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Valyooo (99.63)

"This is a bull market for stocks, not the economy"

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April 16, 2013 – Comments (13)

MoneyWorksForMe posted this in DragonLZ's last blog.  This something I hear all of the time (with slight variation in words), but I never understand it.

Yes, what the Fed is doing is not good long term for the economy, the printing press is crazy, etc.

But if the economy is doing so horrible,  and its just stocks going up because the fed putting a floor on the market, why is the p/e around 16?  If the economy was truly horrible, earnings would be falling, and with a rising market and falling earnings, p/e would be really high, like 25-40...But a p/e of 16 isn't really that outrageous..so how could the market be going up with the economy going down but a p/e staying at about average?

13 Comments – Post Your Own

#1) On April 16, 2013 at 5:49 PM, CCharing (86.90) wrote:

Bear markets and bull markets are only obvious in hindsight If I had to guess

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#2) On April 16, 2013 at 8:27 PM, Frankydontfailme (27.20) wrote:

Why do high earnings mean a strong economy?

 

The average person is poorer year over year, that is the point. 

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#3) On April 16, 2013 at 9:20 PM, TheDumbMoney (42.99) wrote:

The "economy" means real per capita GDP growth and productivity gains, etc., stuff like that.  

Corporate earnings are not really hugely correlated with the "economy" I think.

Now I think the argument is bunk.  But my point is that even if it's not, it's wrong to assume these two things move in unison. 

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#4) On April 16, 2013 at 9:58 PM, Valyooo (99.63) wrote:

If earnings consistently move higher and higher over time, and companies make up the economy, how could the economy be terrible? Maybe the domestic economy if sales are coming from abroad...but the economy is global now

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#5) On April 16, 2013 at 10:13 PM, Frankydontfailme (27.20) wrote:

Because corporations don't make up the economy, they make up the stock market. 

 Maybe stocks are cheap. Maybe the economy is strong. But, the economy is not strong BECAUSE stocks are cheap...

 

(neither is true but, we're concerned with the logic, right?) 

 

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#6) On April 17, 2013 at 12:50 AM, awallejr (82.72) wrote:

Seems like you are changing your tune since this thread:

 http://caps.fool.com/Blogs/overbought-at-its-peak-bull/797877

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#7) On April 17, 2013 at 1:36 AM, MoneyWorksforMe (< 20) wrote:

 Valyooo,

The size of most publicly traded companies, particulalrly those that comprise the Dow, S&P, and Nasadaq are considered "large." Large corporations have been able to insulate themselves from a weak domestic economy by increasing earnings overseas. Small US businesses have never recovered, while they rely on domestic consumption. With the US consumer "tapped out" and trying to pay down debt, small businesses are stuck in nearly the same position they were 5 years ago, and the easy money policies only make this situation worse.

This is problematic for several reasons:

1.) US small businesses are responsible for most of the employment in the US.

2.) The huge amounts of monetary stimulus being pumped into the western economies make matters worse, elevating asset prices, rapidly increasing the cost of living, while the US worker who is employed at an already-struggling small business receives no raise and continues to be squeezed--consumption declines further.

3.) Signifcant prexisitng personal debts, the government's very poor fiscal health (expectations of taxes), and poor small business environment (as mentioned above) is discouraging/preventing entreprenership. I do not know of one person from highschool or college who started their own business. It's really sad when I compare it to my father's generation.

4.) Large corporations, flush with cash from tapping into emerging markets and healthier consumers, buy out small US businesses that have a competing service/product. In some cases the business isn't really accretive, and the purchase is made simply to eliminate competition. Lay-offs of the former small business entity are implemented by the new, larger company and further pressure is added on the US consumer.

Here are a few more general points:

The cost of capital. When interst rates are held artificially low, markets become distorted because captial is too cheap. Investments are being made based on current interest rate levels, as if this is being set by market forces, aka REAL demand. But THE MARKET isn't setting the cost, one BIG entity (the fed) is. When the fed steps away, the markets adjust to their real levels and the enormous mal-investment becomes apparent.

Nothing has changed within the financial sector. The TBTF banks are even bigger than before the financial crisis, and are engaged in the same reckless behavior.

Government deficits and government spending as a percentage of GDP. Nothing more to add there.

So in sum, there is a dichotomy between large, publicly traded companies, and the small businnesess that employ most Americans. The vast majority of companies that comprise the major indexes have been able to do okay, despite the deteriorating US economic fundamentals by tapping into relatively stronger consumers in emerging markets, making their operations leaner via technological advances, and finally, a lack of competiton--relatively few entrepreneurs, and the ability  buyout/kill smaller competitors.

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#8) On April 17, 2013 at 1:50 AM, Melaschasm (65.13) wrote:

In the long run there is significant correlation between the stock market and the economy, but no so much in the short run.  Thus we can have a few years or even a decade where there is substantial divergence.

It is also possible for the long term performance of public companies to vary significantly from other businesses, which would cause a longer term change in the relationship between the stock market and the economy.

Finally if you plot the long term percentage change in the stock market along with the percentage change in GDP you will see that the stock market is much more volatile.  The difference is somewhere in the ball park of three times as volatile, so real GDP growth of 2% could easily coincide with real market returns of 6%.  

Considering the Great recession was maybe a 2 or 3% contraction in GDP, while the S&P was halved, stock gains many times larger than GDP growth should be expected.  This is the explanation I consider most likely for a bull market with stagnant economic growth.

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#9) On April 17, 2013 at 12:42 PM, Valyooo (99.63) wrote:

Moneyworksforme,

That makes sense.  I hope you don't think I was picking on you, I was just asking the question because I had seen that before but forgot until I saw you writeitagain

 

But why would the fed step away ever?  I cant see that unless inflation gets crazy.....and inflation will only get crazy from an increase in bank lending aka a good economy 

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#10) On April 17, 2013 at 1:16 PM, outoffocus (23.59) wrote:

+1 rec for the discussion. 

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#11) On April 17, 2013 at 1:54 PM, Frankydontfailme (27.20) wrote:

#9) Why do you say inflation can only get crazy with an increase in bank lending? We're the 70's not characterized by runaway inflation with a stifled economy?

Deficit spending alone (if not offset by private sector deleveraging), will certainly cause inflation. 

(not that I think inflation is around the corner, I'm struggling with your logic in this thread though)  

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#12) On April 17, 2013 at 3:58 PM, ETFsRule (99.94) wrote:

Melaschasm (80.37) wrote: "In the long run there is significant correlation between the stock market and the economy, but no so much in the short run.  Thus we can have a few years or even a decade where there is substantial divergence."

I agree. They are correlated in the long-term, but not so much in the short term. Also, corporate profits have a lot more variance than GDP.

From around 1950-1990, GDP grew faster than corporate profits. Since 1990, it's been the opposite. I think a lot of that is from globalization: multinational corporations are the ones making the most money. They are benefiting from the economic growth of other countries.

http://research.stlouisfed.org/fredgraph.png?g=hCS

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#13) On April 17, 2013 at 10:01 PM, MoneyWorksforMe (< 20) wrote:

Valyooo,

" That makes sense.  I hope you don't think I was picking on you, I was just asking the question because I had seen that before but forgot until I saw you writeitagain"

No it's fine really. I didn't think you were anyway. I completely see where you're coming from.

"But why would the fed step away ever?  I cant see that unless inflation gets crazy.....and inflation will only get crazy from an increase in bank lending aka a good economy "

The longer they stay and the more they do--you're right--the more difficult it is for them to step away. However, it is somewhat naive to think that inflation will remain low to moderate simply because there is no demand-pull inflation in the states. M2 money velocity is currently very low and inflation is already at a moderate level--no, it's not 1-2% as the fed reports. It's not over 8% either, but I'm inclined to believe real inflation is closer to 5%.

The real risks to much higher inflation here, without an economic recovery or US consumers releveraging, is 1.) a gradual loss of confidence in the dollar--not an epic collapse, but perhaps a loss of reserve status, or shared reserve status, and 2.) a gradual increase in wealth of other nations relative to the US. Many of the dollars being printed are flooding overseas, increasing the wealth and living standards of those in the emerging economies. As their wealth increases, they can consume more and afford to consume items they previously could not afford. With more people competing for the same goods, prices will rise for Americans, quite dramatically, even if the economy and lending remains weak.

 

 

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