Can the market let the air out of the bubble without consequence? The answer relates to my post on economic cycles. That is, panics and busts only occur after booms and bubbles. But what a minute – are you saying this is a bubble? My answer to that is look at where we are in relation to the long-term mean. That’s your litmus test. For example, if we simply take the S&P 500 – it trades at ~22x forward earnings (on the assumption earnings growth this year is 12%). The 10-year average forward PE for the S&P 500 is ~18x (mostly as a function of long-term yields trading near zero). And the 100-year forward PE average is closer to 15.5x. And if we look at tech specifically – valuations are even more extreme.
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Fed Can Keep Raising w/Core CPI 4.8% YoY
The market celebrated the June monthly CPI data. Headline CPI came in at just 3.0% YoY – and Core CPI fell to 4.8% YoY. Good news. However, with Core CPI still more than 2x the Fed’s target – expect them to raise rates again at the end of the month. However, what surprises me is the market believes the war with inflation is basically done. Is it? I think that is presumptuous. The fight with Core inflation will be a long one. If correct, the Fed may not need to keep raising rates aggressively – however are likely hold them there until their objective is met.
Stocks Under-appreciate the Impact of Credit Tightening
The market continues to hit a wall in the zone of 4200. And there is good reason for that… Investors are being asked to pay a large risk premium to own stocks. By my calculation – the forward PE is in the realm of 19x. That’s far too high with interest rates at 5.00%; inflation more than twice the Fed’s objective; and a real risk of recession. Today I will also spend a minute on the so-called banking crisis. I prefer to call it a crisis of confidence – as the US banking system is sound. However, we should expect many more regional bank failures – and that will lead to greater credit tightening. That’s a negative for the economy and risk assets.
What Do Credit Spreads Tell Us?
There are two types of economic indicators which are often cited in the financial media: (i) those which lag; and (ii) those which are leading. The latter of more useful. One of the best real-time leading indicators are credit spreads. These are excellent indicator of the ‘health’ of the financial system. So what do they tell us today with interest rates sharply higher?
For a full list of posts from 2017…