By David Haggith – Re-Blogged From Great Recession Blog
Since Trump’s election, the US stock market has climbed unstoppably along a remarkably steep path to round off at a teetering height. Is this the irrational exuberance that typically marks the last push before a perilous plunge, or is the market reaching escape velocity from the relentless gravity of the Great Recession?
This burst of enthusiasm in response to Trump’s victory, flew in the face of almost everyone’s predictions. That it lifted the market from seven months of languor certainly makes 20K on the Dow look like the elevation marker of a breathtaking summit.
While breaking 20k, if it happens, may be as meaningless as one more mile on the odometer when all the numbers roll over, it is psychologically potent for many. Breaking through it, could cause fear as eyes turn down and see how far below the earth now is, or the rarified air up here may bring euphoria that lifts the market to even greater levels on a rising current of hot air.
Investors have been buying and selling with as much frenzy as Christmas shoppers. Now there will be much eating and drinking to celebrate this record-setting Santa-Clause rally, even if it doesn’t top 20, before Christmas, as investors take a brief rest to enjoy their surprise gains, fat and happy in belief that 2017 will be a prosperous new year.
There is almost no evidence of fear amongst all the cheer. According to Gallop, economic confidence has never been higher in the general population. Some are calling it Trumphoria as people seem to be relieved that eight years of Obamanomics are ending, and business is seizing the reins of government, guided by one of the world’s richest and most dazzling developers.
The first positive double-digit index score since the inception of Gallup Daily tracking in 2008 reflects a stark change in Americans’ confidence in the U.S. economy from the negative views they expressed in most weeks over the past nine years.
A similar CNBC survey indicates this is the greatest breath of fresh air for consumer confidence since Obama was elected in 2008, and it is not just stocks that are soaring. The US dollar has reached its highest peak in fourteen years. TechonoMetrica also says consumer confidence has just hit its highest level since 2006 (just in time for Christmas shopping).
The surge in consumer confidence is primarily due to a collective sense of relief among Americans over the conclusion of the contentious 2016 presidential election season, as well as a feeling of hope regarding the prospect of a new administration taking office…. Consumers are ecstatic that the election is finally over.
Will This Exuberant Ride Continue In 2017?
Many analysts believe the push through a major milestone, if it happens, confirms a strong new market trend; but what does history say about breaking past such major psychological resistance barriers? When the Dow first broke past the 100 level in 1906, it tumbled back down and didn’t break through with any continuance again until the mid 20s! When the Dow ascended past the 1,000 mark for the first time in 1966, it did continue a ways higher; but in less than three months the market sank back beneath 1,000 again and kept falling for the next two years to hit a point 44% lower, while the nation sank into recession. The Dow didn’t break the 1,000 mark again until 1972! And, after the Dow broke 10,000 in 1999, it flirted with that level a bit but never sustained another breakthrough until eleven years later!
What if we look at what history has to say about irrational exuberance by using other measures than the Dow? The ratio of stock prices against corporate earnings is one of the most common ways of assessing the relative height of a market peak. Here again, there are only a few times in history that the S&P 500 has climbed to prices that are 27.9 times more than corporate earnings of the last ten years, which is where the S&P stands now. Once was in 1929 just before the Great Depression, then again in an ill-fated boom of the 60’s, and only one other time in 2002.
The altimeter I’m using here to assess our present peak is called the CAPE (the Cyclically Adjusted Price-Earnings ratio that won Yale’s Robert Schiller his Nobel Prize). In market terms, our present mark on the gauge means we’re entering the stratosphere! Even in 2007, the market was not this overpriced by the CAPE’s measure, and irrational exuberance has always accompanied this level: (Some will argue otherwise, but hang with me a minute.)
Early 1929 was actually a fantastic time to get into the US stock market — so long as you didn’t stick around. So were the late 1990s. Someone who sold their stocks in late 1996, when the CAPE hit 28, missed out on the biggest free-money bubble bonanza in recorded history…. Nonetheless … over the past 150 years, it has generally been an extremely poor move to invest in U.S. stocks with the CAPE at these levels. (Market watch)
Not everyone thinks passing this mark on the CAPE matters. In fact, apparently many don’t, or the stock market wouldn’t have kept climbing into the CAPE’s red zone this month, but according to Valentin Dimitrov of Rutgers University and Prem Jain of Georgetown, the measure has been applied too simplistically by those who disregard it:
In a nutshell: Investors shouldn’t flee stocks simply because the Shiller PE is above average. They shouldn’t flee stocks even when the Shiller PE is way above average. But history has said they should flee stocks when the Shiller PE is at extreme levels — like now. Only when the CAPE is “higher than 27.6”, they conclude, has the stock market proven to be a really bad investment. (Marketwatch)
It is, however, not just the height of this peak, but the rate of rise that evidences irrational exuberance. This month, the US stock roller coaster ratcheted its way relentlessly up its highest hill one clanky link at a time. If the Dow closes above 20,000 this week, it will be the fastest 1,000-point rise in market history! The previous record rate of rise came in 1999 in the run-up to the dot-com bubble crash. Of course, the higher the market is, the less meaningful a thousand-point rise is.
Do These Graphs Look Like Irrational Exuberance?
Sometimes a visual says more than words:
Fastest, longest rise of the Dow in the past two years. Irrational exuberance?
Notice that it is not just prices that have shot up. Sometimes prices soar while trading volume treads flatly. In other words, there are very few traders, but those that are buying are willing to pay more. This time, trading volume has gone astronomical (lower part of graph) as money floods into stocks. That means it’s a flurry of high-stakes trading. The last time we saw this kind of trading volume was …
Is the steepest climb in a decade irrational exuberance, particularly when accompanied by the highest trading volume since the Great Recession began?
Yes, the last time trading volume (lower graph) reached this frenzy was in 2008 and 2009 when we experienced the greatest stock market crash since the Great Depression. And look how long and steep the post-Trump rally (right end of upper graph) looks compared to any other climb during the past decade, including the run-up to the Great Recession. It’s almost a straight-up wall!
How Irrationally Exuberant Are Investors Right Now?
Forget about measures for a moment, let’s look at forecasts by the revered experts in the industry because if everyone is running with glee in the same direction …
Some market experts are espousing an unequivocally bullish outlook for equities. That level of enthusiasm was on full display after Robert Doll, Nuveen Asset Management’s chief equity strategist, on Wednesday said he was “fully invested” in the market. Asked by one CNBC reporter if he recommended keeping any cash holdings … Doll had this to say: Hold cash? “What for? Market’s going up!” (Marketwatch)
Clearly, Doll sees no top to the hill in sight. Apparently neither do others: in spite of our present nose-bleed heights, Wall Street’s gauge of investor fear, the CBOE Volatility Index VIX, rests comfortably at a 16-month low. Seems almost no one sees any reason for concern at all.
Lance Roberts writes,
Over this past weekend, Barron’s Magazine published its big story the “2017 Market Outlook….” After 8-years of a bull market advance not one of the forecasters had a “bearish” outlook. In fact, as the article concludes: “If all goes smoothly, our experts’ forecasts might even prove too tepid. The old bull isn’t ready to call it quits yet….” Of course, since it is rising asset prices which drives their business – being “bullish” is good for business…. However … it is extremes in both “psychology” and “behaviors” that tend to give us the best indications as to future outcomes. The legendary Bob Farrell had two rules specifically relating to today’s topic. The first was … “When all the experts and forecasts agree – something else is going to happen.”
Barron’s panel of ten experts (from JPMorgan, Goldman Sachs, Barclays, Citi, Morgan Stanley, BofA, Blackrock and others) were unanimous in their cheer that the US stock market will ascend well beyond its present record heights.
But, if everything is so rosy, Wolf Richter asks, why are bank insiders and big industrials selling their own company’s stocks faster than ever: (Someone has to be selling for all that buying to happen.)
Why are insiders at banks and industrial companies selling their shares as if there were no tomorrow? Banks had a blistering run. The shares of Wells Fargo, the most hated bank in America these days, soared 28% over the past 30 days, Citigroup 25%, JP Morgan 26%, Goldman Sachs, which is successfully placing its people inside the Trump administration, 37%. It has surged 50% since the end of October…. But high-ranking insiders have been dumping their shares faster than at any time in the data going back to 2003. These executives are considered the “smart money.”
Have market insiders just lost their appetite for dizzying heights, or do they have reason to believe they are selling into the stock market’s last hurrah? Are their banks, perhaps, getting clobbered by the bond crisis that is now developing on the other side of all this trading?
Even the Wall Street Journal, notes Richter, saw this high-volume trading as a bullish sign. They couldn’t, however, say why it was bullish, but only that it might be profit-taking. Well, why take profits now if you’re confident your bank has room to run? Is WSJ’s bullish note just more irrational exuberance from all market experts who can smell nothing but roses since Trump’s victory?
Bonds Are Smarter…And Far From Exuberant
One old adage says that bond traders are the smart money. Money is now fleeing bonds at a record rate of fall that matches the record rate of rise we are seeing in the stock market. Bond money has to go somewhere; so, it could easily be that stocks are going up less because of Trumphoria and more because of bond phobia, triggered by Trump. Fear of what could easily turn into the biggest bond-bubble crash in the history of the world makes stocks look like the safest haven.
The global realization that central banks are not so enthusiastic about additional stimulus anymore, has bond investor’s realizing that the longest bull market in bond history may finally be waning. At the same time Trump’s plan of spending somewhere between half a trillion and one trillion dollars on infrastructure investments (financed on national credit) means interest rates will have to rise in order to attract enough creditors, which they are already doing in anticipation. In many nations, investors’ money is trapped in bonds near zero-percent interest. Knowing higher interest on new bonds is almost inevitable now, these investors want to get their money out of current bonds. Even in the US, who wants to be stuck in bonds at 2.5% for ten years when two to three years from now, interest may be at 5%?
The prevalent thinking is that Trump’s credit-card spending spree will heat the economy with numerous new jobs, and those new jobs will raise wages in order to attract enough workers. The increased demand for great amounts of materials will also drive up the cost of materials for everyone. The combination of many more workers flush with new cash and rising demand for materials means inflation will rise significantly; and inflation eats away at the value of money stored in bonds. So, one more reason to exit bonds. Goldman Sachs believes the main effect from fiscal stimulus this late in the employment recovery curve will be to drive up interest and inflation.
In my view, all of that means the Fed’s statement that it will be raising interest more often next year is now irrelevant. I said that before the Fed’s last meeting, and I think we see it is true in the stock market’s relative indifference to what the Fed said. Interest rates are already rising everywhere in the US economy, regardless of the Fed’s target. So, the Fed is clearly failing to accomplish anything with its stated target rate because the market is finally taking over and driving interest. That is why it was easy for the Fed to say it will increase its number of rate increases. I suspect its stated target will play catchup all year in 2017 to what the market is already doing with interest rates.
So the bond bull is breaking; but that break can cause major bond funds to wind up in liquidity traps where they cannot pay off investors who want out fast enough because the more they sell bonds that people don’t want any way to raise cash and pay out investors, the more they have to lower the price to make a sale, driving down the value of the bonds they continue to hold, causing more investors to want out. The breaking of the longest and highest bond bull market in history could become a financial vortex, and bond values have already been falling at their fastest rate in history.
If bond funds go bust, they’ll take banks and retirement funds and ultimately the whole economy down with them, because almost everyone has been parking large amounts of money in bond funds because they are typically viewed as safe havens in uncertain times. If all of that goes down, the stock market likely does, too. It’s hard to see how it wouldn’t. It’s always been hard for me to see which would go first in the next big drop back into the Great Recession because both look so dangerous, and it is still hard to say. Will the insolvency of bond funds wipe out some banks and hedge fund managers, taking their stocks down to nothing, or will irrational exuberance in the stock market give way to panic? Right now, it appears to me that bonds will lead the crash.
Of course, I predicted the Epocalypse of 2016, so you might not want to listen to me. (Though I did say it might not happen until after the election when the Fed gives up and lets Trump take the fall.) I also predicted a second plunge in the price of oil in 2016, and that didn’t happen either. My predictions for 2016 were apparently badly off (at least in timing) for the first time in almost a decade. I started writing regularly on economics after predicting the crash of the housing market nearly to the month back in 2007, which I said would quickly become an enduring global catastrophe, the likes of which few people alive had ever seen.
That said, I anticipate the remainder of this December will go something like last year’s transition into the new year where the market crashed in the manner I said it would by going up first (due to euphoria that the Fed’s interest rate increase didn’t bring down the house), then rounds off and then falls off a cliff; but we’ll see. I’m not certain of that this year, as I was last year, and the fall off the cliff last year was not as severe as I thought it would be … though it was the worst January in the history of the stock market. This year, the euphoria is MUCH higher, so the fall could be much greater and be the kind that I anticipated for 2016.
Is It Irrational For Stocks To Rise Due To Betting On The Trump Card?
It could be. Consider that the entire marketplace began shifting overnight out of bonds and into stocks when Trump won, and it’s still shifting like a huge landslide. What if it repositions to this large degree, and then Trump changes his positions … again? As a matter of fact, he’s already started to backpedal from his infrastructure pledge just as he has been doing from almost all of his stated campaign pledges since being elected:
Trump made rebuilding the nation’s aging roads, bridges and airports very much part of his job-creation strategy in the presidential race. But lately lobbyists have begun to fear that there won’t be an infrastructure proposal at all, or at least not the grand plan they’d been led to expect…. Senate Majority Leader Mitch McConnell tried to tamp down expectations last week, telling reporters he wants to avoid “a $1 trillion stimulus.” And Reince Priebus, who will be Trump’s chief of staff, said in a radio interview that the new administration will focus in its first nine months with other issues… He sidestepped questions about the infrastructure plan. In a post-election interview with The New York Times, Trump himself seemed to back away, saying infrastructure won’t be a “core” part of the first few years of his administration…. He acknowledged that he didn’t realize during the campaign that New Deal-style proposals to put people to work building infrastructure might conflict with his party’s small-government philosophy. “That’s not a very Republican thing — I didn’t even know that, frankly,” he said. (Newsmax)
Seriously? Wow! How could he not know this, given that Republicans have resisted doing any infrastructure stimulus plans for eight years? He is either scarily out of touch if he didn’t realize he’d have a fight from the Republican congress, or this statement is proof that Trump was a Trojan horse from the beginning. This is a remarkably rapid turn from the New-Big-Deal plan that Steve Bannon advocated as being the economy’s salvation, given that Trump is not even in office yet.
We could have one wild roller coaster ride in 2017 since the market is entirely repositioning itself toward Trump’s infrastructure pledge if that plan takes a few years to come about or doesn’t make it through congress at all … or maybe doesn’t even get presented. It certainly never had a chance of making it through congress unless Trump pushed hard and leveraged his campaign victory toward that end, and the above statements don’t sound like Trump has any push left!
Rapidly rising interest rates already mean the infrastructure program will become much harder to finance. If Trump waits three years to get seriously started, interest rates could make the plan nearly impossible, plus he will likely have expended all his political capital that comes from a surprise election victory, which will be ancient news by then. He will need that capital to get the plan through a reluctant congress.
Rising interest rates already mean the mammoth national debt that came about as the result of the Great Recession will become much harder to finance over the next few years, even without taking out another trillion for new infrastructure. So, that will be a new and serious burden on the economy unless so much money flees Europe to bond and stock safety in the US that we’re saved by dumb luck … as once again being the best horse in the glue factory.
So, is the stock market irrational in its exuberance for shifting so much just because of Trump’s pledges, which are far, far from becoming reality? I think so. I haven’t even talked about Democrat resistance to Trump’s plans, and he’s already got resistance from the Republican leader of the senate. He is already fading back on his own push for the plan … before he is even in office. He has faded back on almost everything he has promised.
So, I think it is extremely irrational for the market to completely reposition from bonds to stocks — especially banking stocks — when Trump is hedging his words on all of his pledges … backpedaling hard on immigration enforcement and on putting Hillary in jail and now even on infrastructure spending.
Gathering around the stock ticker in the US stock market crash of 1929.
That doesn’t mean the market won’t keep going up. Who knows what the maximum height or duration of irrational exuberance is (because who knows how crazy people can get); but I am certain of this much: the higher stock market rockets upward on such irrationality, the harder it falls into the chasm of ever-growing debt from which it has been constructed. NO significant economic reforms have happened since the start of the Great Recession. There has been no significant improvement in corporate earnings, just a lot of expanded debt to buy back shares in order to improve Price-Earning ratios, which still look terrible. The entire market is but a poof of speculative hot air.
But, for the time being, Merry Christmas. If you’re not heavily invested in stocks or bonds, raise a glass of cheer and party on because you have less to fear. There is nothing you’re going to do that can stop the markets (in stocks and bonds) from having their hangover when the bubbly stuff is over and irrational exuberance suddenly looks like delirium. Our greatest economic crashes have always happened when least expected.