I’ve been watching the stock market with a bit of trepidation lately. (Roughly half of our retirement/long-term-care money is in stock market mutual funds, the rest is in less risky bond funds and CDs.) The current “Reddit Revolt” led by a self-assembled group of online trader-warriors against Wall Street hedge funds has turned the popular notion of stock-market-as-casino into something that feels more like the Running of the Bulls.
These self-styled Davids (you know, of Goliath fame), spurred along by everyday Joes and Josies tempted by quick profits, have led to wild gyrations — and absurd valuations — of the stocks of GameStop, AMC Theaters, Blackberry and whatever meme company that the Redditors will decide to target next.
I don’t think this will end well for those companies, for the speculators in those companies, nor inevitably for the whole idea of normal people like you and me using mutual funds as a means to secure one’s retirement. Something has broken, and I am wary of the machine falling apart.
This Gamestop stock-market ploy smells a lot like the January 6th US Capitol rampage: a loosely-coordinated anarchical uprising of people wanting to take something back (but not sure exactly what) and who discovered their sudden and surprising power to create havoc. As Sen. Susan Collins (no relation) of Maine would put it, this is all very troubling. Luckily, there have been no casualties so far in GameStopGate, as it is already called.
Yes, fellow lefties, I realize that hedge funds and the big investment banks like JPMorgan, Goldman Sachs, Barclays and others, have been screwing ordinary saver-investors forever to enrich themselves and their high-net-worth clients. But financial anarchy would portend something far worse. Reddit speculators are not going to topple the powers-that-be and usher in a new era of capitalism-as-a-positive-force in our lives. Rather, financial anarchy a la Reddit would be more like a forest fire, burning down anything in its path. My fear is that government regulators would respond like forest firefighters, i.e., trying to contain things only after much damage is done and lives are ruined.
Have I painted a too fatalistic scenario? I’m not sure. The embers of the fire are there for all to see.
• • • • •
With that sad taste-in-the-mouth, I offer an update on The Trend. The U.S. stock market as of January 2021 is at a level well above what The Trend (its performance between 1950 and 2012) suggests is reasonable. Below is an updated chart of how the S&P 500 Index has fared relative to The Trend since 1950. As of this writing, the S&P 500 Index — which mainly reflects the stock prices of the big U.S. tech companies Apple, Amazon, Facebook, Google and Netflix — is almost 24% above The Trend.
This excess performance represents three-years-worth of normal stock market returns. This is not sustainable, I repeat, not sustainable. The party could go on for quite a while longer, or it could end tomorrow.
• • • • •
If you’re not a fan of The Trend, then may I offer this from Yale economist Robert Shiller. Shiller created a metric (let’s just call it the Shiller P/E) that captures what investors are willing to pay for a dollar of corporate profits. One would think that, after taking inflation and interest rates into account, the amount that an investor is willing to pay for a dollar of profits would be relatively stable. But here’s the real story, a la Shiller:
The white line in the graph above is Shiller’s P/E Ratio, plotted from 2006 to the present. Note how the P/E ratio (how much an investor is willing to pay for a dollar of earnings) has risen steadily since the Great Recession — then less than 15, now approaching 30. Why? Why are investors willing to pay so much more for the same return on stocks?
It’s not just about our ultra-low interest rates since the Great Recession. Rather, it has much to do with the tons of money that have been pumped into the economy and where that money has gone. The green line in the graph shows how the U.S. “M2” money supply (which includes checking, savings, and money-market funds) has grown over the same time period. See any parallels between this and the prices being paid for stocks?
The Great Recession (Bush) tax cuts and Trump tax cuts, on top of the easy-money policies dictated by the Federal Reserve, have clearly benefited corporations, and those who hold corporate stocks, and those who receive corporate dividends, more than they did middle-income families.* The haves who benefited the most from financial stimulus have been using the money to bid up the prices of the assets of greatest interest to them: stocks and real estate. There’s only so much food rich people can eat, and only so much gas they can pump into their BMWs. The rest of their money has to slosh somewhere. That is why we have asset inflation (which the Fed mostly ignores) instead of food/energy inflation.
And that is why stocks are so expensive now, far beyond what The Trend and Shiller would deem that they are intrinsically worth. And now, internet desperadoes have arrived on the scene to stir up this already-boiling pot. Oh, did I forget to mention that we remain in the grips of a worldwide pandemic? What (more) could possibly go haywire? Stay tuned.