Ecstatic U.S. Stock Market Defies History and Ignores Increased International Risks

the Curmudgeon with Victor Sperandeo

Markets Grow Old Too...or Maybe Not?


In his seminal 1992 interview with Jack D. Schwager for The New Market Wizards book, Victor opined that older equity bull markets are more susceptible to sustained declines, most likely due to profit taking and buying power being exhausted.  He compared the health of older bull markets to an 87-year-old that didn’t have the resistance to fight off an illness, like someone in their early to mid-20’s.


The current 7.75-year-old bull market has defied Sperandeo’s hypothesis.  As we’ve noted in previous Curmudgeon posts, there has been little backing and filling, basing or even testing of previous lows.  Risks have been ignored or dismissed within days or hours.  The beat goes on and the money managers keep chasing stocks higher.  [Victor describes this latter phenomenon as “other people’s money.”]


The current US stock market rally from early November has been a straight up affair (see stock index charts on website for evidence).  It’s been built almost entirely on expectations of the Trump administration creating increased economic growth and higher corporate profits.  That may or may not happen and the timing is totally unknown.  Meanwhile, US Treasury bonds and notes as well as gold have gone straight down since Trump won the US presidential election.


Paul Brodsy, founder of Macro Allocation Inc. wrote something that best exemplifies the Trump ecstatic US stock market:


“We are convinced that the best case economic scenario being built into financial markets today is the mother of all bull traps. It anticipates an economic melt-up justified by peak-Trump enthusiasm.”


Market Valuations Today:


The current US stock market is very expensive, when measured against P/E ratios, price to book value, US GDP and productivity growth, and other metrics.  Earnings (bottom line) and sales (top line) of US corporations have not increased for several years, yet stock prices continued to rise during that time.  In fact, sales growth for S&P 500 companies have been declining since 2010, as per this chart. 


“We’re in a big fat ugly bubble.  If you (the Fed) raise interest rates even a little bit, the stock market will come crashing down,” said Donald Trump during the September 26th debate with Hillary Clinton.  What would Trump say today, after the screaming, nonstop stock rally that began on November 7th (the day before the election)?


Current and Historical (Trailing 12-month) P/Es Over President’s Terms:


We believe it’s appropriate to compare today’s stock market valuations with those of others at the beginning and end of a US President’s term.  We use the S&P 500, with a trailing P/E of 26 vs 21.2 one year ago for this exercise.  For reference, the S&P Industrial index has a P/E of 29.7 vs 23.5 one year ago (Source: Dec 11th Barron’s). We can’t use the Russell 2000, because it continues to have a P/E of nil, as there are no earnings to speak of in the last 52 weeks for the combined 1989 companies in that small cap index.  


Here are the historical S&P 500 P/Es- just before and after each President’s term:


·       Eisenhower (Jan 1953 – Jan 1961) — S&P P/E ratio was 10.9 in 1953, by 1961 it was 17.7.

·       Kennedy/Johnson (Jan 1961 – Jan 1969) — Little change to S&P P/E ratio which was 17.7 in 1961, by 1969 it was 17.5.

·       Nixon/Ford (Jan 1969 – Jan 1977) — S&P P/E ratio was at 17.5 in 1969, by 1977 it was 10.

·       Carter (Jan 1977 – Jan 1981) — S&P P/E ratio was at 10 in 1977, by 1981 it was 9.

·       Reagan (Jan 1981 – Jan 1989) — S&P P/E ratio was at 9 in 1981, by 1989 it was 12.

·       George H.W. Bush (Jan 1989 – Jan 1993) — S&P P/E ratio was at 12x in 1989, by 1993 it was 22.

·       Clinton (Jan 1993 – Jan 2001) — S&P P/E ratio was at 22 in 1993, by 2001 it was 30.

·       George W. Bush (Jan 2001 – Jan 2009) — S&P P/E ratio was at 30 in 2001, by 2009 it was 120.*  

·       Obama (Jan 2009 – Dec 2016) — S&P P/E ratio was at 120* in 2009, and is currently at 26x (according to Dec 12, 2016 Barron’s).

*The high S&P P/E multiple in 2009 is due to the significant deterioration in earnings due to the financial crisis. By November 2010, the S&P P/E was 15x.



Rising International Risks with Tensions Growing Exponentially:


It’s astonishing, if not incredible, that the straight up US stock market move from the November 4th lows has occurred in the face of increased international threats, heightened tensions and global risks which have been totally ignored.  We’ve covered many of them in detail in prior posts so we list them here in bullet form as a summary/recap:


·       Unknown effects of Brexit-  UK leaving the EU will certainly decrease economic growth and trade in the region, especially in the UK.

·       Italian government in disarray after PM resigned (see next bullet point below) at the very time government help is needed for so many Italian banks on the brink of insolvency.

·       Rejection of Italian constitutional amendment provides incentive to those that reject the established political elites such that they’ll vote for right wing candidates who want to leave the EU (e.g. Le Pen in France as per next bullet point).

·       France’s Presidential Election (Spring 2017).  France is at the forefront of Europe’s battle with radical Islamic extremism and ISIS.  Its economy has also stagnated with very high unemployment for many years.  If Le Pen wins the presidency, she’s vowed to hold an in/out referendum on France’s own EU membership. Brexit combined with “Frexit” would likely undermine the entire EU foundation and cause a serious recession if not a depression in Europe.

·       Migrant Crisis in Europe jeopardizes economic growth. Social and political disintegration because of massive migration is the world’s most immediate threat, the World Economic Forum has warned in its annual global risks outlook.  The costs of increased border delays and new administrative burdens alone could lead to a 10%-20% collapse in intra-EU cross-border trade, the equivalent of imposing a 3% tax on the value of all cross-border goods and services trade, according to a European Commission analysis.

·       Increased Tensions with Russia.  New CIA allegations that Russia instigated hacking of Democrats to influence the US Presidential election.  Secretary of State Kerry’s condemnation for Russia bombing in Aleppo and other parts of Syria to buttress the Assad regime (which the US and allies want to replace).   And let’s not forget Russia’s continued involvement in Ukraine and their annexation of Crimea.

·       South Korea Enters Period of Uncertainty With President’s Impeachment.  Friday’s impeachment of President Park Geun-hye and suspending her from office puts the US’ number one ally in containing nuclear armed North Korea into a highly uncertain state.  Ms. Park had adopted a tough approach toward North Korea, focusing on stronger sanctions. Her administration had also agreed to deploy an American advanced missile defense system that infuriated the Chinese.  With our relations with China sharply deteriorating, especially to contain North Korea, we urgently need a stable and US friendly South Korea as an ally.  President Obama (and many others) say that North Korea poses the number one nuclear threat to the US and the world.

·       Japan’s Debt Spiral Could Lead to Default:  Japan recorded an all-time high Government Debt to GDP ratio of 229.20% in 2015. Government Debt to GDP in Japan averaged 123.60% from 1980 until 2015. In February of this year, Adair Turner,  former chairman of the United Kingdom’s Financial Services Authority and former member of the UK’s Financial Policy Committee wrote in Japan’s Wrong Way Out:  “There are no credible scenarios in which Japanese government debt can be repaid in the normal sense of the word “repay”: and none in which the bulk of the BOJ’s holdings of Japanese government bonds will ever be sold back to the private sector. The sooner that reality is admitted, the sooner Japan will have some chance of meeting its inflation targets and stimulating total demand, rather than seeking to shift it away other countries.”

·       Trade War with China.  This has heated up with Trump’s phone conversation with Taiwan’s President and his tweets that China is a currency manipulator and new tariffs would be imposed on China’s imported goods.  Add to that China’s island building in the South China sea, dumping exported products (selling below cost to gain market share), intellectual property theft, hacking and other types of cyber-warfare.  Please see Victor’s comments below.


Victor’s Comments on China:


A great deal of concern from business on the election of Donald Trump is directed to his ideas on trade, tariffs and protectionism, especially with China.  It’s vital to realize that Trump speaks without any real belief of what he will do, can do (legally) and really means. He connects with the voter’s rage by what he says.  Yet he must operate within rules, i.e. the US Constitution and existing laws.  The Trump administration must also contend with Senate rules (like the filibuster) on his various desired laws and appointments.  Very little of what he said in general, can be accomplished with the few specifics he has proposed.


China is the most important, because we have our biggest trade deficits with that country (which is #2 worldwide in GDP and whose economic growth is faster than any developed country).  Originally Trump said he would appoint Carl Icahn to negotiate with China on trade. Mr. Icahn is not known for his diplomacy. 


However, Trump just nominated Terry Branstad (the current Governor of Iowa) to be ambassador to China.  Mr. Branstad happens to be a close "friend" of President of China Xi Jinping.  An early and enthusiastic backer of Trump during the election campaign, Branstad has had a personal connection with Chinese President Xi Jinping dating back to Xi’s time in Iowa in the mid-1980s (in what was likely his first trip abroad as a younger Chinese cadre). Xi spent time in rural Iowa on an agricultural research trip; Branstad was governor of Iowa at the time.


Beijing was quick to hail Branstad’s appointment.  From the UK Guardian newspaper: 


Relations between the world’s two largest economies are “facing uncertainty as never before”, China’s international mouthpiece has warned, despite Donald Trump naming “an old friend of the Chinese people” as his ambassador to Beijing.


After a torrid few days for US-China relations, Trump offered Beijing a gesture of goodwill on Wednesday by making Iowa governor Terry Branstad, who first met Chinese President Xi Jinping more than three decades ago, his top diplomat in China.


“Governor Branstad is an old friend of the Chinese people. We welcome him to play a great role in promoting the development of China-US relations,” foreign ministry spokesperson Lu Kang told reporters in Beijing.”


This was a perfect pick to make China and the world, feel better about US trade with China.


China President Xi Jinping and Terry Branstad have known each other since 1985.
Photograph: Andrea Melendez/AP. 
Photo courtesy of The Guardian.


The US exports "account for only 12% of GDP and much are intermediate goods that get shipped back to the US as imports" said Peter Berezin of BCA Research.  One should not logically conclude that foreign countries will put tariffs on US exports. What’s not known is whether the Trump administration will recommend tariffs on goods imported to the US.


Curmudgeon Note:


Trump has threatened to put tariffs on imported goods from China and Mexico.  The former would be especially problematic for world trade. 20+% of everything the US imports comes from China.  For every $1 in goods the US exports to China, it imports more than $4 of Chinese goods.  Trump has blasted the imbalance of the US-China trade arrangement, sometimes in the crudest of terms, citing China as a currency manipulator.



Victor’s Conclusions:


The bottom line is the US has the power to make better trade deals, and/or to use pressure on China for pulling back the leash on North Korea.  If done in harmony, with respect, and based on relationships considered to be friendly, that could be a very productive for US - China trade.  As Adam Smith reminds us: "Every man lives by exchanging." 

Good luck and till next time...

The Curmudgeon


Follow the Curmudgeon on Twitter @ajwdct247

Curmudgeon is a retired investment professional.  He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996.  He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.

Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies.  Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.

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