On Monday the dollar had a ferocious rally, moving up from 15.87mg gold to 16.77mg and from 1.21g silver to 1.32g. In mainstream terms, the price of gold dropped about a hundred bucks, and the price of silver crashed $2.20.
One notion we’re hearing a lot now is, “there is no alternative to stocks.” Certainly, stocks have been rallying. They were up in Sunday evening (as we reckon it here in Arizona) trading. Then Pfizer announced good news for its COVID vaccine, and that seemed to be the signal to bid up stocks even more.
Many in the mainstream believe that stock prices are linked to the economy. Many of the rest would quibble slightly, and say that stock prices predict the economy. However, we argue that stocks and other assets trade inverse to interest rates. A stock has a yield (well, most do) based on its earnings. This is the inverse of the famous P/E, i.e. the less famous E/P ratio. When the interest rate moves down, then so does E/P. This has nothing to do with the economy (falling interest goes with weakening the economy, but that is an argument for a different day).
Quoting stocks as an annualized yield is useful, because then you can compare to bonds. As Zero Hedge writes, the yield of stocks has been falling even relative to bond yields. The difference between S&P 500 earnings yield and the yield on a 10-year Treasury is down now to about 2.5%.
It should be noted that this is based on reported earnings. This is not what investors take home in the form of cash. Not to mention that earnings can include whole categories that should not be counted as earnings. For example, capital consumption.
Dividend yield is what investors take home. Dividends are less subject to creative financial engineering (though too often since 2009, they have been paid with borrowed funds). Dividend yield is a whole point lower than earnings yield. So the spread to Treasurys is more like 1.5% (compared to 2.5% for earnings yield).
Whether or not there is an “alternative” to stocks, when the crowd has not gone mad, they are regarded as riskier than bonds. And should trade at a discount in price (i.e. a higher yield) to provide a safety margin against the risk of adverse changes to the business.
And right now, investors would rather own stocks than bonds, and damn the torpedoes along with the risks. They could benefit from a lecture by economist Russel Napier, who quipped at a talk in London a few years ago that, “Equity is the thin line of hope between the asset and the liability.”
Debt certainly rose during the COVID lockdown (companies borrowed to keep running, while revenues were lower or zero). So that thin line is even thinner. But investors keep bidding it up. For now.
One thing stocks are not a signal of: the degree to which the president believes in free markets. The president does not have that much effect on stocks anyway, not being in charge of either monetary or fiscal policy. But, if anything, the stocks of the 500 biggest corporations should do well in an environment of onerous regulations and punitive taxes. Why?
Big vs. Small
The biggest threat to an incumbent major corporation is a disruptive startup. If an Amazon is allowed to grow, it could eventually wipe out B Dalton, K-Mart, and JC Penney. If a Skype is allowed to grow, it could wipe out AT&T (at least the long distance business part of it).
Regulations impact small companies harder than big corporations. And startups most of all, as the legal costs can be greater than their ability to raise capital. Compare to major corporations, whose lobbyists help Congress draft the new law and then help the regulators draft the new regulations called for by the law. The regulation works out well for them, facilitates their business model—if not petrifying it by disallowing innovation.
Taxes, also, prevent innovative young companies from threatening major corporations. This is because growing companies reinvest their earnings. The higher the tax rate, the less they can reinvest. A dollar of earnings would allow $0.90 of reinvestment at a 10% tax rate. But only $0.50 reinvestment at 50%.
In other words, the higher the tax rate, the more that a dollar of capital already invested is worth in terms of new dollars of earnings.