Bounding To The Top

August 12, 2020

The US markets are back to their all time highs! Great news if you own a lot of equities. It is the fastest drop and climb ever, in the history of markets and it is truly awe inspiring.

Unfortunately, the economy is terrible and liquidity is driving investors into a market that is likely to fall under it’s own weight. Of course this blog has been making that prediction for over four months and so it seems crazy. It is certainly worth considering that the timing will not meet the needs of the average reader, but there is a good chance that the market will be forced to accommodate reality in the not too distant future.

What reality?

The chart below shows continuing claims for unemployment overlaid on the S&P 500 over the past 13 months. This sort of result can only work out in a situation where the government is protecting people through provision of benefits, protection from being evicted and no social unrest. The current market valuation has reached crazy time (note the red line is continuing claims for unemployment).

But that’s not all. You can see interesting aspects of the market in plenty of other areas as well. Yesterday, Tesla, the maker of electric vehicles announced a five for one stock split. Now if you know anything about finance, this is the equivalent of taking a five dollar bill, and exchanging it for five one dollar bills. There is no change to the company. But Tesla rallied 13%. Tesla has stopped growing and is only profitable when it counts revenue from NOT selling cars, yet it is trading at a P/E ratio over 800.

Plenty of other companies are participating in crazy too. Here is a chart of the PE Ratio for the S&P 500. It has climbed steadily over the past 10 years and now sits at 29. That is well above the long term average which is closer to 18, yet the economy is in the dumps.

P/E Ratio for the S&P 500 is at a 10 year high

Investors of course have been buoyed by improvements in retail sales, employment data, expectations for COVID vaccines and continuing support from fiscal measures such as support for the unemployed. Unfortunately all of the improvements being shown by these measures, when looked at in context, also show a dramatic drop in economic measures.

Retail Sales are holding up pretty well, but bankruptcies are rising rapidly, and many small businesses are simply closing down. This may bode well for larger companies for a while, but soon the drops in income will affect revenue and profitability.

Employment is being celebrated which is baffling to anyone who has watched economics for a long time. An unemployment rate over 10% was considered horrible. It is currently sitting at 10.2%, with over 16 million people unemployed, almost three times as many as were unemployed at the depths of the last recession.

Continuing Claims for Unemployment (July 24, 2020)

The latest information on vaccines for COVID-19 buoyed the markets again this week when Russia announced a vaccine. Experts around the world are voicing concerns for good reason. Normally before a drug (including vaccines) are used broadly in humans they are tested in hundreds of people (a Phase II trial) and then in thousands of people (a Phase III trial). Russia appears to have given their drug to 76 people so far and those results have not been peer reviewed. It is likely that this is yet another area where markets may be reading too much into the headline, without looking at the data.

Of course this leads to the additional financial support that the president signed into action using executive orders on Saturday. These measures were hailed so far this week, but they may not even be workable, legal or meaningful. To anyone who understands the ‘how’ of getting things done in the US bureaucracy, these orders seem impossible. To anyone who understands the scale of the problems coming, they seem almost irrelevant.

Of course markets continue to bound higher, like none of this matters. Perhaps we have entered a new phase in the euphoria where nothing does matter, but sooner or later economics tends to overwhelm even the smallest inconsistencies.

Be very careful with your capital.

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