Tags: stocks | market | Alan Greenspan | economy

Beware of Bullish Outlook From 30-Year Stock-Market Bull

By    |   Wednesday, 05 August 2015 03:57 PM

When stock market guru Laszlo Birinyi told bubblevision that the S&P 500 stock index would rise another 50 percent to 3,200 points by 2017, his argument was essentially to keep on keeping on:

“What we’re really trying to tell people is stay with it, don’t let the bad news shake you out…There’s no reason we can’t keep on going,” he said.

That got me to thinking about when I first ran into Birinyi at investment bank Salomon Brothers in 1986. He was then a relatively underpaid numbers cruncher in the equity research department who was adept at making the bull case. Almost 30 years later he has become a rich man crunching the numbers and still making the bull case.

I don’t ever recall when he wasn’t making the case to be long equities, and you didn’t actually have to crunch the numbers to get there. Just riding the bull from 200 points in January 1986 to today’s approximate 2,100 on the S&P 500 index computes to a compound annual growth rate of 8.4 percent and a 10 percent annual gain with dividends.
Even when you take the inflation out of it, this 30-year run is something close to awesome. But, alas, that’s my point. It’s too awesome.

In inflation-adjusted terms, the S&P 500 index rose by 6.2 a year over the last three decades. That compares to just a 2.2 percent annual advance for real gross domestic product, meaning that the market has risen nearly three times faster than national output in real terms.

You don’t have to be a math genius to realize that a few more decades of that kind of huge annual spread, and the stock market’s value would be several hundred times larger than GDP.

Also, you don’t have to be a PhD in quantitative historical research to recognize that the last three decades are utterly unique. If you run the clock backwards by 30 years from the January 1986 starting point, for instance, you get a totally different picture.

Not Your Father’s Rally

Between the relative sunny Eisenhower times of 1956 through the eve of Alan Greenspan’s ascension to the chairmanship of the Federal Reserve, the S&P 500 rose by only 4.4 times, not 10 times. Even more significantly, when you strip out the inflation, the real index rose by 1 percent a year, not 6.2 percent.

Those dramatically less awesome stock market trends occurred during an era when the U.S. economy was riding at its post-war high and clocked GDP growth of 3.5 percent a year. That’s 60 percent more than the most recent equivalent period.

And while we are at it, let’s throw in the ultimate litmus test by comparing the real median family income growth between the two periods. During the 1956-1986 interval, this basic measure of the Main Street standard of living rose from $36,000 to about $60,000, or 1.7 percent a year.

Since then, not so much.

Between the days when Birinyi was peddling stock charts at Salomon Brothers and the present, the real median family income has risen by less than $4,000 or by 0.2 percent a year. You could call that flat-out stagnation for 30 years — unless you like to quibble about rounding errors.

Greenspan’s Bubbles


So the question recurs: If real GDP growth has decelerated so sharply and if family incomes have stagnated so unfortunately during the last 30 years why has the stock market been so relentlessly hyper-bullish?

Enter Greenspan at the Fed in August 1987. At length, something else started growing like gangbusters.

The Fed balance sheet exploded by 22 times during the last three decades. That amounts to 11.5 percent a year in nominal terms, 9.2 percent in real terms and four times the growth rate of real output.

The link between the Fed’s erupting balance sheet and the stock market’s 30-year bull run isn’t hard to fathom. Not unless you are a Keynesian economist and resolutely insist that balance sheets don’t matter — that it’s all about flow and “aggregate demand.”

But that’s a ridiculous self-serving rationalization that Greenspan-era central bankers blather about and Wall Street finds stupendously convenient. In fact, the Fed’s relentless money printing caused a sweeping financialization of the U.S. economy driven by a supernova of credit market debt.

During the approximate span of the modern bull run, credit market debt outstanding in the U.S. — household, business, financial and government — has soared by $50 trillion. That compares to just a $13 trillion gain in GDP. Self-evidently, it doesn’t take a spreadsheet to recognize that the nation’s leverage ratio soared in lock-step with the upward-bounding stock market.

National Leveraged Buyout


In fact, the 2.0 times leverage ratio of 1986 was already significantly elevated from the historic 1.5 times leverage ratio that had prevailed for a century prior to Nixon’s 1971 folly of destroying the gold standard. But by the time of the financial crisis, it had soared to 3.5 times, and since then has retraced hardly at all.

In short, the last three decades have essentially witnessed a national leveraged buyout in which the productive capacity of the Main Street economy was hocked to a massive increase of fiat credit. The staggering growth of debt and leverage didn’t result from some kind of rollicking outbreak of thrift.

The household savings rate has been plunging ever since 1971 — today’s mountain of debt wasn’t funded from honest savings; it was conjured from thin air by the nation’s central bank, and the banking and financial system into which its massive emissions of fiat credit were deposited.

This collapse of domestic savings raises the question of the economic dog that didn’t bark. In a closed economy this kind of massive outbreak of fiat credit should have caused a nasty surge of consumer inflation.

But it didn’t because just as Greenspan was cranking up the printing presses, Chinese leader Deng Xiaoping proclaimed that it was glorious to be rich, and that communist party power under the new regime of red capitalism would no longer issue from the barrel of a gun, as Mao had insisted. Now it would come from the end of a printing press.

People’s Printing Press of China


Greenspan exported the massive dollar liabilities that accumulated on the Fed’s balance sheet, while China, oil-exporting countries and Asian mercantilists including Japan mopped them up by printing staggering amounts of their own money.

Those countries inflated their own currencies, suppressing exchange rates and showering America and much of the developed-market world with artificially cheap goods. At the same time, a tidal wave of wage compression known as the “China price” flattened labor costs in the DM tradable-goods industries and spilled over onto their suppliers, vendors and adjacent sectors.

This mutually linked monetary and credit tsunami enabled the massive financialization of the U.S. economy and the 30-year bull run that it fostered. With labor priced at close to zero and capital massively subsidized by the People’s Printing Press of China, exports from the Deng’s gleaming new export factories virtually swamped the planet.

In a world of honest money and credit funded from real savers, not central bank printing presses, there isn’t a remote chance that China’s exports could have risen by 40 times in less than three decades. That was 17 percent a year — a rate of gain that cannot be sustained without systemic falsification of exchange rates and financial prices by the central banks.

In a true free market, the China export machine would have run out of capital to build cheap factories and would have suffered soaring exchange rate increases long ago.

Global Distortions


In the short run, these vast deformations of credit, trade and capital flows all amounted to a giant economic swap. The vast rice paddies of Asia were awakened and brought into the global trading system and monetary economy. They absorbed the Fed’s monetary inflation and permitted Main Street American to goose its living standard with debt-financed consumption, while not inflating the cost of goods and labor.

At the same time, America’s $50 trillion uptake of new debt provided the financial fuel that funded a massive increase in stock market speculation and corporate financial engineering in the form of LBOs, stock buybacks and incessant merger and acquisition deals. In a roundabout but unmistakable manner, the East Asian central bank printing presses recycled the Fed’s monetary inflation back into domestic financial asset inflation.

That is the true reason for the stock market’s 30-year bull run. There has been a huge increase in the capitalization rate of national income, or the implied price-to-earnings ratio of the stock market. But that didn’t reflect a permanent improvement after 1986 in the productive efficiency or profitability of the U.S. economy.

Value Illusion

In fact, measured productivity growth has been cut in half. If real GDP weren’t overstated because of ridiculously low price deflators, the true rate of productivity gain since the late 1980s would have registered at a mere fraction of its pre-1986 trends.

The U.S. stock market value’s increase from 60 percent of GDP upon Greenspan’s ascension to 200 percent today is purely a monetary effect. In practical terms, it reflects a giant ratcheting upwards of leveraged speculation in the financial system.

At the end of the day, that’s what zero-interest rate policy, quantitative easing and the implicit Greenspan/Bernanke/Yellen “put” do. They fuel a cycle of debt-funded speculation that drives asset prices ever higher, which in turn, become the collateral for an even bigger credit-funded bid for financial assets.

In sum, at the time that Birinyi was peddling his Salomon stock research reports back in 1986, the financial sector — defined here as the market value of equities plus credit market debt outstanding — was about $12 trillion.

Today it is $93 trillion. You might call it the “mother of all bubbles.”

Blinded by Bubbles

And you might also ask why that bubble can be expected to “keep on keeping on” when at last something epochal has changed. Namely, the world’s convoy of central banks have run up against the limits of money printing.

In the U.S., the Keynesian apparatchiks who run the Fed have decided to quit printing money on the basis of doctrine and their thoroughly misguided belief that the U.S. economy is “fixed.”

But once they embark upon “normalization” later this fall, there will be no turning back. A reversal into a new round of massive balance sheet expansion would amount to a repudiation of the last 20 years of Fed policy, thereby triggering a collapse of confidence in the casino and a selling panic of epic scale.

Likewise, China’s printing press is being forced into neutral as well. Having turned a few hundred billion dollars of domestic credit at the time of Deng’s early 1990s proclamations into $28 trillion today, the overlords of red capitalism sit atop the most lunatic pyramid of credit and speculation in human history. Capital is now fleeing the swaying towers of the Chinese Ponzi — upwards of $800 billion in the last year alone.

Accordingly, China’s central bank is being forced into an about face. After nearly three decades buying dollar liabilities with newly printed renminbi to keep its exchange rate from rising, it is now in the position of selling dollar liabilities and shrinking the renminbi supply in order to keep the exchange rate from plunging into an abyss.

This means that the principal central banks of the world don’t have the firepower to keep inflating the global financial bubble.

They are helpless in the face of a worldwide deflationary wave that is the product of their own falsification of asset markets and systematic financial repression.

In a word, Birinyi’s 3,200 call is bull, because the central bank enabled 30-year bull run is over. At last.

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DavidStockman
Laszlo Birinyi’s 3,200 call on the S&P 500 is bull, because the central bank enabled 30-year bull run is over. At last.
stocks, market, Alan Greenspan, economy
1949
2015-57-05
Wednesday, 05 August 2015 03:57 PM
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