Fed's New Paradigm Adds Helium To The Stock Bubble

Valuations are not only high, they are among the highest on record.

The Laws of Investing

The Wall Street Journal asks Has the Fed Rewritten the Laws of Investing?

It has been an odd year with the Covid-19 crisis hammering the economy, but stocks recovering from sharp losses and then powering to new highs. As a result, standard measures show valuations are at rarely-seen levels that have typically ended in tears.

The S&P 500 trades at 22 times analysts’ expected earnings—its most expensive level since the dot-com bubble. It also trades at its richest multiple to its inflation-adjusted earnings over the past decade—the valuation method popularized by economist Robert Shiller —in nearly 20 years. The total value of U.S. stocks as a percentage of the U.S. economy, which Warren Buffett once called “the best single measure of where valuations stand at any given moment,” is now higher than at any point during the dot-com years.

Stocks vs Interest Rates

Some suggest stocks may not be as expensive as they seem because interest rates are extremely low. 

John Hussman has pointed out the fallacy of that theory many times. The Journal explains the fallacy this way.

The 10-year Treasury largely reflects investor expectations of what the overnight rates set by the Fed will average over the next decade. The Fed responds to what is going on with the economy, setting rates higher when it is trying to cool things down, lower when it is trying to heat things up. So low yields are tantamount to a low-growth, low-inflation economy—one in which profit growth would be low, too. Why pay up for stocks under that scenario?

Stocks vs Bonds

Some argue that stocks are cheap compared to bonds. But that is like saying truffles are cheap compared to moon rocks. 

It sounds good on the surface but makes little sense if you think about it for more than a few seconds.

TINA

Then there's TINA: There Is No Alternative. The idea behind TINA is people have to invest somewhere, they want to be liquid, so they pick stocks and bonds making bubbles out of both.

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