The Wall Street Journal is usually a rah-rah booster for the investment industry. They are the very definition of conventional. They are certainly not contrarians, since the contrarians are (by definition) acting against conventional wisdom. So it’s a little shocking to see the WSJ finally waking up to and actually printing on the first page the ugly possibilities of cycles that experienced investors have already seen multiple times in our lives.
https://www.wsj.com/articles/this-could-be-a-lost-decade-for…
**This Could Be a Lost Decade for Stocks**
**U.S. shares could go nowhere for a while based on long-term valuations, or they could get it over with and crash**
**By Spencer Jakab, The Wall Street Journal, May 18, 2022**
**U.S. stocks could well bounce back from their awful start to the year. How they do in the longer run is another matter....**
**Pundits love to talk about earnings growth, but it hardly accounted for the excellent decade that ended last December....More important was the price that investors were willing to pay for a dollar of earnings. That went from a multiple of 13 times to 23.6 times over the decade ended Dec. 31, 2021. A multiple of 15 to 16 is about the historical average....**
**As sour as the mood has seemed lately, the S&P 500 would drop by another 45% or so if both margins and price/earnings multiples reverted to their long-run averages taking the benchmark back to a level it first crossed five years ago....** [end quote]
The charts show that the SPX entered a historic bubble in 2020 as the Federal Reserve and Congress pumped massive, historic monetary and fiscal stimulus into the economy.
https://www.multpl.com/s-p-500-pe-ratio
https://www.multpl.com/shiller-pe
The fiscal stimulus has not been renewed in 2022.
IF the Federal Reserve was to follow their current plan of going back to their historic practice of controlling inflation, maintaining a “neutral” fed funds rate and stopping their purchases of longer-dated Treasury and mortgage debt, thus allowing a free bond market as it was historically…
THEN the stock market would return to its historical levels. Either quickly (if the bubble pops) or slowly (with a long hiss).
That’s a very big IF.
Conventional central banking wisdom is that inflation can only be reversed if the fed funds rate is higher than the inflation rate. Currently, the inflation rate preferred by the Fed is 6.6%. (This is the Personal Consumption Expenditures Price Index generated by the Bureau of Economic Advisors.)
https://www.bea.gov/data/personal-consumption-expenditures-p…
The Fed has finally stopped adding to its long-term bonds and it has begun to raise the fed funds rate.
https://fred.stlouisfed.org/series/WALCL
https://fred.stlouisfed.org/series/FEDFUNDS
The bond market doesn’t really, truly believe that the Fed will raise the fed funds rate that high, as shown by the short end of the Treasury yield curve. But the middle durations of the yield curve and the 5-Year, 5-Year Forward Inflation Expectation Rate also shows that the bond market thinks the Fed will be able to control inflation pretty soon.
I don’t see how both those things can be true. I think the bond market has its head in the sand. Yields are rising but they are not rising very fast or very high.
https://stockcharts.com/freecharts/yieldcurve.php
https://fred.stlouisfed.org/series/T5YIFR
https://stockcharts.com/freecharts/candleglance.html?$IRX,$U…
The stock market depends heavily on the behavior of the bond market. Bond yields directly affect businesses, especially ones that are heavily indebted and need to keep rolling over debt. (Such as many high-growth tech companies.) Rising bond yields also attract investors who never liked “TINA” (there is no alternative to stocks).
I’m not the only one who thinks the bond and stock markets are not yet responding to the true level of risk.
https://www.wsj.com/articles/recession-looms-but-markets-hav…
**Recession Looms, But Markets Haven’t Got the Message**
**For all the talk of recession, stocks and bonds aren’t reflecting much risk**
**By James Mackintosh, The Wall Street Journal, May 18, 2022**
**...**
**A new narrative of impending recession is quickly taking hold in the markets. Yet, look at the markets themselves and the story isn’t much reflected in asset prices, which are still beholden to the Federal Reserve. ...**
**Prices sensitive to monetary policy have fallen a lot. Really a lot. ...If the Fed turns yet more hawkish, these losses could intensify. But futures traders are already anticipating a lot of monetary tightening, and rate-sensitive stocks have responded with big falls, not only in the price but also in the valuation. ... But this isn’t like the post-dotcom recession, when industrials eventually lost a third of their value and consumer staples stocks rose....**
**The market seems not to be preparing for a deep recession, and perhaps not for a recession at all...The risk of recession has clearly risen, with the European economy heading down, China in a Covid panic, the Fed tightening fast and consumer confidence slumping....** [end quote]
The stock and bond markets both seem to think that the Fed will chicken out rather than cause a recession…or that they will quickly run back to monetary stimulus if a recession does start so everything will go back to the recent “normal” of Fed pumping.
Do they think that inflation will go away by itself? Controlling inflation is one of the Fed’s primary mandates, but supporting market valuations is not.
The stock and bond markets have huge risks at this time. They aren’t facing reality.
Wendy
