Once upon a time investing in stocks was about value. When you buy a share of stock, you buy a stream of future payments. Question is, how much do you have to pay for that stream? The lower the price, the higher the value.
Investing basics: Price/earnings
One common measure of stock value is the price/earnings ratio or P/E. That divides the company’s current share price by its earning over the last year. If a share costs $45 and last year it earned $1.96, then the P/E would be $45/$1.96 or 22.96. P/E gives you a rough idea of how long it would take the stock’s dividends to repay your capital, in this case, about 23 years. That means it is yielding roughly 3%.
On 6/18/2013, the Price Earnings Ratios were Dow Industrials, 16.74 Dow Transports, 21.43 Dow Utilities, 25.70 S&P500, 18.28 Nasdaq 100, 18.55 Russell 2000, 59.12 [sic] Historically, P/Es around 6 signal that stocks are undervalued and a good buy; P/Es above the mid-teens signal stocks are overvalued and expensive. Since the 1990s bull market, however, P/Es have been persistently high, well above the range of the last 100 years most of the time.
Dividend yield or “yield” shows how much a company pays in dividends every year relative to its share cost. Setting aside any added capital gain from a share price increase, the dividend yield measures the stock’s return on investment. Dividend yields on 6/14/2013 were Dow Industrials, 2.38% Dow Transports, 3.5% Dow Utilities, 3.06% S&P500, 2.08% Nasdaq 100, 1.47% Russell 2000, 1.74%. (You can find current P/Es and dividend yields here at the Wall Street Journal.) Over the last 100 years, the dividend yield ranged from 3-3.5% on the low side to 10-11% on the high side. You sold stocks when they yielded 3.5%, and bought them when they yielded 10%. However, in the last 20 years, that 3.5% has become more ceiling than floor as dividend yields have been the lowest in history. More, both dividends and yield disappeared as measurements during the dotcom bubble. Companies with no earnings or even projected earnings flew up, but without any real means to evaluate them. Clearly, this is a casino, and not investing.
As Clint Eastwood’ Dirty Harry said, “You’ve got to ask yourself one question: Do I feel lucky? Well, do you, punk?” Are you really lucky enough, is the stock market lucky enough, to continue to outrage history’s witness? Have we really reached a “new era” when valuation and economic performance don’t count?
Personally, I don’t feel that lucky. And I don’t draw to an inside straight.
Besides, I’m no day trader, not even a week trader. I want to find and ride a market in an upward primary trend (“bull market”) that will last 15 to 20 years.
This much is clear: New stock bull markets do not launch from P/Es in the 20s, and dividend yields below 3.5%. You aren’t that lucky. Not even Ben Bernanke is that lucky.
Now return to that question of capital gain, the advance in the share price. Logically, the share price can only rise if the company grows or becomes more profitable. Well, markets aren’t always logical, and the stock market today certainly isn’t. Since the 1990s markets have been transformed from arenas for valuation into casinos. “I don’t care what the value of the company is, only that its share price might rise.” Speculation has replaced valuation.
But don’t take my word for it. Earlier this year the president of the Dallas Federal Reserve Bank, Richard Fisher, said in a 21 February 2013 interview, “The Fed has artificially sustained markets.” Stocks’ gains “have not come through improvements in corporate fundamentals, or sustainable economic recovery, but instead through artificial manipulation by the [Fed] in markets themselves.” www.examiner.com/ article/fed-admits-that- stock–market -gains- are-tied-to-central-bank-manipulation. Clearly Bernanke has focused on raising stock prices as a way of creating economic growth, as loony as that sounds: “If I can just force this cart uphill, the horse will have to come with it.”
In any event, it won’t work. Newly created money flows first into the financial markets, and much of that excess liquidity will bleed into stock market speculation. The gains, however, are an illusion. Hyperinflation in Germany caused a stock market boom that made many millionaires, but in the end those gains did not keep pace with the inflation (read: currency devaluation and purchasing power loss). Prices grew, but purchasing power fell. We are watching the same thing in slow motion in the United States today. I say “slow motion” not because Bernanke’s inflation is either slow or measly in itself, but only compared to the 1920-1923 German hyperinflation.
Why hasn’t Bernanke inflation shown up?
The greatest question, one I have not seen answered in satisfactory depth, is why Bernanke’s monetary inflation hasn’t created greater price inflation.
First, government figures lie, and understate the true rise in prices. John Williams of www.shadowstats.com makes a career out of debunking government statistics. He ignores the periodic “adjustments” the government makes to church up the statistics and uses the 1980 methods, before the gimmickry was introduced. While in May 2013 the various confusing government inflation measures showed year to year increases from 1.06% to 1.65%, ShadowStats Alternative Consumer Inflation Measure showed prices increasing 9.0% year over year. (Shadowstats, No. 534, 18 June 2013).
But in common with most everybody else, Mr. Williams allows that the reason Bernanke’s balance sheet bloat is not flowing into the broad money supply is that “banks still are not lending normally into the regular flow of commerce.”
Is Bernanke really that lucky? Can he really inflate the Fed’s balance sheet by $2.5 trillion in four years without igniting price inflation?
(Never overlook this point: The chief aim of Quantitative Easing has always been to clean up the banks’ balance sheets. Bernanke is buying $45 billion monthly in risky mortgage-backed securities from the banks at full nominal value so they can buy riskless Treasury bonds with the money. By expanding the Fed’s balance sheet, he has made it the garbage can for the banks’ bad assets. All the rest – raising the stock market, stimulating the economy, fighting halitosis – is just lagniappe that comes with bailing out the banks.)
About that multiplier
Remember that banks are the main engine of inflation. The Fed only creates new money, but banks take it and multiply it roughly 100 times. If banks won’t lend, the Fed can’t inflate much.
OK, this is my unorthodox measure of the bank “multiplier.” What’s that? The “multiplier” measures how much money banks can create from a dollar’s worth of new reserves. If they are required to hold in reserve 10% of deposits, then the whole banking system can created 1/0.10 or 10 new dollars for every dollar deposited
Here’s how it works: the Fed buys a million dollar T-bond from a bank, creating the million bucks out of thin air by accounting magic, and credits the bank’s account with “reserves.” The bank cannot create this sort of dollar out of thin air, but once it gets these dollars as “reserves,” it can create dollars of its own credit, pyramided on these reserves. Then those credit dollars are spent, deposited in another bank, and except for the “reserve” that bank must keep, the second bank can lend out the rest, and so on through the banking system until the one dollar deposited becomes ten dollars of bank credit.
The “reserve requirement” is the percentage of those credit dollars the banks must keep, but its reciprocal is also the number of times they can multiply those dollars by loaning out their credit. If a bank must keep 10% (0.10) of deposits as reserves, then it can loan out 1/0.1 or ten times the dollars deposited. Thus under a ten percent reserve requirement, a $100 dollar deposit as it passes through the banking system can create $1,000.
Trying to calculate the multiplier/ reserve requirement for the entire banking system, you quickly run onto the rocky shoals of banking regulations. For reserve purposes, deposits are divided into several classes, according to the size of the bank, nature of deposit, etc. Years ago it seemed sensible to me to calculate it this way: take all the banking systems’ reserves and divide them by all the banks’ deposit liabilities. That should tell you exactly what the operational (never mind regulatory) multiplier is in fact.
And back in 1998-9 and the early 2000s it was around 0.75%. Yes, 1/0.0075 = 133.33, so for every $100 deposited into the banking system, the banks could create $13,333 in credit.
But then came 2003 and the Fed, probably digging a grave in advance for the corpse it planned to murder, stopped publishing M3 money supply, upon which my calculation rested, so I haven’t been able to calculate it since. I guess, however, that it’s around 1.5%, which means a 66.66 multiplier.
But the banks aren’t lending is what we hear on every side. What happens when they start lending again?
When government debt is turned into money
Meantime, the Fed is monetizing debt. “Monetizing debt” means that the Federal Reserve is itself directly buying federal government debt, literally, turning that debt into money. When the public buys bonds, that buying does not increase or decrease the money supply, it merely moves money from one pair of hands to another. When the Federal Reserve System buys the bonds instead of the public, however, it must create money to buy the bonds, i.e., turns the bonds into money or monetizes them.
But why is the Fed buying the bonds? Most likely because nobody else will, not a good sign in itself. They become the “buyer of last resort.” Given the federal government’s insatiable spending demands, once this monetization starts, it is very easy to continue. The Fed becomes the government’s crack dealer.
What makes it so portentous, so frightening? It is exactly the mechanism that the Reichbank’s head, Rudolf von Havenstein, applied in 1920-1923. “Monetizing debt” was the German hyperinflation.
Since 2013 began, the Fed has “effectively monetized 78.4% of new net debt.” (Shadowstats, 18 June 13). Clearly, federal government bonds are getting harder to sell.
Well, if Bernanke and the Fed stumble and fumble into a hyperinflation, at least it will be good for stock prices. At least, as long as we don’t correct the gain for inflation.
The underlying causes: Debt & fiat money
The problem that underlies all the economy’s woe is found in the monetary system: all our money is borrowed into circulation. Bear this in mind, because unless this is changed, the economic situation won’t change.
Thanks to federal government policies in every field, over the past 50 years debt has been substituted for production as the means of economic growth. Therefore, the debt must keep growing, or the economy shrinks. Consumers must borrow to maintain living standards. Of course, that means the interest burden grows as well as the economy, so debt must have some limit.
Think of loading a pack mule. You put on 100 lb., and he’s fine. Add 50 lb., he can still walk. Pack on another 100 lb., he’s still standing. But you throw on one more two pound bag of salt, and his knees buckle.
Keynesian orthodoxy says, if consumers won’t borrow, then the government must, for without spending the economy dies. And if no one is producing anything, then government must borrow more.
One more little problem: economies habituate to debt just as addicts habituate to heroin. Over time, it takes bigger and bigger doses to get the same kick.
From 1947-1952, every dollar of new debt increased GDP $4.61. From 1953 to 1984, every dollar of new debt increased GDP only 63¢. From 1985 – 2000, a dollar of new debt bought only 24¢ of GDP growth. From 2001 – 2012, a new debt dollar bought only eight cents in new GDP.
Please read Part II of this essay that looks in debt in pictures; the U.S. government’s unfunded liabilities are 550 percent the gross domestic product.
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