Friday, August 21, 2015

A rare look at fundamentals

Knowing exactly when to buy or sell the stock market has nothing to do with fundamentals such as economic growth, the unemployment rate, corporate earnings, or interest rates.  Rather, market timing is about noticing the first indications of a change in patterns of buying and selling stocks.  There are any number of reasons for patterns to change, but for a market timer the only thing that matters is the behavioral change of buyers and sellers, not the cause of it.

That being said, fundamentals can provide a long-term forecast of possible resolutions of a rally or of a bear market, and to put it mildly, our fundamentals are very bearish.  Rather than fill this page with charts and explanatory text, I'll outline the big issues here as concisely as I can and leave deeper discussions for later:
  1. The Federal debt-to-GDP ratio is about as high as the previous record level that was reached at end of WWII, and unlike a victorious U.S. that was able to stop building war machines cold-turkey in 1946, today future government payments (Medicare, Medicaid, Social Security, Unemployment, Welfare, Obamacare credits...) are supposed to keep rising indefinitely. That simply can't happen unless the value of a dollar is allowed or forced to collapse.
  2. The Federal Reserve interest rate has been at 0% for more than six years, meaning the Fed is now boxed in to a corner if the economy starts to sag again.  Raising rates would only worsen the economic decline.
  3. The Federal Reserve has printed more than $3 Trillion (bought more than $3 Trillion of government debt) since the most recent financial crisis in order to prevent defaults, and it will probably print even more if the economy starts to decline.  If the policy isn't changed, eventually all that counterfeited - er, printed money will crush the value of the dollars sitting in your bank and retirement accounts.
  4. Zero-percent interest rates and money printing have simply re-inflated bubbles.  It's easier to afford a house when interest rates are low and banks are flush with cash, so this has kept home prices artificially high along with the supposed net worth of lending banks.
  5. Corporations have used the low interest rates to borrow money and buy back stocks, and this has inflated the stock market to maddening valuations.  Today the S&P 500 index has a P/E ratio (assuming the data isn't fudged) of 21 and a dividend yield of 2%.  Historically the P/E averages around 15 and the yield averages about 4%.  Prices would need to fall 30% to 50% from here just to return to average, leaving alone the fact that the P/E ratio sometimes falls below 10 and the yield sometimes surpasses 6%.
  6. Speaking of the economy, things do not look rosy.  The fraction of working-age U.S. citizens who are employed is 62.6%, which is the lowest fraction since 1977.
  7. Recent college graduates have college loans totaling $1.4 Trillion.  They'll have a hard time paying them off - interest notwithstanding - if the employment rate keeps falling.
  8. Retirees, or people who wish to retire, have few options for generating cash flow from their savings.  For them, low interest rates mean low retirement income, which forces them either to retire in very modest conditions or keep working well past retirement age.
  9. Recent estimates of economic growth (GDP) are less than inspiring, and past estimates of growth have a funny way of being revised downwards on a regular basis.  This lackluster performance has come despite the Fed's frenzied counterfeiting money printing.
There's much more that I could add, but the above list covers most of the big quantifiable factors.  In short, a big economic storm has to hit eventually - it's just a matter of when, how much pain there will be, and where the government allows the pain to hit.

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