the present, ever so slight reduction in liquidity, and the subsequent lowering of stock prices, has a cleansing influence.  For it will serve to eliminate marginal businesses, and trim the fat from larger businesses. Consequently, business owners, managers, and workers of marginal undertakings will have to redirect their efforts into something new…something that’s of greater value.

For example, Walmart recently announced it would be closing 269 stores and laying off 16,000 workers.  Obviously, we don’t wish any harm to hard working Walmart employees.  But we’re also confident many of these 16,000 people will now find a new, more meaningful, and more prosperous purpose in life.

Though it can be painful at times, eliminating and minimizing wasteful activities is how the world becomes more affluent.  On the other hand, propping up negligible endeavors with cheap credit ultimately subtracts wealth from the world.

 

Mean Reversion

How much more stocks will fall, no one really knows for sure.  Perhaps they’ve already fallen as far as they will.  But we wouldn’t bet our life savings on it.

This is merely conjecture, of course.  But we do recognize that even with the 7.37 percent drop year-to-date, the S&P 500’s Cyclically Adjusted Price Earning (CAPE) Ratio is 23.97.  We also recognize that the CAPE Ratio’s mean, going back to 1881, is 16.65.

 

2-PE10-STD-Geo-MeanIn terms of the P/10, this is one of the most overvalued markets since 1880 (in fact, it is in the 92nd percentile of the entire data series – only the peaks of 2007, 1929 and the tech bubble were even more overvalued) – click to enlarge.

 

On top of that, we understand that valuations always revert back to their mean eventually.  Similarly, we know that when reverting back to their mean, valuations often overshoot not only to the upside; but to the downside too.  This is how an average is formed.

Certainly, there are countless ways for valuations to come down.  One obvious way is for corporate earnings to increase.  Another way is for share prices to decrease.

From what we gather, fourth-quarter earnings for S&P 500 companies are expected to fall 6 percent year over year.  What’s more, this is the third consecutive quarter that earnings have fallen on an annual basis.  Thus, it seems likely, that for stock valuations to get anywhere near their historical average, share prices will need to go down much, much more.

These are some simple facts regarding stock valuations as we understand them.  Don’t listen to us, if you don’t agree with them.  For there’s plenty out there that we don’t agree with.

 

3-Wilshire and GDP from 1980A longer term chart of the Wilshire vs. GDP – indexed to 100 as of 01/01/1980 – this shows how enormous the divergence has recently become – click to enlarge.

 

Something’s Gone Horribly Awry

For instance, we don’t agree with the illusion and degradation of prosperity that’s readily visible to us as we make our way through our daily rotes in downtown Los Angeles.  There are tall shiny buildings, sleek new cars, and chic restaurant fronts up 5th Street and Grand Avenue.

Then, several blocks down 5th Street, at San Pedro Street in Skid Row, there are sidewalk tents, concrete ruble, and multitudes of empty stomachs outside the collection of of rescue missions.

 

skid rowA part of skid row in downtown LA

Photo credit: Lawrence K. Ho

 

Clearly, something’s gone horribly awry.  Hard work, perseverance, and ingenuity likely have something to do with the shiny streets.  Conversely, sloth, drug abuse, and mental defectives likely have something to do with the blighted streets.  But we also have an inkling that 20 years of activist Fed policy has left its marks all over both.

No doubt, the collection of shiny skyscrapers has sprouted up over the years thanks to the fertilizer of cheap credit.  At the moment, Korean Air / Hanjin Group is financing construction of The Wilshire Grand Tower.  When it opens its doors in 2017, it will be the new tallest building in Los Angeles and the tallest building west of the Mississippi.

Our friend Pater Tenebrarum of Acting Man, recently explained how the construction of marque skyscrapers coincides with the late stages of an artificial, central bank induced, boom.  The Wilshire Grand Tower will forever be a monument to ZIRP.

At the other extreme, it may be unclear upon first glance how the Fed’s artificially cheap credit has wrought abject poverty.  Ironically, John Maynard Keynes, the godfather of modern day economic intervention by governments, provided one of the better, succinct explanations of this hidden and insidious relationship. Thus we’ll close with an excerpt of Keynes from The Economic Consequences of the Peace, written in 1919.

 

peaceBefore Keynes became a Keynesian, he wrote this….

 

“Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency.  By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens.  By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some.  The sight of this arbitrary rearrangement of riches strikes not only at security, but at confidence in the equity of the existing distribution of wealth.

“Those to whom the system brings windfalls, beyond their deserts and even beyond their expectations or desires, become “profiteers,” who are the object of the hatred of the bourgeoisie, whom the inflationism has impoverished, not less than of the proletariat.  As the inflation proceeds and the real value of the currency fluctuates wildly from month to month, all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless; and the process of wealth-getting degenerates into a gamble and a lottery.

“Lenin was certainly right.  There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency.  The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”

 

Charts by St. Louis Fed, Doug Short/Advisorperspectives

 

Chart and image captions by PT

 

M N. Gordon is the editor and publisher of the Economic Prism.

 

 

 

Emigrate While You Can... Learn More

 


 

 
 

Dear Readers!

You may have noticed that our so-called “semiannual” funding drive, which started sometime in the summer if memory serves, has seamlessly segued into the winter. In fact, the year is almost over! We assure you this is not merely evidence of our chutzpa; rather, it is indicative of the fact that ad income still needs to be supplemented in order to support upkeep of the site. Naturally, the traditional benefits that can be spontaneously triggered by donations to this site remain operative regardless of the season - ranging from a boost to general well-being/happiness (inter alia featuring improved sleep & appetite), children including you in their songs, up to the likely allotment of privileges in the afterlife, etc., etc., but the Christmas season is probably an especially propitious time to cross our palms with silver. A special thank you to all readers who have already chipped in, your generosity is greatly appreciated. Regardless of that, we are honored by everybody's readership and hope we have managed to add a little value to your life.

   

Bitcoin address: 12vB2LeWQNjWh59tyfWw23ySqJ9kTfJifA

   
 

Your comment:

You must be logged in to post a comment.

Most read in the last 20 days:

  • Pushing Past the Breaking Point
      Schemes and Shams Man’s willful determination to resist the natural order are in vain.  Still, he pushes onward, always grasping for the big breakthrough. The allure of something for nothing is too enticing to pass up.   From the “displays of disbelief, revealing touching old-fashioned notions” file... [PT]   Systems of elaborate folly have been erected with the most impossible of promises.  That prosperity can be attained without labor.  That benefits...
  • The Myth of Capitalism - A Book by Jonathan Tepper
      Crony Capitalism vs. Free Markets Many of our readers are probably aware of the excellent work our friend Jonathan Tepper does for Variant Perception (VP)*****, a financial research boutique that really does bring a unique perspective to the table*. Jonathan (with co-author Denise Hearn) has just added a new book to his résumé, which is going to be released on 12 November: The Myth of Capitalism (MoC) – Monopolies and the Death of Competition** (a link to the official site is at the...
  • Three Cheers for James Riley!
      Going All In All people, of both good and questionable character, share a singular talent.  They excel at taking something that’s tolerable in moderation, and then pushing it to the outer limits of absurdity.  Why live with restraint when you can get radical?   A fairly famous stretch of LA riverbed graffiti... [PT] Photo credit: saber   Public and private debt levels, NASDAQ stock valuations, the federal register, face tattoos, canned energy drinks.  You name...
  • Crumbling Piles of Sand
      Just a Little Avalanche or an Implosion? A few years ago, we briefly discussed the dynamics of sand piles in these pages, which are a special field of study in mathematics and physics (mathematically inclined readers can take a look at two papers on the subject here:”Driving Sandpiles to Criticality and Beyond “ (PDF) and  'Games on Line Graphs and Sand Piles “(PDF) – unfortunately two other studies that used to be available have in the meantime disappeared from the...
  • When Fake Money Becomes Scarce
      Remaining Focused A rousing display of diversions this week assured the American populace was looking every which way but right under its collective nose.  Midterm elections.  White House spats with purveyors of fake news.  The forced resignation of Attorney General Sessions...   Old drug warrior (otherwise recused) on his way home to Alabama...   Sideshows like these, and many more, offered near limitless opportunities to focus on matters of insignificance.  Why...
  • Fun and Profit - Precious Metals Supply and Demand
      While Not Saving The Planet, Let Us At Least Have A Good Time The price of gold went up seven bucks, and that of silver rose eight pennies. For many people, the attraction to gold and silver began with a desire to protect themselves from the monetary train wreck of 2008. That often grew into a sense that gold is the solution to that problem.   The post 2008 GFC monetary train wreck: US true broad money supply is expanded by more than 153% in a mere decade, as the Fed takes...
  • Wizard’s First Rule – Precious Metals Supply and Demand
      The Last to Go Terry Goodkind wrote an epic fantasy series. The first book in the series is entitled Wizard’s First Rule. We recommend the book highly, if you’re into that sort of thing.   An image from the title page of Terry Goodkind's best-selling fantasy epic “Wizard's First Rule”. We'd be at bit wary of standing around on that stone-slab bridge to be honest. [PT]   However, for purposes of this essay, the important part is the rule...
  • US Stock Market - Re-Coupling with a Panic Cycle?
      The Mighty Gartman Investment newsletter writer Dennis Gartman (a.k.a. “the Commodities King”) has been a target of ridicule at Zerohedge for a long time. His pompous style of writing and his uncanny ability to frequently make perfectly mistimed short term market calls have made him an easy target.* It would be quite ironic if a so far quite good recommendation he made last week were to turn into the call of a lifetime (see ZH: “Gartman: 'We Are Officially Recommending Shorting...
  • Roger Barris for Congress!
      Economic Man Threatens to Leave You Alone if Elected This one is mainly for readers residing in that glorious water source for California commonly known as Colorado. In case you are not aware of it yet, Roger “Economic Man” Barris, an occasional contributor to this site, is running for Congress in Colorado on a Libertarian Party ticket. We will briefly explain why you should vote for Roger, but first two pictures:   Roger Barris, Libertarian Party candidate for the House...
  • Revisiting the Halloween Effect
      From Crash Danger to End-of-the-Year Ramp   [Ed note by PT: we are unfortunately a week late in posting this issue of SI, which didn't reach us in time due to a technical problem. We decided to post it belatedly anyway: for one thing, the effect under discussion is normally in effect until the end of the year; for another, the statistical validity of this information goes beyond the current year, as it is a recurring phenomenon. Lastly we would note that we have a strong...
  • It's Not That Day Just Yet - Precious Metals Supply and Demand
      Degrees of Urgency Monday was Veterans Day, a bank holiday in the US. The prices of gold and silver dropped $23 and $0.61 respectively. “But isn’t gold supposed to go up when...?”   Warren Buffet and Aragorn discuss what to do with the gold. Aragorn wants it, because he knows that even if it's not today, “that day” will come. [PT]   Why? Because everyone else will bid it up. Why? Because they expect someone else to bid it up. Why? Warren Buffet is...

Support Acting Man

Item Guides

Austrian Theory and Investment

j9TJzzN

The Review Insider

Archive

Dog Blow

350x200

THE GOLD CARTEL: Government Intervention on Gold, the Mega Bubble in Paper and What This Means for Your Future

Realtime Charts

 

Gold in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Gold in EUR:

[Most Recent Quotes from www.kitco.com]

 


 

Silver in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Platinum in USD:

[Most Recent Quotes from www.kitco.com]

 


 

USD - Index:

[Most Recent USD from www.kitco.com]

 

Mish Talk

 
Buy Silver Now!
 
Buy Gold Now!