Market cap to GDP ratios March 2009 vs. March 2014 flash valuation warning

Probably the broadest measure for stock market valuation purposes is total stock market capitalization divided by GDP. Warren Buffett uses it and John Hussman has spoken approvingly of the measure.

But because we have to wait for GDP numbers for at least a month after the quarter end, the ratio cannot be a real-time valuation tool. And given that revisions to GDP can be substantial in the 2nd and 3rd estimates, as well as in the annual summer revisions, precision using the 1st estimate is also wanting. Nevertheless the calculation provides a big picture snapshot of where we have been in the market cycle, and gives forward guidance for long term investors. Presently it appears to counsel taking chips off the table and waiting in cash for a better opportunity to invest. 

For the following I use nominal figures for GDP as revised in the most recent updates from bea.gov and calculate market cap using the popular Wilshire 5000 (level x $1.2 billion) as close to March 31 as practicable.

A comparison of March 2009 to March 2014 is instructive, since March 2009 was a pretty good buying opportunity both in terms of the absolute level of the stock market after its decline and the coincident Shiller p/e valuation which was about 13.3 on March 1. The ratio has almost doubled in the interim, indicating that now is probably not a good time to commit large new sums to stock markets. The current Shiller p/e begins the day at 26.31, which is also nearly doubled from five years ago.

That said, the 10 year Treasury presently pays just 69 basis points more than the dividend yield of the S&P500. At the October 2007 stock market high, the 10 year Treasury paid 276 basis points more than the dividend yield of the S&P500. You could argue the Fed caused the markets to crash by taking rates much too high in 2006 and 2007 and that Janet Yellen is bound and determined not to let that happen again anytime soon, meaning stock markets could have higher to go. Keep in mind that the inflation-adjusted all-time high of the S&P500 was 2045.09 on August 1, 2000. We're at 1962.46 this morning. 

March 30 2009

$10.32 trillion market cap

---------------------------------------------- = 0.72

$14.38 trillion GDP

March 31 2014

$23.99 trillion market cap

---------------------------------------------- = 1.41

$17.02 trillion GDP

Bank purchases of Treasurys at highest level since 1Q 1994 help drive demand and prices higher, yields lower

The Wall Street Journal reports here:

U.S. banks also have been big buyers of government debt. Treasury bondholdings of commercial banks and savings institutions rose to $237.2 billion at the end of March, the highest since 1995, according to data from the Federal Deposit Insurance Corp.

Traders and analysts said the purchases have been driven by tighter banking regulations aiming at improving banks' balance sheets after the 2008 financial crisis. Overhauls such as the Dodd-Frank financial law in the U.S. and global regulations require financial institutions to hold more high-graded debt. The $12 trillion U.S. Treasury bond market is the world's most liquid bond market.

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The 1Q 1994 level held by financial institutions was $310 billion.

The 10 year Treasury yield fell to 2.44% yesterday. On May 1 it had stood at 2.57%.

Why Money Market Funds Are Especially At Risk If The Government Defaults

the one-month T-bill settled at .27 after spiking to .32

Money market funds invest in ultra short term securities like T-bills with average maturities under 60 days. These came under pressure yesterday, as reported here:

The one-month U.S. Treasury bill yield spiked to a multiyear high on Tuesday amid mounting concerns that the U.S. may not fulfill its payment obligations to short-term bond holders. The yield on the one-month T-bill traded as high as 0.322 percent, levels not seen since the fourth quarter of 2008, before settling at 0.273 percent, according to data from Thomson Reuters. The yield stood at 0.083 at the start of the month. ... 

"If the U.S. was to default, T-bills are under real threat of not being paid... and the risk premium in the bond yields is reflective of that fear," said Evan Lucas, market strategist at IG. A large portion of demand for T-bills comes from institutional investors, such as money market funds. "Ten-year bonds [by comparison] are relatively unaffected by the shutdown and debt ceiling as coupon payments will flow over the life of the instrument and one or two missed coupons can be recuperated," he added.

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To put the fear in perspective, a 2-year Treasury yields only 0.373% this morning, so the spike in the one-month to 0.322% shows how seriously the bond market can react to the prospect of debt default.

10-Year Treasury Rate Ends The Week At 2.64%

The 10-year US Treasury Rate ended the week at 2.64%, 43% below the mean level going back to 1871.

Despite the best efforts of the US Federal Reserve to suppress interest rates on behalf of other "investments" like housing and stocks, the current rate of the 10-year Treasury still bests the dividend yield of the S&P500 by 34%, which ended the week at 1.97%. From another perspective, it's even worse than that.

John Hussman noted this week here that based on the ratio of equity market value to national output, you might expect less than zero from the S&P500 going ten years out: 

Likewise, Buffett observed in 2001 that the ratio of equity market value to national output is “probably the best single measure of where valuations stand at any given moment.” On that front, the chart below [follow the link above] shows the value of nonfinancial corporate equities to GDP (imputed from March to the present based on changes in the S&P 500). On this measure, the likely prospective 10-year nominal total return of the S&P 500 lines up at somewhere less than zero. Suffice it to say that our estimates using both earnings and non-earnings based measures suggest a likely total return for the S&P 500 over the coming decade of less than 2.9% annually, essentially driven by dividend income, and implying an S&P 500 that is roughly unchanged a decade from now – though undoubtedly comprising a volatile set of market cycles on that course to nowhere.

In other words, it's possible stocks could return absolutely nothing over the next decade, or just barely beat bonds by less than 10% based on the current 10-year Treasury rate. For sleeping soundly at night, the choice is easy.

The 10-year Treasury rate has backed off about 10% since Ben Bernanke reversed himself on tapering bond purchases this month, seeing how it was knocking on the door of three.

Normalization of the 10-year yield would cost the US government dearly, jacking up interest expense costs over time which are paid from current tax revenues, by nearly double. In the last four years under Obama, interest payments on the debt have averaged $403 billion annually. Increasing those payments 43% would add another $173 billion to budgetary requirements, again, not all at once but over time.

QE Is For The Banks, Nothing Else

Quantitative easing is for the banks and nothing else, despite the long-standing professorial deflections to the contrary by Ben Bernanke.

Oh, he can say it's to help housing recover, or employment, or whatever else happens to be languishing depending on the exigencies of the moment. But God forbid Ben should say what everyone ought to have understood from the beginning, that there's a huge pile of non-performing loans on the banks' books. Ben's various iterations of QE have kept him busy systematically transfering to the books of the Federal Reserve Bank of the United States significant tranches of those bad loans, and it won't be until those transfers end decisively that you can be sure that the banks are finally in the clear.

Meanwhile, have you considered that when Keynes said markets can stay irrational longer than you can remain solvent that Keynes never imagined how un-free markets were to become in the Western world? Five years out from the troubles of 2008, that the purchases of MBS continue apace should at once frighten everyone and galvanize support to reform the banking system and prioritize the commitment of its central bank to the integrity of the US dollar.

The voices warning us are out there. You just won't hear them on your television, which you should turn off at a minimum, and preferably execute loudly in your backyard with a shotgun, or drop on your driveway from a second story window. Please send film.

Consider this from Manuel Hinds, former finance minister of El Salvador and 2010 winner of the Hayek Prize, here:

"[H]igher interest rates would burst the bubbles in asset prices that monetary printing has created, bringing to the surface the losses that banks have accumulated by years of lending to unsustainable activities. Thus, the Fed is between a rock and a hard place. If it does not increase the rates of interest, excess demand will explode leading to high inflation, large current account deficits or both. If it increases interest rates, the activities that are profitable only with very low interest rates will collapse, including the equity and commodity markets. This would expose the banks to very large losses, which would trigger a serious crisis because the banks have accumulated bad assets for over a decade now and have cleansed them only partially because they trust that the government will save them without having to take painful write-offs. As a snowball going down a slope, the problem gets worse with time. ... The coming breakdown is likely to be much worse than that of 2008."

Or this from Joseph Calhoun of Alhambra Investment Partners, here, who doesn't consider that QE is so negative for present GDP growth because it is "financing" past growth now ensconced as bad debt:

"There are any number of reasons why QE might be negatively impacting growth, from high oil prices to the diversion of capital to speculative purposes to its effects through exchange rates on other countries with which we trade. I do not claim to know the full extent of the effects of QE but most importantly, neither does Ben Bernanke. That being the case and considering the evidence to date, why does Bernanke persist in pursuing the policy? Is there some other reason for the policy other than the stated one of spurring economic growth? If so, Bernanke sure isn't telling anyone what it is."

Or this from the ever-wise John Hussman, here:

"Meanwhile, with a monetary base of $3.27 trillion and an estimated duration of at least 7 years on present Fed holdings, the recent 100 basis point move in bond yields has created a loss of over $200 billion for the Fed. The Fed reports capital of only $55 billion on its consolidated balance sheet. but then, just like major banks, the Fed does not mark its assets to market. Most likely, the Fed is now technically insolvent. Moreover, the Fed is levered more than 59-to-1 even against its stated capital. The benefits of QE seem vastly overpriced and excessively trusted, particularly in an environment where the internal debate even within the Fed is becoming more pointed. Two members already want the Fed to taper in order “to prevent the potential negative consequences of the program from exceeding its anticipated benefits.” ... We don’t observe any material economic impact from quantitative easing, and continue to believe that the key event in the recent credit crisis was the FASB move to abandon the requirement for mark-to-market accounting among financial institutions (the Fed’s zero interest policy has merely allowed banks to recapitalize themselves on the backs of savers and the elderly on fixed incomes)."

QE is financial repression of the American taxpayer for the benefit of institutions which should be wound down and broken up. How long are you going to put up with it? Can you last another five years?

The 3-Month Treasury Yield Is An "Abomination"

So says John Hussman, here:

The 3-month Treasury yield now stands at a single basis point. Unwinding this abomination to restore even 2% Treasury bill rates implies a return to less than 10 cents of monetary base per dollar of nominal GDP. To do this without a balance sheet reduction would require 12 years of 6% nominal growth (which is fairly incompatible with sub-2% yields), a more extended limbo of stagnant economic growth like Japan, or significant inflation pressures – most likely in the back half of this decade. The alternative is to conduct the largest monetary tightening in the history of the world.

Normalization of yields to even 2% implies 50% balance sheet contraction [see his last graph].

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The latter would mean a contraction of $1.55 trillion or so based on the current level, and that those securities would not mature on the balance sheet for their respective terms and come off naturally over time but quickly in a disorderly fashion, and therefore a bond market debacle is implied, and that to be defensive under this threat is to remain in cash, painful as that is.

Central Bankers Buying Stocks: Is This Another Sign Of A Top?

Bloomberg reports here:

Central banks, guardians of the world’s $11 trillion in foreign-exchange reserves, are buying stocks in record amounts as falling bond yields push even risk-averse investors toward equities.

In a survey of 60 central bankers this month by Central Banking Publications and Royal Bank of Scotland Group Plc, 23 percent said they own shares or plan to buy them. The Bank of Japan, holder of the second-biggest reserves, said April 4 it will more than double investments in equity exchange-traded funds to 3.5 trillion yen ($35.2 billion) by 2014. The Bank of Israel bought stocks for the first time last year while the Swiss National Bank and the Czech National Bank have boosted their holdings to at least 10 percent of reserves. ...

Currency reserves among the world’s central banks climbed by $734 billion in 2012 to a record $10.9 trillion, according to data from the Washington-based International Monetary Fund. That’s about 20 percent of the $55 trillion market value of global stocks, data compiled by Bloomberg show. ... 

Even so, 70 percent of the central bankers in the survey indicated that equities are “beyond the pale.”

Notice how the first paragraph calls central banks "risk-averse investors", showing that the line between investing and banking has been completely erased in the popular reporting even as the evidence of the survey shows that for most central bankers the line remains boldly drawn. Banks don't invest, they bank.

Purchases of gold by central banks in recent years is interesting in that context. While buying stocks might mean investing to central bankers, something to be shunned, buying gold is not really investing, otherwise they wouldn't have been doing so much of it.

Gold reserves in the world now total roughly 31,000 tonnes, or about $1.5 trillion if gold is $1,500 the ounce. This amounts to 13.7% of the total forex reserves of $10.9 trillion mentioned in the article. In the context of the Basel III capital rules, that's considerably more hard collateral being set aside by the folks running the show as time goes by than by the downstream bankers who protest against building up to seven, eight or nine percent capital ratios.

I'm glad central banks are buying more gold. They should do even more of it. But investing in stocks by banks, central or otherwise, isn't banking. It's gambling, especially at these levels.

101 Years Of The US Government 10yr Bond Yield

US Government 10yr Bond Yield Pops 10% On Fiscal Cliff Deal

But quickly cools, meaning the bond market's opinion was Meh.

By way of contrast, yields plunged roughly 33% between July and September 2011 from the 3s to the 2s in the wake of the debt-ceiling mini-compromise.

The five year yield nadir was about 1.38 in late July 2012. Yields today are almost 35% higher than that, but are still 50% off what they were in early January 2008 near 4.

Interactive chart here.

Bernanke Claims Large Scale Asset Purchases Of $3.35 Trillion Yielded 2 Million Jobs

Among other farcical things.

Transcript here:

[I]n late 2008 the Federal Reserve initiated a series of large-scale asset purchases (LSAPs). In November, the FOMC announced a program to purchase a total of $600 billion in agency MBS and agency debt.  In March 2009, the FOMC expanded this purchase program substantially, announcing that it would purchase up to $1.25 trillion of agency MBS, up to $200 billion of agency debt, and up to $300 billion of longer-term Treasury debt.  These purchases were completed, with minor adjustments, in early 2010. In November 2010, the FOMC announced that it would further expand the Federal Reserve's security holdings by purchasing an additional $600 billion of longer-term Treasury securities over a period ending in mid-2011.

About a year ago, the FOMC introduced a variation on its earlier purchase programs, known as the maturity extension program (MEP), under which the Federal Reserve would purchase $400 billion of long-term Treasury securities and sell an equivalent amount of shorter-term Treasury securities over the period ending in June 2012. The FOMC subsequently extended the MEP through the end of this year.  By reducing the average maturity of the securities held by the public, the MEP puts additional downward pressure on longer-term interest rates and further eases overall financial conditions.

How effective are balance sheet policies? After nearly four years of experience with large-scale asset purchases, a substantial body of empirical work on their effects has emerged. Generally, this research finds that the Federal Reserve's large-scale purchases have significantly lowered long-term Treasury yields. For example, studies have found that the $1.7 trillion in purchases of Treasury and agency securities under the first LSAP program reduced the yield on 10-year Treasury securities by between 40 and 110 basis points. The $600 billion in Treasury purchases under the second LSAP program has been credited with lowering 10-year yields by an additional 15 to 45 basis points.  Three studies considering the cumulative influence of all the Federal Reserve's asset purchases, including those made under the MEP, found total effects between 80 and 120 basis points on the 10-year Treasury yield.  These effects are economically meaningful.

Importantly, the effects of LSAPs do not appear to be confined to longer-term Treasury yields. Notably, LSAPs have been found to be associated with significant declines in the yields on both corporate bonds and MBS. The first purchase program, in particular, has been linked to substantial reductions in MBS yields and retail mortgage rates. LSAPs also appear to have boosted stock prices, presumably both by lowering discount rates and by improving the economic outlook; it is probably not a coincidence that the sustained recovery in U.S. equity prices began in March 2009, shortly after the FOMC's decision to greatly expand securities purchases. This effect is potentially important because stock values affect both consumption and investment decisions.

While there is substantial evidence that the Federal Reserve's asset purchases have lowered longer-term yields and eased broader financial conditions, obtaining precise estimates of the effects of these operations on the broader economy is inherently difficult, as the counterfactual--how the economy would have performed in the absence of the Federal Reserve's actions--cannot be directly observed. If we are willing to take as a working assumption that the effects of easier financial conditions on the economy are similar to those observed historically, then econometric models can be used to estimate the effects of LSAPs on the economy. Model simulations conducted at the Federal Reserve generally find that the securities purchase programs have provided significant help for the economy. For example, a study using the Board's FRB/US model of the economy found that, as of 2012, the first two rounds of LSAPs may have raised the level of output by almost 3 percent and increased private payroll employment by more than 2 million jobs, relative to what otherwise would have occurred.  The Bank of England has used LSAPs in a manner similar to that of the Federal Reserve, so it is of interest that researchers have found the financial and macroeconomic effects of the British programs to be qualitatively similar to those in the United States.

What rot.

Eight million fewer full-time jobs exist today than in 2007. Is he saying there would be ten million fewer had the Fed not intervened?

That's only $1.675 million per job.

Wouldn't it have been more efficient simply to have dropped the cash from helicopters in our backyards?

That way all ten million of us could have enjoyed a cool $335K each. A prudent man could easily live on that for 10 years or more.

Instead we're all suckin' wind out here.

Famous Spaniard Threatens Leaving Euro On Wednesday, ECB Moves On Thursday

And markets pop accordingly to finish the week, solely on a serious promise of coming central bank intervention.

As reported here on Wednesday the 25th, Spanish elder statesman Francisco Alvarez Cascos, former secretary-general of Spain’s ruling party, became the first major figure in Spain to openly suggest leaving the Euro, saying,

'This can’t go on for long, or we will have to think about leaving the euro before we are thrown out.'

Is it any coincidence that the European Central Bank "moved" on Thursday, as reported here?

'Mario Draghi, the ECB president, vowed to do "whatever it takes" to save the euro within limits of its mandate. "Believe me, it will be enough," he said in London.

'Picking codewords instantly understood by traders, Mr Draghi said the violent spike in bond yields in recent days was hampering "the functioning of the monetary policy transmission channels" - the exact expression used to justify each of the ECB's previous market interventions.'

It was bad enough that ousted Italian leader Silvio Berlusconi had been openly suggesting in recent weeks that Italy should think seriously about whether it ought to continue in the Euro. To put that on the table in Europe's third largest economy was a serious sign that events were turning. Now joined by a similar suggestion in the fourth largest economy in Europe, the ECB had to act to stanch the wound.

The bond markets are forcing everyone to do what they do not want to do, but they will have their say, one way or another.

The Whole World Is Turning Japanese, He Really Thinks So

So says Scott Sumner, here:


Wherever people draw a line, bond yields just seem to plunge right through, to one record low after another. And we know from Japan that they can go even lower. But what does this mean?

It probably means multiple things. ... We are looking at BOTH low inflation and low real GDP growth for many years to come. ... Japan is the future of the world.

Massive Global Central Bank Balance Sheet Expansion Interferes With Interest Rates

The balance sheets of the world's biggest central banks have exploded 178 percent between May 2006 and November 2011.

So says the data compiled and illustrated by James Bianco in late January at The Big Picture here:

The combined size of [the world's largest] eight central banks’ balance sheets has almost tripled in the last six years from $5.42 trillion to more than $15 trillion and is still on the rise! ...

QE is an expanding of balance sheets via increasing bank reserves.  The purpose of QE ... is to increase bank reserves through purchases of fixed income securities in order to lower interest rates. ...

[I]t is fair to compare the size of these balance sheets (now $15 trillion) to the capitalization of the world’s stock markets (now $48 trillion). ...

Prior to the 2008 financial crisis, the eight central bank balance sheets were less than 15% the size of world stock markets and falling.  In the immediate aftermath of Lehman Brothers’ failure, these eight central bank balance sheets swelled to 37% the capitalization of the world stock market.  But keep in mind that the late 2008/early 2009 peak was due to collapsing stock market values combined with balance sheet expansion via “lender of last resort” loans.

Recently, the eight central bank balance sheets have spiked back to 33% of world stock market capitalization.  This has come about not by lender of last resort loans, but rather by QE expansion (buying bonds with “printed money“) even faster than world stock markets are rising.


Some people look at this information as evidence that the intent of the central banks is to boost asset prices to keep the illusion of growth going. But what if it's really just about buying time, attempting to secure lower roll over interest rates for refinancing massive debt loads which have become a giant millstone around the neck of the world?

The total public and private debt of the world's 35 most indebted nations alone tops $57 trillion, which is 95 percent of the $60 trillion in 2011 GDP of the world's 35 most productive nations. Of 27 of those most productive nations (not counting Greece whose 34.38 percent rate is an outlier) shown here, sovereign 10 year bond yields last week averaged 4.2 percent, implying world wide debt service payments of $2.4 trillion just to stay current.

The US alone spends nearly $0.5 trillion annually in debt service payments, and calls it a victory when $0.04 trillion in spending is cut. Meanwhile deficits and debt continue to build, here and abroad.

GDP growth averaging 3.5 percent per annum is the way out, but the debt burden eats up the progress.

This can't go on forever. 

Yeah, Thanks Bernanke

"Interest rates are amazingly low and that, thanks to Ben Bernanke, is driving everything."

"We’re on the verge of a great, great depression. The [Federal Reserve] knows it."

"We have many, many homeowners that are totally underwater here and cannot get out from under. The technology frontier is limited right now. We definitely have an innovation slowdown and the economy’s gonna suffer."

"Any bears out there better be careful because the dividend yields on these stocks look awesome relative to all the other investment vehicles out there. So bears are going to have to find a new way to express their discontent with the U.S. economy."

-- Peter Yastrow, market strategist, quoted here

These guys keep talking their book, which is the Fed's book, which is the politicians' book, until, you know, we vote them out of office. "Don't fight the Fed" is their number one rule.

Why do we have to find a new way to express our discontent? What's wrong with expressing our discontent in the usual way, like we've been doing? You don't want us to march in the streets again, do you? We aren't buying anything, we aren't traveling anywhere, eating out, investing, or working for a paycheck. In short, we're on strike. Howdoyalikethemapples, chump?

The only thing we can do is plant. And wait. And vote. And we're really looking forward to voting again.

Or have you forgotten last November?

The True Meaning of 666

Don't buy stocks, unless you like overpaying, says John Bethel.

Here:

Back in January 2006, I posted about something Peter Cundill referred to over the years — “The Magic Sixes.”

As I wrote at the time:

“The Magic Sixes” are something Cundill got from a man named Norman Weinger of Oppenheimer in the 1970s. They are companies trading at less than .6 times book value (or less than 60% of book value), 6 times earnings or less, and with dividend yields of 6% or more. Cundill remembers that there were HUNDREDS of publicly traded companies in the US qualifying back in those days.

When I posted the above more than five years ago, I ran a screen on Barron’s Online and it gave three stocks meeting the test.

I just ran it again a few minutes ago and it listed one stock meeting the test. And a second that was on the bubble (and might meet it as the stock price fluctuates a bit).

The Magic Sixes isn’t meant to give specific stock tips. It’s used to gauge the broad market — and whether it’s cheap or not.

It’s clearly not here in the US.

Apathy Precedes Bull Markets, Not Fear

The secular bull market in gold since 2001 is coincident with a secular bear market in stocks since 2000, if this November 30, 2009 analysis by Brett Arends for The Wall Street Journal is correct. The current stock market rally is therefore a cyclical bull market within the long term bear market, which at present elevated levels is ground where angels fear to tread, or ought to, as the title "Gold Run a Reason to be Wary of the Stock Market" suggests:

The booming gold price is making me very nervous. About Wall Street.

Why? Because gold's rocketing boom -- it's risen from around $260 an ounce about a decade ago to just under $1,200 now -- is a vivid daily example of what a real bull market looks like. ...


Looking back to early March, there certainly was a lot of panic and capitulation, which you usually see at a market bottom. People talked of a new "Great Depression." One thing I noted at the time was that investors were shying away even from rock-solid defensive stocks with big, well-protected dividend yields. People weren't just scared; they were petrified.

Is that really how a massive bear market usually ends?

The last example before our eyes was gold, whose big bear market ended a decade ago. It looked very different.

Like shares in the 1930s and the early 1980s, gold ended its secular bear market in 1999-2001 with a whimper, not a bang. People didn't panic; they simply lost interest.


Read the rest at the link.