SPX Highs A Fed Illusion
The surreal US stock markets have continued melting up in recent months, spurred ever higher by the Federal Reserve's money printing and jawboning. The resulting record highs in the headline indexes have been widely trumpeted by Wall Street as evidence of a strong secular bull underway, with years still left to run higher. But these records are misleading, mere illusions conjured by the Fed's relentless inflation.
The flagship benchmark index for tracking the US stock markets is the mighty S&P 500, often shortened to SPX. The whole financial world literally revolves around this dominant index, with most global equity markets and even some major commodities markets like oil closely mirroring it. American stock traders can directly trade the SPX through a handful of gargantuan ETFs including the leading SPY S&P 500 ETF.
As a broad-based market-capitalization-weighted index comprised of 500 of American's biggest and best companies, for all intents and purposes the S&P 500 effectively is the US stock markets. So strings of new SPX record highs are widely-celebrated events. This latest stretch started on the last trading day of March 2013, when the SPX broke out above its previous record-high close of 1565 in October 2007.
Since then there have been no fewer than 70 new record closes, out of just 328 trading days. Over a fifth of these have happened since late May 2014, helping to breed the extreme euphoria and complacency rampant today. Wall Street zealously believes these records are a powerful testament to the underlying health and staying power of this bull market. So each new record feeds into the overwhelming optimism.
Record highs necessarily rely on long-term price comparisons. But thanks to the Federal Reserve's printing presses endlessly spewing out vast torrents of new US dollars, the ultimate measuring rod of the dollar is far from constant. We all instinctively know the value of the dollar is perpetually eroding, but this insidious inflationary process is so slow that it lurks below the perception threshold most of the time.
The longer the timeframe considered, the greater the impact of monetary inflation. Back in January 1980 for example, the US median household income was under $18k. New houses across this nation averaged just $76k, while new cars generally cost less than $6k. With far fewer dollars in circulation then, each one had relatively more purchasing power. But the relevant SPX record-high span is much shorter.
The last secular stock bull crested in March 2000, when the SPX hit the then-staggering level of 1527. But a dollar back then went a heck of a lot farther than one does today, so considering 1527 in today's dollars is an inherently-flawed and misleading apples-to-oranges comparison. Back at those dazzling SPX record highs, the Fed's narrow and broad M1 and MZM money supplies were running $1109b and $4463b.
Today, after the epic money printing by uber-inflationists Alan Greenspan, Ben Bernanke, and Janet Yellen, these money supplies have ballooned to $2823b and $12484b! This is staggering growth of 2.5x and 2.8x respectively, vastly outpacing underlying US economic growth. With dollars worth much more back then, any given SPX level was much higher in real inflation-adjusted terms than the same one today.
While the Fed's money printing is pure inflation, Wall Street has always preferred to focus on the effect rather than the cause. And that's rising prices. The dominant measure of general price levels remains the US Consumer Price Index, which is published monthly by the Department of Labor's Bureau of Labor Statistics. Between March 2000 and today, this popular price index merely climbed from 171.2 to 237.9.
This 1.4x growth greatly lagged the source of inflation, underlying money-supply growth. Unfortunately the CPI is intentionally lowballed for political reasons. The BLS systematically employs all kinds of statistical trickery to keep the CPI from revealing the true price picture in America. Have your family's living expenses merely risen by an average of 2.4% annually since March 2000? The reality is likely double or triple that.
The government actively manipulates the CPI because monetary inflation has such a broad and detrimental impact. If true inflation was reported, stock markets would be radically lower. Americans would believe our economy was far worse, and would kick politicians out of office. The huge welfare payments indexed to inflation, along with interest on Treasuries, would soar. This would threaten to bankrupt the whole government!
Nevertheless, since the myth of low inflation helps boost stock prices Wall Street happily plays along with this political charade. Since it dramatically understates real-world inflation, the CPI is probably the most conservative way possible to view the SPX in constant-dollar terms. So this first chart uses the CPI to show the real inflation-adjusted SPX since 2000 in blue, overlaid on the usual nominal unadjusted SPX in red.
The only honest way to do long-term market comparisons is to use constant dollars. And in real terms, the SPX has not seen a single new record high since March 2000! All 70 of the nominal record closes over the past 16 months are mere illusions driven by the eroding value of the Fed's inflated dollar. The SPX peaked at 2123 in today's dollars back in March 2000, and hasn't returned anywhere near there ever since!
In fact, as of its latest nominal record close of 1985 just a couple weeks ago, the SPX was still 6.9% below that March 2000 record high. The implications of that fact are incredible. In the 14.3 years since the peak of the last secular stock bull, US stock prices have still not recovered! As this chart reveals in stark terms, all the US stock markets have done since early 2000 is grind sideways at best. This is ominous.
The only market environment where stock prices can consolidate and make no progress for over a decade is a secular bear. The stock markets gradually meander in great third-of-a-century cycles that I call Long Valuation Waves. 17-year secular bulls, like the monster ending in March 2000, are followed by 17-year secular bears. Stocks blast higher in secular bulls, and then drift sideways in the subsequent secular bears.
The reason is quite simple. Towards the ends of secular bulls, widespread euphoria catapults stock prices to levels far beyond where underlying corporate earnings can fundamentally justify. Stock prices are driven to such expensive levels that they then need to consolidate sideways for the better part of the next couple decades to give earnings time to grow into those lofty stock prices. Secular bears bleed off overvaluations.
The single-most-important question in all the stock markets today is whether we are still in the 17-year secular bear that started in March 2000 or a new secular bull that was allegedly born in March 2009. The latter is fervently believed by the legions of stock bulls cheering this past year's long string of new nominal record highs in the SPX. And these very records are trumpeted as some of the best new-secular-bull evidence.
As a professional student of the markets and speculator, I have CNBC turned on all day every day. As usual it has done an outstanding job of chronicling prevailing stock-trader sentiment during this past year's big streak of new nominal records. And the times I've heard analysts and money managers claim these new records confirm a new secular bull is underway are countless. These records greatly fed the bullish sentiment.
But by merely recasting the SPX in constant-2014-dollar terms using the lowballed CPI, this thesis is irrefutably shattered. The SPX's 70 new nominal record closes since last April are not the product of an exceptionally-strong stock market, but the result of the value of the dollar measuring stick falling thanks to the Fed's relentless inflation. In real purchasing-power terms, stocks are still lower after 14.3 years!
There have been no real new SPX record highs yet, not a single one, since March 2000. And none are coming before SPX 2123 at best. I say at best because with each passing month's money printing by the Fed, each dollar's value keeps falling and continues to push up that March 2000 real high in today's dollar terms. The bulls' belief that record highs show how special these stock markets are is total garbage.
These stock markets are indeed special, but only because the Federal Reserve has recklessly and foolishly incited a stock-market levitation. Secular bears, those great sideways drifts, are comprised of an alternating series of smaller cyclical bears and cyclical bulls. The cyclical bears generally cut stock prices in half, and then the cyclical bulls double them again. This continues over the secular bear's 17-year lifespan.
The stock markets functioned normally between most of 2000 to 2012, consolidating sideways on balance to give corporate earnings time to grow into the lofty stock prices of the last secular bull. Note in particular the normal cyclical-bull advance after the last cyclical bear bottomed in March 2009. It enjoyed a normal healthy ascent in its first four years, strong uplegs punctuated by occasional corrections to rebalance sentiment.
But in early 2013, Ben Bernanke inexplicably took it on himself to convince stock traders the Federal Reserve was effectively backstopping the stock markets. It had to be one of the dumbest things an elite central banker has ever done, crazy-dangerous. The Bernanke Fed fell all over itself communicating that if a significant stock-market selloff arrived, it would be quick to spin up its printing presses and spew money.
So selloffs vanished, with traders quick to buy every slight dip on the belief the Fed wouldn't let the stock markets fall. Without necessary and healthy selloffs to rebalance sentiment, it soon became wildly euphoric. This led to stock prices being bid up far faster than underlying earnings, pushing stocks back near bubble valuation territory! Stocks just rose and rose, without meaningful selloffs, in a bull-killing trajectory.
And the stock bulls rejoiced! Rather than scold the Fed for single-handedly spawning a dangerous stock-market levitation, they claimed stocks were rallying because the US economy is recovering strongly and corporate earnings are surging. And they claimed the many nominal record highs were evidence of these blatant rationalizations. But the records themselves never really existed, they too were Fed-driven illusions.
This next chart zooms out to a really-long-term view of the real SPX, since the start of the last secular bear before today's in early 1966. It reinforces the damning perspective that today's US stock markets remain trapped in a 14-year-old secular bear. And if that is indeed true, then today's lofty stock markets have a long, long ways to fall once today's overextended cyclical bull rolls over into the next cyclical bear.
This long-term chart highlights the critical truth that today's euphoric bulls have totally forgotten, that stock markets are forever cyclical. 17-year secular bulls are followed by 17-year secular bears, and these sideways grinds are made up of smaller cyclical bears and bulls. The last secular bear ran from 1966 to 1982, a period of time where the SPX actually gained 8.9% nominally but lost a staggering 64.3% in real terms!
As the Fed ramped up its printing presses in the late 1970s to try and stimulate a stagnant economy, the value of the dollar kept eroding. So though stocks were flat on balance over that last secular-bear span, the purchasing-power losses investors absorbed were massive. That last secular bear didn't end until the S&P 500's trailing price-to-earnings ratio fell below 7x earnings, which signals secular bears have run their course.
The subsequent secular bull was mind-blowingly awesome, catapulting the SPX 1391% higher in nominal terms and 751% in real terms over the next 17 years or so. The final couple years of that secular bull marked its terminal bubble phase, when stocks rocketed straight up on unbridled euphoria to hit an astounding 43.8x earnings in SPX terms. But with valuations so extreme, that secular bull gave up its ghost.
And that ushered in today's secular bear, which is only 14.3 years old so far. That is well under the 17-year average. And if today's wildly-optimistic stock bulls are right, then the secular bear actually ended in March 2009 which would have made it last only 9 years. It is hard to imagine a secular bear surrendering after just 9 years, just over halfway into its normal duration. And valuations were far too high to kill it then.
Remember secular bears are valuation phenomena. And near the March 2009 lows the elite 500 component companies of the SPX had only retreated to a trailing P/E ratio of 11.6x. This was still a whopping 2/3rds higher than the 7x levels seen at the ends of secular bears! So the idea that the secular bear magically ended back then makes absolutely zero sense. It is a typical bull fantasy, a rationalization ignoring hard facts.
That leaves us 14.3 years into a not-yet-mature secular bear today, still trading at real levels below those seen at the last secular bull's peak in March 2000. Even with today's lofty stock prices, the SPX is only up 30.0% in nominal terms over that entire span. That means the US stock markets have returned a piddling 1.9% annually at best over the decade-plus since the last episode of extreme euphoria, utterly terrible.
How on earth can that excite anyone? Since secular bears are sideways grinds in nominal SPX terms, in real terms they tend to be downtrends. This was readily apparent during the last secular bear that straddled the 1970s. And the same thing happened in today's secular bear before the Bernanke Fed unleashed its crazy SPX levitation in early 2013. The entire stock rally since then is Fed-manufactured.
While the lack of new real records is damning, that is trivial compared to the extreme overvaluations in the stock markets today. As of late June, the S&P 500 component stocks were trading at a trailing price-to-earnings ratio of 23.5x! That is dangerously high, way above 14x historical fair value. And that is if these components' individual P/Es are weighted by their market caps, which makes it more conservative.
In simple-average terms, the SPX's trailing P/E ratio in late June was a jaw-dropping 26.4x earnings. This isn't far from the 28x historical threshold for bubble conditions! The last cyclical bull topped back in October 2007 at much lower valuations, and the fact that valuations are so extreme today virtually guarantees that we are not midway through a new secular bull as the bulls so desperately try to convince themselves.
Again secular bears don't end until the general-stock-market valuation falls down near 7x earnings. So if a secular bear remains in force as all the evidence strongly suggests, US stock prices would have to be slashed by a catastrophic 70% to hit those bear-slaying valuations! I really doubt they will plunge that far, as earnings will gradually grow over the next couple years while stock prices slide. But they will get cut in half!
Making long-term stock-market comparisons in nominal terms, which is necessary to declare records, is inherently misleading. With the Fed continuing to aggressively print money like there is no tomorrow, the value of the dollar is not a constant long-term measuring stick. It has to be adjusted for inflation, even if it is lowballed CPI inflation, to get a more realistic perspective on what is really going on out there.
And when you consider the SPX in today's dollars, the past year's long string of nominal record-high SPX closes is merely another Fed-conjured illusion. The S&P 500 has not made a single new record close yet in real terms, and remains far from its last secular-bull peak in March 2000. But even more damning than that is the extreme overvaluations, which all but prove we aren't midway through a new secular bull.
All the stock-market upside of the past 18 months or so, and all the resulting euphoric sentiment, was simply manufactured by a reckless Fed. All investors and speculators have to ask themselves what is going to happen as the Fed's implied backstopping is soon removed when the QE3 bond monetizing ends later this year. Odds are the levitated stock markets are going to come crashing back down to reality.
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The bottom line is this past year's long string of new record highs in the flagship S&P 500 is merely a Fed-driven illusion. Once this flagship stock index is adjusted for inflation, it reveals that these stock markets haven't achieved a single real record yet. Even today, stock prices remain way below those seen at the end of the last secular bull in early 2000. All the past year's euphoria based on record highs was misplaced.
And without any new highs, the case that we remain mired deep in a not-yet-mature secular bear is even stronger. Couple that with the extreme overvaluations rampant in stocks today thanks to the Fed's crazy levitation, and the markets are perfectly set up for a new cyclical bear. This is going to eviscerate the deluded bulls trapped in their own euphoria, but will offer vast opportunities for prudent contrarians.