As the great Willie Mays used to say,
"Baseball is easy.
They throw the ball, I hit it.
They hit the ball, I catch it.
Baseball is easy."
Economists and analysts try to make investing a lot harder than it actually is.
All you have to do is have the same clarity about the economy and the stock market as Wille Mays had about baseball.
A Quick Preface From Quantum Financial Strategies
If you are currently a QFS Client, the content of this post will be familiar to you. You will also recognize that measures have been taken to insulate you and your money from the econmic tsunami that may be heading our way.
If you are not a QFS Client, you may already sense much of what you'll read, and we'd welcome an opportunity to schedule a conversation (scheduling link provided at the bottom of this email).
In the realm of finance, the interplay between economic data and the real economy is an intricate dance that often perplexes even the most seasoned investors. Recently, I had the reading this article written by Chief Investment Strategist, Paul Dietrich. We are sharing this information with you as a part of our committment to inform, educate, and empower Americans with the goal of preventing fear - not create it.
AN UPDATE FROM PAUL DIETRICH
THE DISCONNECT BETWEEN ECONOMIC DATA
AND THE REAL ECONOMY
6/24/2024
The Mania of Crowds
We all know this is an election year and every U.S. Administration in history has tried to spin every government economic report to make a case for how good the economy is and how the politicians should be thanked for making everything so wonderful.
We also know that what the government and politicians tell us is often NOT true, but when it comes to stock market bubbles, investors often get sucked into what psychologists call the "Mania of Crowds."
We are all human. We all desperately want to believe there is a Santa Claus, and an Easter Bunny, and there has to be a "free lunch" out there somewhere.
After the Dot-com bubble in 2000 and the Mortgagebacked Securities bubble in 2008, a groundbreaking book called, "Extraordinary Popular Delusions and the Madness of Crowds" was republished to explain why so many investors lose their minds during stock market bubbles that are completely untethered to any underlying economic fundamentals like price/earnings
ratios, moving averages, or corporate earnings.
Charles Mackay's book examined a staggering number of popular delusions, and stock market crazes regarding economic bubbles, like the infamous Tulipomania, wherein Dutch tulips rocketed in value amid claims they could be substituted for actual currency.
What about the meme stock investing bubble where kids investing on discount investing platforms have driven up the price of stocks like GameStop to hundreds of dollars per share, when they are only worth a few dollars a share by most conventional valuation methods? Professional magicians call this the "suspension of disbelief'' where people willingly replace reality for magic.
Everyone Has Forgotten The 2000-2002 Dot-com Bubble
The hype over Artificial Intelligence (Al) reminds me of the manic promotion of the internet during the Dot-com bubble. The internet has changed all of our lives, just as Al will in the future. But that does not mean that every internet stock in 2000 was a good company and even the best were wildly overvalued during that bubble.
In the end, when the internet Dot-com bubble burst, the S&P 500 Index dropped -49% peak to bottom during that recession and the NASDAQ dropped over -77%. By the end of 2001, most NASDAQ publicly traded Dot-com companies had failed and were delisted from the Exchange.
Even the most successful tech companies of that period suffered significant declines and losses.
Apple was a hot tech company in 2000 and, over the years, has been relatively successful. On March 23, 2000, Apple hit its Dot-com peak and by December 20, 2002, it had lost -79% of its stock market value.
Microsoft was also a hot tech company in 2000 and, over the years, they too have been relatively successful. On January 14, 2000, Microsoft hit its Dot-com peak and by September 23, 2002, it had lost -62% of its stock market value.
Amazon, another hot tech company in 2000, has also been relatively successful. On February 9, 2000, Amazon hit its Dot-com peak and by October 2, 2001, it had lost -92.5% of its stock market value.
IBM was the largest tech company in the world in 2000. To give some context to younger investors, it was sort of the Nvidia of its day. On September 1, 2000, IBM hit its Dot-com peak and by October 11, 2002, it had lost -52.2% of its stock value.
BOTTOM LINE: For investors who were invested in the four best tech stocks in 2000, they wiped out somewhere between -52% to -92% of their invested retirement savings.
The chart below shows that the average S&P 500 investor in 2000 made no gains in the stock market from 2000 to 2013 because it took them 13 years to get back to breakeven after their losses in those two recessions.
I repeat, THAT WAS 13 YEARS WITH NO INVESTMENT GAINS in their investment accounts!
2024 May Be The Bubble of All Bubbles
Historically, a bull market in the United States has lasted on average about 6 to 9 years.
But if you don't count the artificial, man-made, two month 2020 Covid Recession, we have experienced a 15 year bull market since the stock market's low of the last recession on March 9, 2009.
This current 15 year bull market is the single longest bull market in U.S. history.
The primary reason for that historically long bull market is that the U.S. government started to flood the economy with trillions of dollars in stimulus since the 2008 downturn.
Since 2008, we have benefited from around $27 trillion in stimulus in accumulated budget deficits and the amount of cash printed since then. Over half of that stimulus, or $15 trillion, has come in the last five years since 2020.
Interest rates for much of the past decade have been artificially low and that has also helped inflate asset prices like stocks.
What Does This Mean?
It means that because of trillions of dollars in newly printed money through budget deficits flooding the U.S. economy and a decade of artificially low interest rates, asset prices like stocks and the stock market have artificially soared in value.
During the four years of the Bi den Administration, both Republicans and Democrats in Congress have voted to deficit spend over $11 trillion in newly created and printed money.
This is money that in a number of years will have to be devalued, which is a fancy word for "inflation." There is always a lag between the time the money is appropriated, and then spent, and when inflation comes.
Much of the $11 trillion in deficit spending went as stimulus to social programs affected by Covid like child care, expanded food programs, money to hospitals, airlines, help for restaurants and small businesses, infrastructure programs, clean energy, electric vehicle subsidies, and a significant amount of money to support state and local governments which lost tax revenues during Covid.
Much of this money was appropriated over the past four years, but most of it was just spent during the past year.
Perhaps I am unduly cynical, but does it surprise you that this massive percentage of stimulus money was injected into the economy right before the election?
This Is All About To Change & It Is Not Going To Be Pretty
Almost all of the current economic stimulus will finish at the end of the government's fiscal year end on September 30, 2024.
Just as the presidential election will likely be a very close race, so will that of Congress.
Most polls show that the Democrats are likely to control the House with 4 to 8 seats. Most polls show the Republicans have a good chance of controlling the Senate with a 1 or 2 seat majority.
No matter who wins the Presidency, nothing is going to get done. Nothing is going to pass. We will have the same stalemate we have now.
Taxes Are Going Up No Matter Who Wins
As many of you know, the Trump Tax Cuts will "sunset" on January 1, 2025, and revert to the Obama Tax Program.
But many investors forget that Trump's tariffs offset about 50% of his tax cut benefits.
So those increases in tariff taxes will most likely stay no matter who wins the Presidency. Biden (QFS edit: or a replacement candidate) likes tariff taxes as much as Trump.
The bottom line is that taxes will substantially increase after the election in 2025 and Trump won't have the votes in Congress to reinstate any tax cuts.
Taxes are going up no matter who wins the Presidency. Trump or Bid en-it doesn't matter for taxes-they are going up substantially.
Inflation may trend down very slowly over the next 12 months - but will more likely trend sideways and then start to head up again in late 2025 as the lag in deficit spending and money printing starts to drive inflation higher.
The Federal Reserve will have to keep interest rates higher for longer and eventually raise them again as Congressional deficit spending increases long-term inflation.
Bottom Line: The U.S. Is Entering A New Long Term Economic Era
Over the past 15 years, artificially low interest rates and $15 trillion in stimulus payments from deficit spending have caused asset prices like the stock market and housing prices to soar.
In the future, higher interest rates and higher long-term inflation will significantly take the air out of asset prices like stocks and home prices.
Historically, this transition from a low interest rate, low inflation economy to a higher interest rate, higher inflation economy has been done through a recession.
It has now been 15 years since the last recession.
Over the past 111 years, the United States has had a recession on average every 6 to 9 years as part of the normal business cycle.
Politics, the world economy and the U.S. economy are now transitioning through a completely new economic reality-a new economic era-that will largely be the opposite of what we have experienced over the past 15 years.
Since the recession has currently been pushed off for several years because of stimulus deficit spending and low interest rates, I believe the upcoming recession will result in a deeper stock market decline than we experienced in 2000 and 2008.
Stock market bubbles have almost always been followed by a recession.
The Stock Market Is Historically Overvalued
The top 10 U.S. stock valuations are now higher than during the 1990s Dot-com bubble. The only year when P/E ratios were higher was 2020.
It is clear that the U.S. stock market is now in a bubble 24 years after the last one burst.
The S&P 500 is trading at the second most overbought level ever. At the same time, the NASDAQ index of technology stocks is the most overbought since February 2018.
Historically, it is time for a market correction.
The two biggest risks in putting new money into this stock market right now is first, right before the beginning of almost all recessions there is a run-up and sometimes a dramatic run-up-in the stock market just before it crashes. Please see chart below.
Second, these explosive runups in the stock market areoften driven by emotion and momentum, and little regard for economic fundamentals.
Remember the Dot-com and internet hysteria in 2000 and the mortgage-backed securities euphoria in 2008. No economic fundamentals-just mindless emotions and momentum.
This current run-up in the stock market is based on the strength of seven mega-cap tech stocks and the excited betting on when the Fed will lower rates.
No one seems to notice that the economy is cooling and there are risks to the economy everywhere. Let's review some of the more common methods investors determine whether the stock market is overor undervalued.
Price Earnings Ratio:
This is one of the most widely used methods. Investors compare the current P/E ratio of the S&P 500 to historical averages. A significantly higher P/E ratio usually suggests the market is overvalued, whereas a lower ratio indicates it is undervalued.
The next chart shows the historical Price Earnings Ratio (P/E) for the S&P 500 Index over the past 100 years. You can see that except for one instance in the 1990s, the current P/E Ratio is higher than every other P/E ratio for 100 years, except for the past three recessions.
The Shiller P/E Ratio (CAPE Ratio), is a slightly different way to look at historical P/E's. The Cyclically Adjusted Price-to-Earnings Ratio, also known as the Shiller P/E Ratio, takes the S&P 500's P/E ratio based on average inflation-adjusted earnings from the previous 10 years. This helps smooth out fluctuations from economic cycles.
The chart below goes back 153 years. As you can see, the current Shiller P/E Ratio is at its highest level with the exception of only the Dot-com Recession of 2001- 2002 and the Covid Recession in 2020.
One of the first things you learn in any college Economics 101 course is that in the short term, the stock market can be influenced by almost anything. But in the long term, the stock market always reverts to the long-term directional trend of the underlying economy. Corporate earnings are one of the key elements of the directional trend of the underlying economy.
The next chart shows the current gap between the S&P 500 Index price and the P/E ratio of the S&P 500.
In the last almost 30 years, including the last three recessions, the PE ratio of the S&P 500 Index has NEVER been so historically out of alignment with the S&P 500 Index market price.
Dividend Yield:
The Dividend Yield compares the current dividend yield of the S&P 500 Index to historical averages. A lower than average dividend yield usually indicates that the market is overvalued, while a higher yield suggests undervaluation.
The current dividend yield is historically low at 1.35%. Investors can get a safe short-term U.S. Treasury yield that pays 4% - 5%. This indicates that the stock market is very overvalued using the dividend yield valuation.
Technical Indicators:
Technical analysis looks at charts and patterns to predict future movements and assess whether the market is overvalued or undervalued. The most common method is by comparing the S&P 500 Index's 200 - day Moving Average, which is its long-term trend. If the S&P 500 is significantly above its long-term average, most investors consider that overvalued.
Even compared to previous recessions, the S&P 500 Index is trading above its long-term average more than at any time in the last 30 years. It is interesting to note that today, it would take a stock market drop of over -12% for the S&P 500 Index to revert to its current 200-day moving average.
I still believe there is a strong possibility the economy will go into a mild recession this year. If that is the case, historically the S&P 500 Index has dropped on average -36% during a recession.
If there is a recession, you can add the -12% above, plus the average recession drop of -36%. That means it is possible we could see a total drop from the current overvalued stock market of -48% .
Diversification:
What makes investing in the S&P 500 Index so risky right now is that only seven stocks, in only one economic sector (the tech sector-a notoriously volatile sector), are completely driving the stock market-both the S&P 500 and the NASDAQ.
The stock market often moves in a three-phase cycle. Once a trend, like Al technology, gains broad recognition, there is an initial fear of missing out, and then mindless piling in. That phase is followed by a pullback (which can range from mild to catastrophic). This pattern tends to be most evident in technology - remember the period before and after the Dot-com boom or the progression of the fintech and biotech investment trends. The third phase is when the highflying stocks with outrageously high P/E ratios, revert back to their long-term fair market value and trends.
This is where the S&P 500 Index is right now.
This is how the Magnificent 7 tech stocks have done against every other market index.
If you look at how the S&P 500 Index, which is a cap weighted index, versus the S&P 500 Equal Weighted Index, you can see how those seven tech stocks dominate. They now represent 30% of the weighting of the S&P 500. The other 493 stocks only make up 70% of the weighting.
The Warren Buffett Indicator:
Over the past few months, the legendary investor Warren Buffett has been selling stocks and raising cash. He now holds an all-time high of $190 billion in short-term treasuries and cash alternatives.
That is a + 70% increase in his cash horde over the last 24 months.
In recent interviews, he has stated that he believes the stock market today is massively overvalued. How does he know that?
Warren Buffett invented his own stock market indicator, commonly called the "Buffett Indicator." The Buffett Indicator is currently ringing alarm bells for Buffett's investment firm, Berkshire Hathaway.
Over the years, he said the Buffett Indicator was "probably the best single measure of where stock market valuations stand at any given moment."
The indicator takes the 5000 stocks in the Wiltshire 5000 Index, which is just about every stock traded in the United States, and divides it by the latest estimate of quarterly Gross Domestic Product (GDP). This gauge essentially takes the total stock market capitalization of all actively traded U.S. stocks and divides that by the size of the U.S. national economy.
The indicator is now above every extreme reading before the start of past recessions like 2000 and 2007.
The Indicator has historically averaged around 65%. The ratio peaked at 88.3% prior to the 1929 crash, and hit its highest reading late last year of nearly 200%. At the peak of the Dot-com bubble, the ratio was 140%. At the peak of the 2008 - 2009 Recession, the ratio was 105%. Currently, the ratio is 188%.
Buffett wrote in a Fortune Magazine article in 2001 that when the indicator soared during the Dot-com bubble, it was a "very strong warning signal" of an impending stock market crash.
He suggested that stocks would be cheap at a 70% or 80% reading, and offer fair value at 100%, but it would be "playing with fire" to buy when the gauge was around where it is now at 188%.
Gold:
Gold just hit a high of $2,330.50 an ounce. Over the trailing 12 months, gold is up almost +20%.
Smart and sophisticated investors both here in the U.S. and abroad buy gold as a hedge against a market correction, a recession, energy disruptions, and geopolitical risk like we see in Russia-Ukraine, Israel-Gaza, China-Taiwan, U.S. elections, etc.
I believe the recent surge in gold prices is because many institutional investors believe there will be a major correction or stock market crash due to our wildly overvalued stock market and a slowing underlying economy.
Last Thoughts On The Stock Market
I'll give Warren Buffett the last word:
"The stock market is a device-for transferring money
from the impatient to the patient."
-Warren Buffett
Link to Download Original Publication
Disclosures
Paul Dietrich, Chief Investment Strategist, B. Riley Wealth Portfolio Advisers Paul Dietrich is focused on managing investments for private investors, retirement funds and private institutions throughout the United States. He also serves as an on-air commentator and contributes market analysis to business and financial media including CNBC, Fox Business, Bloomberg TV, CNN, The Wall Street Journal, Yahoo! Finance, Reuters and The Washington Post.
IMPORTANT DISCLOSURES:
Information and opinions herein are for general use; are not unbiased/impartial; are current at the publication date, subject to change; may be from third parties, and may not be accurate or complete. Past performance is not indicative of future results. This is not a research report, solicitation, or recommendation to buy/sell any securities. B. Riley Wealth Management does not render legal, accounting, or tax preparation services. Opinions are the Author's and do not necessarily reflect those of B. Riley Wealth Management, Quantum Financial Strategies, or their affiliates. Investment factors are not fully addressed herein.
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