PEfer Madness

Are stocks overvalued?

Here is a metric that is accurate back 150 years - the Shiller Price/Earnings Ratio.

This looks at average prices divided by the previous ten years earnings.  It signals massive overbought when the ratio hits 26.6.  It is 26.7 now.  This is about the same level that it was at just before the market crash in 1929.

So, this week I have shown you that the velocity of money is at its slowest since the Great Depression, and that stocks are as overvalued as they were just before that depression started with a massive stock market crash in October, 1929.  The writing is on the wall people.

But what will be the trigger?

Trump was elected promising trade wars.  The markets went up on the hopes for more tax cuts and a happy consumer.

The Italian referendum was a bust.  The markets went up on the promise of even more ECB stimulus.

This was all good, but in the next 7 days we have a very significant happening.

On December 14, the US Fed will increase interest rates for the second time in 8 years. What if they surprise us and raise them by half a percent?

The last time the US Fed raised rates, markets moved lower by 11%.

Dump your stocks and buy Gold.

It is going to fall....

We have seen two massive pull-backs in the DOW in the last 18 months...

May 11 '15, 18,272

Aug 31 '15, 16,102

That was a 11.8% drop in 3.5 months

Nov 2 '15, 17,910

Feb 8 '16, 15,973

That was a 10.8% drop in 2.5 months.

We have seen a 6.8% rise in the last five weeks...apparently because Donald Trump was elected.

Oct 31 '16, 17,888

Dec 5 '16, 19,211

There will be another drop.  

The last time a new president took office, the DOW dropped from about 8,500 on election day to 6,626 on Mar 2, 2009.  That was a 22% drop in 3.5 months.

And the time before that, when Bush became president, the DOW was at 10,434 when he was confirmed by the US Supreme Court.  On Sept 10, 2001, it was 9,065...a 13% drop in 10 months.

The year after a new president takes office has historically seen a significant pull back in the markets at some point. The only exception in the last 45 years was Clinton.

Moving along.....slowly

Velocity of Money:

"The velocity of money is the frequency at which one unit of currency is used to purchase domestically- produced goods and services within a given time period. In other words, it is the number of times one dollar is spent to buy goods and services per unit of time. If the velocity of money is increasing, then more transactions are occurring between individuals in an economy."

Roughly speaking, "Hot" economies drifting toward inflation have a high velocity of money as more money chases fewer goods.  "Cool" economies see the opposite as spending dries up no matter what prices are offered.

From the late 1950's to the end of the early 1990's recession, the velocity of money (M2 - cash plus savings and other deposits) moved within a fairly narrow band.  At its lowest it was 1.655 (1964), and at its highest it was 1.932 (1981).

Then in the 1990s the VOM started to grow markedly.  In 1992, it hit its highest level up to that time at 1.937 and it kept rising until it hit 2.206 in 1997.

It started to drop prior to the recession in 2001, dropping to 1.923 in 2003, then recovered to 2.034 in 2006.

Since that year it has been trending down steadily.  In 2011, it dropped below its 1964 post-WW2 low and hit 1.653.  It has continued to drop since so that today it is 1.438.

There is a direct correlation between recessions and the slowing down of the velocity of money.  The early 1980's recession; the early 1990's recession; the collapse of the tech bubble in 2001 and resulting recession; and the Great Recession of 2008 - 09 were ALL identified by significant drops in the VOM.

Here is a rather sobering graph....

The VOM is now at its lowest point EVER - even below the level it was at during the Great Depression.

To repeat - the VOM has NEVER been lower than it is now. It has plummeted since 2006, in spite of massive injection of stimulus into Western economies.  One could predict a recession from this...but the fact is that we have never seen a situation like this before, outside of the Great Depression.

But Wait! Wouldn't adding more dollars normally caused the VOM to fall as more dollars would normally slow all the other dollars in the economy down?

The whole point of stimulus is that adding more cash to the economy is supposed to cause those "more dollars" to chase relatively "fewer goods", therefore encouraging the creation of more goods to meet the demand of the more dollars.  The result should be a VOM that stays in a predictable range as economic activity picks up to match the stimulus that was added.

But the "more dollars" that have been added, especially since 2008, are not really chasing much more in the way of new goods, so the VOM is falling...OK, it is collapsing. In classical Keynesian economics, this isn't supposed to happen.

Would there be ANY real economic growth absent 1% interest rates, and massive government borrowing and spending?

What if we were in a depression, and no policy maker, bought-off media talking head, or politician would admit it?

Dump your stocks, take your profits, and buy Gold.