Perspectives

A New Milestone in Peaks

SP500 Peak Price-to-Sales

This should make the front page news everywhere, but it probably will not.  Peter Boockbar posted this chart on Financial Sense using Bloomberg data.  We just hit the highest price-to-sales ratio for the SP500 *ever* including the 2000 stock market bubble! This is more telling than price-to-earning ratios.

Valuations in earnings should be suspect since earnings are so manipulated.  Companies write off half their losses as large “one-time” expenses instead of depreciating them or reporting them to investors.  This leads to overstated earnings each quarter and in the future.  Financial engineering also uses expenses for pensions, stock buybacks with debt and other games to keep bull markets going.  Sales for the most part are sales.

Price to Sales Peaks

What makes this new peak different is that the price of the SP500 is not high from a few extreme tech stocks with low sales.  We hit it with across the board high valuations of SP500 companies. This may make the current bubble more stable and allow it to continue for awhile.

In 2000, the tech stocks burst first and this caused the SP500 to hit its first peak.  Months after the tech bubble burst, the SP500 put in its final (double) peak as money flowed to the largest stocks in the SP500. The bursting of the tech bubble was the reason the SP500 ultimately tumbled, but money initially flowed to the largest “safest” companies.

In 2007 it was the housing sector that went early.  Then all the companies that benefited from the housing boom succumbed and the whole market rolled over.  The reason the 2007 peak was lower in the chart above was because the most over-valued companies from 2000 were still working off their excess valuations.

By the 2009 low, the entire market had worked off its over-valuation.  That 2009 low was actually a return to the mean valuation of 1982 – 1995.  The Fed wanted to blow their bubbles back up along with all the other central banks due to impaired balance sheets of the banks.  When asset prices collapse, the debt backing them does not go away and this made for insolvent banks and households.

The current bull market is central bank driven as money is created out of thin air and the central banks buy financial assets which in turn removes supply.  Corporate buybacks using low interest rates removes stocks from the market.  Prices go up from limiting the supply of financial assets. The money has flowed to all corners of the financial universe – a trickle made it to the economy.

 The next chart produced by Dr. Hussman highlights how this cycle is broad-based in terms of valuations.  In terms of the medium (middle) SP500 company, we past the old record long ago.  Note the 2007 peak was also more broad-based in terms of valuations than the 2000 stock market bubble. How the Fed can talk endlessly about missing their arbitrary 2% consumer inflation target by tenths of a percent is beyond ethical when this is the result of their policies.

The chart highlights something else in my view.  The Federal Reserve should have stopped QE by 2011.  The markets had recovered to elevated levels but were not in a bubble.  At that time Europe faced their own financial crisis and the ECB President said “he would do whatever it takes” and the Fed wanted to see if the “wealth effect” could get the economy going. The rest is history.

The Fed’s policies have probably slowed the economy down as companies found it more profitable (CEO pay checks) and safe to buy back their own stock with cheap loans than to invest in future production.  They will be long gone with their extracted wealth when their companies face the next great recession and pensions are defaulted on.

What this chart tells us is that a 50% drop in the median price only brings us back down to the last two market peaks!  A 70-80% drop is needed to return to the pre-Greenspan bubble era ratio.

In my recent post I discussed Jeremy Granthams take on bubbles.  He thinks this one can run 50% higher in the next 6 months to 2 years.  He may be right if the same effect happens during this bubble as 1929, 1972 and 2000 in the US stock market.

In those bubbles, the end game saw money flow to the largest companies while the broader market began to slide.  If this scenario repeats the SP500 would continue to climb as market internals (breadth of the market) declines.  I pointed out that we had this situation in 2015 when I called a top, not imagining the central banks would so recklessly pump another 4 trillion into the global credit markets in a short time.

This is what makes this cycle so difficult to predict.  The 2015 market internal divergence did not fully go away, but the short term market internals are stable.  This is something to watch closely going forward.

Those 2003 and 2009 *lows* in the Price-to-Sales ratio were the *highest* bear market lows in history to give you an idea of how misleading the chart can be when only looking at the bubble era.  Today a 50% decline in the SP500 only gets us to about 1.15 on the ratio which is well above the SP500 average ratio just below 1.00.

As long as the broader market climbs and corporations can borrow to buy back shares and high yield investors are not spooked, this bubble has the potential to melt-up the 50% Jeremy Grantham talks about.  And that is scary considering where we already are. Because the other side of every bubble is not pretty in one way or another.


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