Our Lord and Master, the unelected Fed Chair Janet Yellen, spoke yesterday at the Finance and Society conference in Washington, D.C.
Yellen said, “I would highlight that equity market valuations at this point generally are quite high. There are potential dangers there.”
This was in response to a question from International Monetary Fund Managing Director and Sith Lord Christine Lagarde, who is also unelected by the people and is currently under investigation in France on fraud charges.
This leads me to think I need some cronies to help me spin my lies. A straight man to play off — a Dean Martin to my Jerry Lewis…
But the problem with cronies, as with minions, is that they tend to want something from you in return.
A little quid pro quo, some mutual back scratching, or at least promises of a brighter tomorrow. And well, to tell you the truth, I’ve never been a team player.
Buttonwood Trees
But I digress. I’m not here to talk about the cozy relationships of the monetary elite. We are talking about the equity markets. Those things that, in the past, existed to pool money to start an enterprise.
In the quaint old days, one would gather people with capital to form a company to, say, run a railroad or make soap. You would build a factory, hire workers, and pay the capitalists out of whatever profits the business may have at the end of the year.
And if you were lucky and the company grew and prospered, you could sell the shares of the company for a higher price at a later date. If not, you lost your money and sucked it up.
Ratios of Lies
But say you wanted to buy a preexisting company. The going rate then, as well as now, for a private company was about five times annual profits. This means after five years, you would get your money back.
In the shorthand of Wall Street, this would equal a price-to-earnings ratio (P/E) of 5. For a public company, you pay more because they are easier to buy and sell. The transaction friction is less. How much more depends on the fashions of the market.
P/E has been a marker of value for over 100 years.
Today, the P/E ratio on the S&P 500 is 20.32. The mean is 15.54, and the median is 14.58. The low was set in December 1917 at 5.31 after the Russians quit the First World War.
The highest P/E ratio ever recorded on the S&P 500 was 123.73 in May of 2009, a few months from the very bottom and right before the market more than doubled.
The reason the record-high valuation on the market was set at the bottom is because values were bolstered by free money from the Fed.
The market looks forward, and the forward price/earnings ratio in May of 2009 was 16.7. Not much different from where it is now, and much lower than the bubble of 2000, when the P/E hit 42.
Yes, earnings estimates are falling (down 5.9%) for this year. And yes, the market is more expensive than it was last year… But we aren’t in bubble territory in terms of high valuations.
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Where We Are Now
What we do know is that Yellen has an agenda.
Yellen’s simple observation that “market valuations are quite high” sent global markets down overnight. The S&P 500 is at 2,069, gold is swapped $1,179, and oil is at $61.08. The dollar fell over 1% and rates surged, especially in Europe.
It was almost two decades ago that then-Fed head Alan Greenspan tried to talk the market down. His speech on December 5, 1996:
Clearly, sustained low inflation implies less uncertainty about the future, and lower risk premiums imply higher prices of stocks and other earning assets. We can see that in the inverse relationship exhibited by price/earnings ratios and the rate of inflation in the past. But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?
It is funny how bubbles are all blown the same way, with jargon and double speak — a little noise and flash and don’t look behind the curtain.
What Alan Greenspan was really saying was, “I’ve cut rates from 6.5% to 1% to save my cronies. That money is getting dumped into dot-com stocks, and this will end badly. I feel kinda bad about you poor schmucks who aren’t hooked into Goldman Sachs, so this will assuage my ego a little bit, and I can point to it later and say I warned you.”
But Sir Alan Greenspan didn’t have to worry too much about his manipulation of the markets, as he didn’t anticipate how far the boom would run. The market zoomed up for another three years!
Say “irrational exuberance” again. We Love it!
The Dow from the year 1996 to 2000:
Here’s to another three years of money making bubbles.
All the best,
Christian DeHaemer
Check us out on YouTube!Christian is the founder of Bull and Bust Report and an editor at Energy and Capital. For more on Christian, see his editor’s page.
