Here Comes the Pin
IT is drifting into view. Its outline is beginning to take shape…
Yes, we can see it now, sharp and shiny — a pin — on a collision course with a bubble…
The stock market bubble.
What is propelling this pointy menace? When might it impact? Answers to follow.
Let us first glance at the expanding blister it is bearing in on…
The day counted plus and minus — plus for the S&P and Nasdaq — minus for The Dow Jones.
The S&P gained eight points. The Dow Jones lost eight points, washing away the S&P’s gain. But the Nasdaq tipped the board with a 56-point boost.
And so there is somewhat more joy in heaven today.
Gold, meantime, scratched out a gain of $3 and change.
So much for today. Let us now train our vision on the approaching pin…
Citi’s “Panic/Euphoria” index has struck a record high. That is, market euphoria has struck a record high.
Investors are dumbstruck and delirious, dizzied by trillions in Federal Reserve liquidity.
Trees can indeed scrape the sky, growing under the nurturing influence of Jerome Powell’s hoses.
Dow 30,000? Why not. On to Dow 40,000. On to Dow 50,000.
As a percentage of assets, investor equity holdings approach record heights.
Meantime, our minions inform us these investors are buying up call options at record rates — that is, wagering on higher stock prices ahead.
Pay no mind to today’s stratospheric valuations, they say. It is true, valuations approach those of the late 1990s — shortly before another pin found its mark.
The S&P’s price-to-earnings (P/E) ratio presently reads roughly 30… nearly double its historical average.
That is, history argues stocks are extravagant.
But this time is different… shout the dumbstruck, delirious and dizzied…
Today’s ground-level interest rates justify today’s stratospheric valuations… and today’s skyscraping stock prices.
Goldman — for example — claims stocks are no more expensive than 15 years ago. That is, stocks are no more expensive than in 2006. The bubble is a mirage, it concludes.
Just so. But we would remind Goldman that a bubble was inflating in 2006.
We would also remind Goldman that the market is not a study in mathematics. It cannot be captured in lines, bars or graphs.
The Elusive Markets
How do you represent fear on a chalkboard? Or greed?
Markets are a study of psyches. Of emotions. And passions. They will not be reduced to numbers.
As well attempt to reduce love to numbers… to translate Romeo and Juliet into a mathematics textbook…
Or to plot a sonnet along an ‘x’ and ‘y’ axis…
Or to express Nancy Pelosi’s hatred for Donald Trump through quadratic equations.
It cannot be done.
Do you wish to comprehend markets? Look to the head, look to the heart, look to the glands.
The head shrinker and the romance scribbler hold out far greater promise than the number cruncher.
The head shrinker in particular has an easy diagnosis at present…
It’s Different This Time
Mr. Lance Roberts of Real Investment Advice:
One does not have to dig too deeply to find evidence of the “psychology” driving the current stock market bubble.
Speak with almost any retail investor, and you will hear a common refrain from “the Fed won’t like markets decline” to common justification catch-phrases like the “Fear Of Missing Out (F.O.M.O)” or “There Is No Alternative (T.I.N.A.)”…
It is all reminiscent of the market peak of 1929 when Dr. Irving Fisher uttered his now-famous words: “Stocks have now reached a permanently high plateau.”
This “time IS different.”
However, “this time” is only different from the standpoint the variables are not the same as they have been previously.
The variables never are. But the outcome is always the same.
We must agree. The outcome is always the same. Only the variables differ.
So let us now turn to one variable that may “yield” the inevitable outcome — the bubble’s bursting.
That is, let us identify the approaching pin…
Omens From the Bond Market
Today’s gorgeous stock prices are justified by low interest rates, say Wall Street’s drummers. They will remain justified so long as interest rates remain low.
But have you glanced recently at the bond market?
10-year Treasury yields are on the jump. Below 0.90% in mid-December, yields have lurched to as of 1.18% yesterday.
1.18% is piddling by the standard of history. 10-year yields average 4.40% across time.
But with markets — as with life — it is not so much where you are. It is where you are going.
And yields are going up.
That is largely because — we hazard — the bond market has caught a glimpse of approaching inflation…
Not quantitative easing’s phantom inflation that only inflated stocks. But actual consumer price inflation.
The Kindling for an Inflationary Flame
The pandemic has turned out blizzards of spending… including the recent $900 billion “stimulus” package.
The bond market spots additional spending ahead now that Democrats have seized all branches of government.
The long-anticipated inflation may finally gurgle.
As we have explained prior, yields rise because inflation eats into a bond’s value as the termite eats into wood.
Under inflation, a bond is a sawdust asset.
Bond holders therefore demand a higher yield to compensate them for the termite’s ravages, for inflation’s ravages.
Thus we have our pin: Rising interest rates.
Again, we are told today’s vanishingly small interest rates warrant today’s obscenely high stock levels.
What then can you expect when interest rates rise? That is correct. You can expect stocks to plunge — at least you should expect stocks to plunge (we have cried false alarms before).
But what is the interest rate that could topple the stock market?
3%… 2.5%… perhaps 2%? Recall, the 10-year Treasury presently yields 1.18%.
When the Pin Strikes the Bubble
We turn to SocGen’s Albert Edwards for the possible answer:
We all understood in 2018 (and we still know now) just how dependent this equity bull market is on low bond yields… But back then, with the S&P just shy of 3000 and much more moderate multiples than today it took a rise in 10y bond yields above 3% to ‘break’ the bull run. Now with the U.S. tech sector on a forward PE close to 30x (vs 20x back in Q4 2018), it will clearly take a lot less to break the equity market and trigger the bursting of this bubble.
What then is the bubble-popping figure?
I don’t believe there is a cat in hell’s chance that… U.S. 10y yields can rise to 1.5%. The equity market bubble will burst long before we get there!
10-year Treasury yields are within range of 1.5%.
That is, the stock market is presently within range of the prickly pin.
When that pin strikes — if it strikes — we do not know.
Again, we have yelled wolf before.
But you may wish to keep a weather eye on 10-year Treasury yields…
Managing Editor, The Daily Reckoning