The Economist's Buttonwood Tree has become a stock-market bear. Is that allowed?
Economist.com: Even after this latest tumble, the price-to-earnings (p/e) ratio on Nasdaq is around 60, a level that could be justified only if you thought that profits would continue to climb at a vertiginous rate. The question, of course, given that the broader stockmarket is scarcely a giveaway—the S&P 500 trades at a p/e ratio of about 21, far above its historic average—is whether the treatment meted out to tech stocks foreshadows something nasty for the stockmarket as a whole.
Corporate America, you might have noticed, is fantastically profitable. Indeed, pre-tax profits are at their highest for 38 years, says Mark Precious, a global strategist at UBS, and after-tax profits at their highest for 50 years. And they are likely to have grown by a fifth or more in the second quarter, which is only the fifth time in the past 50 years that profits have grown that much for that long, according to Mike Thompson of Thomson Financial....
On two of the previous occasions when profits had risen this fast for this long, stocks rose thereafter; and on two they fell. There are many reasons to plump for a less rosy outcome this time round, however. The first is that shares are expensive. High p/e multiples are perhaps justifiable when profits are depressed, but much less so when they are frothy. As your columnist has said before, when things can’t get any better they won’t. As a percentage of national income, corporate profits are already at record highs, and will, in the none-too-distant future, have to cope with, inter alia, tightening fiscal policy, tightening monetary policy, strong oil prices, the scrapping of corporate tax breaks, slowing demand (on which, more later) and quite possibly less pricing power....
America’s inventory-to-shipment (I-S) ratio. This, says Mr Bowers, is at an all-time low, largely due to a very rapid growth in sales. But it is set to rise. When it has done so in the past, he writes, “bonds have been a ‘buy’, earnings growth has been scarcer, industrial pricing power weaker, and high-yield credit spreads wider. Ignore this indicator at your peril.” Suitably admonished, Buttonwood read on. Shipments, it turns out, have been rising exponentially. And when things are flying out of the factory door at such speeds, factories stock up. Inventories, says Mr Bowers, could end the year 6-8% higher than they started it. Which would be fine if shipments followed suit. They are unlikely to do so because exponential growth is simply not sustainable. When final demand starts to weaken, the I-S ratio will rise, dramatically weakening corporate pricing power and (one assumes) profits.
Which is where we get back to technology. Inventories have already started to rise sharply at Intel (by 29% year-on-year in the first quarter), Texas Instruments (30%) and Cisco (47%). Possibly, this is a foretaste of a broader problem, for America relies on demand from consumers who have, to be frank, consumed to the max and done so with borrowed money. In the 13 quarters from 2000, household debt surged by $2.5 trillion, writes Kurt Richebächer, an extreme bear (perhaps, then, a polar bear?). Of late, for the first time in history, consumption growth has exceeded growth in GDP. Against such a backdrop of tiny household savings and huge debts, the Federal Reserve has started raising interest rates. Small wonder, perhaps, that although consumers say they are confident, they are starting to rein in their spending. Car companies and retailers are already suffering as a result. At some point, so will the stockmarket...
All very sound and cogent--if the Federal Reserve does tighten interest rates substantially over the next couple of years.
Posted by DeLong at July 13, 2004 08:04 PM | TrackBack | | Other weblogs commenting on this postFunny -- I just posted something on this very subject earlier today -- its the historical impact of inflation on market performance, with a long time chart of the S&P500's P/E ratio.
have a look: http://bigpicture.typepad.com/comments/2004/07/_chart_of_the_w.html
Posted by: Barry Ritholtz on July 13, 2004 08:24 PM
Dang it, I came here to get away from all the bestiality talk about Sen. John Cornyn and his box turtle and Sen. Santorum over at Eschaton & Political Animal. So I come here, and find pondering on whether so-and-so can become a bear. There's no escape!
Posted by: John Owens on July 13, 2004 09:34 PMokay, smart guys, if stocks are expensive, and bonds are too, what's cheap? are we supposed to stuff cash in money markets?
Posted by: c. on July 14, 2004 12:12 AMCould I just remind BDeL readers who have meagre savings to preserve that the Economist originally called the top on the DJIA a few months before Alan Greenspan's "irrational exuberance" speech, at around 6000, about the same time they were saying that Clinton would be thrown out of office and EMU would never happen? As forecasters, they had a good run with Thatcher, Reagan and the Berlin Wall, but have been going through a rough patch of late.
Posted by: dsquared on July 14, 2004 01:14 AMIf there's nothing worth buying, head for the beach. That's what I've heard, anyway.
Posted by: Ville on July 14, 2004 02:07 AM"Of late, for the first time in history, consumption growth has exceeded growth in GDP"
What does this mean? One would assume it means the % growth in consumption has exceeded the % growth in GDP for the first time, but that a) isn't true, and b) couldn't be true unless consumption as a % of gdp has been falling consistently since records began.
DOes it mean in absolute terms, i.e. consumption grew by $2 trillion but GDP by only $1.8 trillion?
Posted by: Matthew on July 14, 2004 03:07 AMNone of the asset classes are particuluarly cheap right now. A place to look is in the preciouc metals (hold the comments about the PMs not being money anymore). Debt free or near debt oil & gas explorations are pretty cheap, US and Canadian. Cash isn't bad right now. Short term US government bills are a good place to be right now. You'll lose from inflation, but the unit value of a dollar is still a dollar after all the other markets tank.
Anybody holding the S&P, DOG and Dow is going to lose money. The markets in the US are supremely manipulated by the ESF/PPT/Fed and cabal pals, so don't short unless you are confident.
Consider holding foreign cash, too.
Posted by: phil on July 14, 2004 08:15 AMTo C:
Nothing is cheap when the Fed holds the short-term rate lower than inflation for the past two/three years, at least no financial asset is cheap. Your choice is losing money now (by putting your savings in short-term cash accounts) or losing money later (by taking risk investing in all sorts of other stuff). Stock up physical stuff may be a better alternative, which of course will be counted as spending, and that is the purpose of the Fed's holding the short rate so low -- to stimulate spending.
Posted by: pat on July 14, 2004 10:24 AMTo C:
Americans in general are way too focussed on US markets.
If everything in the US is overpriced that suggests that the US is overcapitalised - ie, demand and supply are out of whack with too much supply of capital and not enough demand.
So switch to markets that are not overcapitalised.
Unless you think the US dollar is going to rise a lot in the medium to long term (a difficult thing to imagine right now) you should invest broadly outside the US. Hell, you can get 6% just on on bank term deposits in Australia or New Zealand, and while their dollars are no longer undervalued the way they were a year ago (cf Economist Big Max index) they're hardly overvalued. But play it safe: spread your money across europe, australasia, and asia. Or get Vanguard to do it for you.
That foreign central banks are investing in the US's lousy markets doesn't surprise me: there are systemic incentives for beaurocrats to think short-term, follow the herd, and leave the mess to their successors. But why US investors invest so much in the US is utterly beyond me.
If a fund manager suggested to a US investor a 'diverse portfolio' of a dozen investments in Japan and 2 investments in the rest of the world, the US investor would think that utterly bizarre. Yet many US investors seem to think that a 'diverse portfolio' of a dozen US investments and a couple of small investments outside the US is fine. Madness!
Wake up and smell the globalization.
meno
yeah, well, P/E's for europe and japan are both up around 20 also. they're not cheap either.
Posted by: c. on July 14, 2004 08:34 PMSo if the world famous Economist columnist Buttonwood calls for a "readjustment" should we be scared? Well, yes, they did call the last Nasdaq bubble too...
Posted by: AllenM on July 15, 2004 05:17 PMIf one wanted to invest in foreign currencies and 1) didn't want to grab a pile of forign cash to stuff under the mattress and 2) didn't have a few million to risk, but more modest sums, how would one best do this?
Posted by: palamedes on July 17, 2004 08:07 PMnice site i really like your writings
Posted by: cigarettes on August 3, 2004 06:21 AMMost of them smoked cigarettes Save money on cheap cigarettes Cigarette smoking has been buy cigarettes. order cigarettes the most popular method of taking offer discount Camel cigarettes nicotine the year a report offer discount marlboro cigarettes that concluded that buy cigarettes. order cigarettes cigarettes and other Save money on cheap cigarettes forms of tobacco smoking cigs for all the Buy cigarettes and pack of smokes for you rolling tobacco would you like cigarettes with Free delivery of cigarettes years of smoking can cause cigarettes Chesterfield cigarettes bar talking with people Lucky Strike cigarettes Marlboro
Posted by: cigarettes on August 4, 2004 07:22 AMnice site i really like it http://www.a1-cheap-cigarettes.com
Posted by: cheap cigarettes on August 5, 2004 08:15 AMnice site i really like it http://www.my-discount-cigarettes.com
Posted by: discount cigarettes on August 6, 2004 06:15 AM3038 You can buy viagra from this site :http://www.ed.greatnow.com
Posted by: Viagra on August 7, 2004 01:30 PM152 Why is Texas holdem so darn popular all the sudden?
http://www.texas-holdem.greatnow.com
2826 get cialis online from this site http://www.cialis.owns1.com
Posted by: cialis on August 10, 2004 11:09 AM2854 Get your online poker fix at http://www.onlinepoker-dot.com
Posted by: poker on August 15, 2004 09:25 PM7522 black jack is hot hot hot! get your blackjack at http://www.blackjack-dot.com
Posted by: blackjack on August 16, 2004 06:59 PM