Control Panel: Market melt-up or topping?

Investment Analysis Clubs Macro Economic Trends and Risks
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https://www.wsj.com/finance/investing/investors-are-betting-on-a-market-melt-up-3a007dd4?mod=hp_lead_pos1

Investors Are Betting on a Market Melt-Up

They have flocked to stock funds at a pace rarely seen since 2008, but some warn that shares look expensive historically

By Gunjan Banerji, The Wall Street Journal, Updated Nov. 17, 2024

A roaring market rally since the U.S. presidential election has driven up the price of everything from shares of technology and manufacturing giants to cryptocurrencies. Many investors are betting it has room to run.

Investors have stampeded into funds tracking U.S. stocks and picked up trades that would profit if the rally that recently sent the S&P 500 above 6000 for the first time reaches new heights…

One measure closely tracked by investors, the equity risk premium—or the gap between the S&P 500’s earnings yield and that of 10-year Treasurys—shrank close to zero, the lowest level since 2002, according to Dow Jones Market Data. That means the reward for owning stocks over bonds is dwindling… [end quote]

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The earnings yield refers to the earnings per share for the most recent 12-month period divided by the current market price per share. The earnings yield (the inverse of the P/E ratio) shows the percentage of a company’s earnings per share. [end quote]

The equity risk premium has two variables: the earnings yield of companies and the yield of the 10 year Treasury bond. Note that the earnings yield is NOT the dividend yield of a stock. The holder of a Treasury bond will receive an interest distribution while the holder of a share of stock may or may not receive a dividend distribution.

The chart begins in 2000 with a negative earnings yield. Look at the chart of the CAPE to see why: 2000 was the year of the P/E ratio bubble peak followed by the dot-com crash. The Federal Reserve artificially suppressed the Treasury bond yield between 2001 and 2022. This provided an artificially high equity risk premium for 20 years. An entire generation of stock investors has never seen a neutral fed funds rate or a free market (without QE) for Treasury bonds.

It’s no coincidence that the equity risk premium now resembles 2002 more than the years of extreme Fed yield suppression. The P/E ratio of stocks is near a record high while the bond market is returning to normal since the Fed is backing away from QE and has allowed the real yield of the fed funds rate to return to its historic average of about 2.5% over inflation.

The post-election stock market melt-up paused last week. The Fear & Greed Index is neutral. Only time will tell whether the advance will continue or whether this is a topping formation like 2000.

The Treasury yield curve is essentially flat. The 10-Year Treasury Constant Maturity Minus 2-Year Treasury Constant Maturity is close to zero in a pattern that has repeated before recessions.

There’s no sign of recession on the horizon. The Atlanta Fed’s GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the fourth quarter of 2024 was 2.5 percent on November 15.

Fed Chair Jerome Powell announced that the FOMC will not be in a hurry to cut the fed funds rate since the economy is still growing well and inflation has not retreated to the Fed’s goal of 2%. The Cleveland Fed’s inflation Nowcast shows Quarterly annualized percent change 4Q24 inflation closer to 3% than 2%. Most speculators still expect the Fed to cut in December 2024 but the number of predicted cuts in 2025 is falling relative to a few weeks ago.

The stock market reacted with disappointment as it has before. This is probably noise. A genuine trend change would take weeks to develop.

With just weeks left in 2024, the S&P 500 is on track to jump more than 20% for the year, the second consecutive year of gains of that magnitude. It is a back-to-back advance that has been seen only three times over the past century. Real GDP is only growing about 2.5%. A similar discrepancy is what caused me to leave the stock market in 1999. It’s characteristic of a bubble.

The METAR for next week is cloudy with some showers. The stock market’s disappointment will probably continue for a few days. There’s no obvious change that would pop the bubble so next week isn’t likely to be a topping week. But that can only be seen in retrospect.

Wendy

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It could be that, after the initial run on the assumption of policy that will be universally good for “JCs”, everyone is waiting for the details. The three moves I made were based on a shift to more slack regulation, and one with a proven track record of being a winner in a protectionist tariff environment.

Seems that, if the promised tariffs actually materialize, instead of being negotiated away for promises of better behavior by the counterparties, inflation of such magnitude will occur that any sort of bond or savings vehicle will be slaughtered. That means the only way to keep up with inflation would be stocks, as the “JCs” will mark up their prices, and earnings, to keep pace with, or exceed, inflation.

Steve

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How quickly we forget Smoot-Hawley and the Great Depression.

Smoot-Hawley was a republican bill (244 Republicans and 20 Democrats in the House and 39 Republicans and 5 Democrats in the senate voted in favor of the bill) designed to protect American farmers and manufacturing. It contributed significantly to a global economic decline coincident with the US Great Depression. This occurred at a time when the US was running a trade surplus and was much less dependent on imports.

Today the economies of China, the EU, and Japan are either slowing or moribund and US consumers require low import prices to maintain their standard of living. Seems like a bad time to start a global trade war. Additional tariffs might initially be inflationary, but if the global economy declines as a result, this inflation probably won’t last long. Global debt is currently very high, so an additional slowdown is very likely to lead to a recession.

Are stocks where you want to be during a prolonged recession?

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I have heard a different theory, tho the tariff did play a role

According to the theory, because the US had high tariffs on imports, imports fell, but other countries continued to buy US exports. Because all the parties were on the gold standard, the US’ trade surplus sucked gold out of trade counterparties, shrinking their money supply, while the incoming gold was not used to increase the US’ money supply. With their shrinking money supplies, trade counterparties could not continue to buy US exports, so the depression spread.

No-one is on the gold standard anymore. Government can create all the money they want, out of thin air, to reinflate their economies.

Then there is the theory that the stock market bubble had inflated the US economy. When the speculative bubble popped, people were forced to deleverage, and that caused the depression. Sort of a 2008 on steroids, as, in 1930, being on the gold standard, the US government could not reinflate the economy with helicopter money.

Personally, as stated before, I suspect the tariffs, in general, are a way of backing in to a flat tax, like the “fair tax” that Huckabee shilled for: replacement of the income tax by a national sales tax. As the CEO of Apple said, some years ago, it is impossible to move some products back to the US, because the supply chain and skilled workforce to product those products no longer exists in the US.

Steve

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No, Smoot did not cause the Depression, but it surely made it worse. The usual marker for the start is the stock market fiasco(s) of September, 1929. Smoot-Hawley wasn’t signed into law until June of 1930. (It was being debated - and actually passed the House almost a year earlier. The Senate came along in the Spring of 1930, and Hoover didn’t sign it until a month later.)

The tariffs were 20%, plus or minus, on almost everything, and trade fell abruptly. Discretionaries were smacked immediately. Some things (like food and other necessities) took longer, as nations had no alternative, but by 1933 Imports fell by 2/3, from over $4B to $1.5B, and Exports fell similarly from $5.4B to $2.1B.

Needless to say, other countries retaliated, some immediately, some a bit later, but overall the tariff idea was destructive to world commerce, and not just in the US.

Now nothing says imports would fall by 2/3 again, but suppose for a moment they did: you would have nearly empty shelves at WalMart and Target. Your phone replacement would cost significantly more, so people would replace them less often. In fact most thing electronic would go up in price almost immediately.

Food might not be as hard hit, except for the vast numbers of foods we now import seasonally that we didn’t before the last couple decades. I remember when strawberries were “in season”, now they’re on the shelves year ‘round. Likewise grapes, corn, and so many others.

Tariffs, designed to help the rurals would come back and bite them in the posterior, as exports would likely also crater - perhaps not in the first season but surely shorter thereafter.

Yeah, that idea got what it deserved. This one, well, if it plays out anything as textbook economics says it will: happy days aren’t here again.

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Those are amazingly low numbers! $4B in 1933 is the inflation-adjusted equivalent of just under $100B in 2024. International trade has sure expanded a lot since 1933, we import over $4 TRILLION a year today!!!

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Sure, but much of the world was still in ruins from The Great War and the recessions that followed it, so: no industry. Transportation was crude, with bags of wheat manually tossed into slings loaded by stevedores on the dock. No high value high tech, and not a lot of raw materials flowing as we are used to today. But look at what happened! Crash, Boom! Pow! Worse than a fight between Batman and the Penguin.

And here, for better or for worse (almost surely worse), here we go again.

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Keep in mind, the 1920s were a period of USian isolationism, racism, and protectionism…which sounds a lot like now.

In 1922, the US enacted the Fordney–McCumber Tariff

the tariff law raised the American ad valorem tariff rate to an average of about 38.5% for dutiable imports and an average of 14% overall. The tariff was defensive, rather than offensive, as it was determined by the cost of production and the market value.

But the 1920s “roared” anyway.

Steve

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The difference is, on this go around, it is being spun, not as a tax, but punishment on those “horrible” foreigners.

Steve

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Adam Smith warned about protective tariffs around the time of the American Independence. Maybe politicians don’t read the right books.

The Captain

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I am not worried about a recession. With our existing budget surplus we can just deficit spend our way out of it.

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A friend accused me about worrying about money. I set him straight!, “I don’t worry about money. I worry about not having enough money.”

The Captain :imp:

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The negotiation process has been shown to us over 4 years ago. First comes the threats. The negotiations begin a week or two later. The counter party nation can not figure out how to accept higher tariffs. Time runs out. Meaning an impulse to end negotiations happens. The tariff as stated is levied. The idea this round is to target Mexico first. As if that was organization.

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And the votes for the Fordney-McCumber Tariff of 1922:

*On July 21, 1921, the Fordney tariff bill passed the House by a margin of 289 to 127. Only seven Republicans voted against the measure, while seven Democrats voted for it. *

August 19, 1922, the Senate voted 48 to 25 in favor of the Senate tariff bill. The only Republican to vote against the bill was William Borah of Idaho, while only three Democrats voted for it,

US tariff rate history up to that time:

Payne-Aldrich (1909)

  • Average duty on all imports was 19.3 percent*
  • Average on dutiable imports was 40.8 percent*

Underwood-Simmons (1913)

  • Average duty on all imports was 9.1 percent*
  • Average on dutiable imports was 27 percent*

Fordney-McCumber (1922)

  • Average duty on all imports was 14 percent*
  • Average on dutiable imports was 38.5 percent*

https://eh.net/encyclopedia/the-fordney-mccumber-tariff-of-1922/

But the 20s “roared” anyway.

Steve

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The 1920s roared because of two factors more powerful than tariffs. The first is that the aftermath of WWI left the US as one of the few unscathed economic powers. Foreign competition was minimal. The second is that prior to about 1924, the US had largely unrestricted immigration that created a young and ambitious work force. It would have been very difficult for the US to not have a roaring 1920s.

Compare that to today. Currently the US faces intense competition in most industries. The US workforce is aging and declining as a proportion of the population while at the same time we are acting to restrict immigration. No influx of foreign workers to increase our productivity. The US was globally in a much more favorable economic position in 1924 with a still recovering Europe and China early in industrialization, than it is now in 2024.

The immigrant work force made up much of the roar in the Roaring 20s.

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There was not much material damage in the UK, tho they lost a lot of young men. The US did come on like a loan shark, demanding repayment of war debt. So the UK passed the buck, demanding it’s allies repay their debts to the UK, as well as putting the bite on Germany, so the UK could pass the loot to the US. For that matter, away from the front, there was not a lot of material damage in France, Germany, Austria, or Italy, as strategic bombing was not yet a thing. The Netherlands, Denmark, and Norway were neutral, so they were not injured, materially, or financially, by the war.

The tariffs were steep enough that Rolls Royce opened an assembly plant in Springfield, Massachusetts. Austin produced cars in Butler, PA, as “American Austin”.

Steve

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And the upward curve of that graph, starting in the 70s, probably explains a lot of the current xenophobia.

Steve

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Although, as your graph shows, that had been the case for over half a century when the '20s came along, and was certainly not the case for the roaring '50s.

DB2

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Of course, the “Asian Exclusion Act” predated the racist 1924 immigration law.

Steve

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How does that fit in with bt’s idea that the Roaring 20s was due to largely unrestricted immigration?

DB2