The Fed Puts off the Day of Reckoning
The times are out of joint… and the old familiar signposts point wrong.
The stock market runs once again at record heights. And the economy simmers along.
The United States unemployment rate — if you accept official figures — plumbs 50-year lows.
In apparently hale times such as these…
The Federal Reserve might bridle the animal spirits, choke the reins some… and raise interest rates.
Or at the least hold rates steady.
The pace is brisk, after all.
Yet today Jerome Powell loosened his hold, applied the whip… and urged the nag onward…
A Rate Cut It Is
Powell and his fellows lowered interest rates an additional 25 basis points.
The federal funds rate now ranges between 1.50% and 1.75%.
The Federal Reserve first crossed into this territory on the way up — when it was attempting to “normalize” rates.
Now it has ranged into this zone on the way down… as it abandons normalization.
We are not certain it will ever normalize. We are — in fact — confident it will not.
It races a race with no finish line.
It must run and run and run some more… lest the horsemen of the apocalypse run it down.
But let us remain in the here, let us remain in the now…
How did Mr. Market, viewing from the grandstand, take today’s action?
An Overall Muted Reaction
The major indexes opened in red this morning, the three of them.
They remained in red through 2 p.m. Eastern. Then at the appointed hour, word came down…
And the animal spirits began to stir — somewhat.
The Dow Jones ended up gaining 115 points on the day. The S&P gained 10. The Nasdaq, 27.
But today’s rate cut had already been “baked into the cake.”
Hence, the subdued reaction.
The market is far more concerned about the future.
With markets, it is not so much where you are — but where you are going…
Looking for Clues
All ears were glued to Mr. Powell’s post-announcement babblings, in search of clues.
Suggestions of additional rate cuts would scintillate and enrapture.
A hearty denial of additional rate cuts would leave Wall Street sullen and glum.
What did Mr. Powell say about the future?
Did he dangle a plum… or grab a stick?
He dangled no plum.
Today Mr. Powell claimed only a “material change” would force another rate cut. More:
We see the current stance of monetary policy as likely to remain appropriate as long as incoming information about the state of the economy remains broadly consistent with our outlook.
Moreover, he claimed, “Monetary policy is in a good place.”
We are vastly unconvinced by the chairman’s flubdubbery. And we do not believe monetary policy is “in a good place.”
But let it go for now.
Instead, cast your gaze toward the uncertain future…
Will the Stock Market Rise 20% Over the Next Year?
Today’s was the third consecutive 25-basis point rate cut.
The Federal Reserve has yielded three consecutive 25-basis-point rate cuts on previous occasions.
Foremost among these were the years 1975, 1996 and 1998.
Taking history as your example… what can you expect from the stock market in the year ahead?
A bonanza — evidently.
MarketWatch, forwarding the conclusions of LPL Financial:
[Returns] have been spectacular in the six- and 12-month period following those decisions by the rate-setting Federal Open Market Committee. LPL data show that the S&P 500 index has been up 10% a half-year later and 20% a year out, gauged by three initial 25-basis-point cuts in 1975, 1996 and 1998.
Trump Would Be Happier Than Anyone
If true — if true — few will dance a livelier waltz than the incumbent president.
The 2020 election is one year and one week distant.
If the S&P rises 20% over that space, Mr. Trump will likely keep his throne.
(Here we assume impeachment will not first heave him out.)
But beware — the past throws out false clues and false leads to send you astray.
2019 is not 1998, is not 1996, is not 1975.
Circumstances, characters change.
We find no reason why the stock market must go down the same rising road.
Today’s stock market valuations remain in what our former colleague David Stockman labels “the nosebleed section of history.”
Stocks Are Wildly Expensive by Historical Standards
Yale man (and Nobel winner) Robert Shiller hatched the cyclically adjusted P/E ratio (CAPE).
The lower the number, the cheaper the stock. And vice versa.
Its historical average runs to 16.6.
Today’s ratio is 29.9 — let us round up to 30.
That is, stocks are vastly expensive by history’s standards.
Today’s valuations rise even above 1929’s — and show 2008’s their dust.
Only during the dot-com delirium were stocks dearer than today:
Who knows what pin might collide with what bubble within the next year?
A 35% Plunge
Financial journalist Mark Hulbert has perspired over the market history since 1900.
His research reveals bear markets tend to greater severity when stock valuations are elevated.
Given today’s wild valuations, how far might the Dow Jones drop next time?
The answer, says Hulbert… is some 35%.
But Hulbert is not the only analyst hollering about today’s Himalayan stock valuations…
Analyst Rob Bennett likewise believes these valuations constitute a staggering threat.
They run far ahead of the underlying economy. And soon or late, gravity will work them down:
We can’t just create money out of thin air by pushing stock prices upward. At some point the market insists that prices reflect real value (this is Shiller’s core finding). Pushing prices up is a holding action. Sooner or later we have to accept that fair-value prices will prevail again and that the economic pain that follows from a return to fair-value prices must be endured.
High stock prices are a lie.
This Bennett further believes the 2008 crisis never ended. The Federal Reserve’s cheap medicine merely sent it into remission.
But like a vicious cancer, it will come back around:
To my way of thinking, we will be seeing a resumption of a crisis that we experienced for only a few months in late 2008 and early 2009 and then put off for another time. We put that crisis off… But the put-off was a temporary thing.
The only lasting cure?
To achieve more permanent solutions to the problems that received national attention in late 2008, we are going to have to come to terms with the primary cause of those problems — the high stock prices that still apply today.
Whether the curtain comes down within the next year, the next two years, the next five years or 10… the answer is beyond our slender abilities.
We simply cannot say.
Managing editor, The Daily Reckoning