by Lance Roberts, Clarity Financial
During my morning reading, I ran across a couple of very interesting articles that tied a common theme relating to the current risks in the financial markets.
88-year-old investing icon John “Jack” Bogle, founder of the Vanguard Group, said:
“The valuations of stocks are, by my standards, rather high, but my standards, however, are high.
When considering stock valuations, Bogle’s method differs from Wall Street’s. For his price-to-earnings multiple, Bogle uses the past 12 months of reported earnings by corporations, GAAP earnings, which include ‘all of the bad stuff,’ to get a multiple of about 25 or 26 times earnings.
‘Wall Street will have none of that. They look ahead to the earnings for the next 12 months and we don’t really know what they are so it’s a little gamble.’
He also noted that Wall Street analysts look at operating earnings, ‘earnings without all that bad stuff,’ and come up with a price-to-earnings multiple of something in the range of 17 or 18.
‘If you believe the way we look at it, much more realistically I think, the P/E is relatively high,’
‘I believe strongly that [investors] should be realizing valuations are fairly full, and if they are nervous they could easily sell off a portion of their stocks.'”
This, of course, from the father of “buy and hold” investing with whom millions of Americans have pumped roughly $4.7 Trillion into a whole smörgåsbord of indexed based ETF’s provided by Vanguard to meet investor appetites.
Think about that for a moment while you read the following snippet from Bloomberg:
“A buoyant and complacent stock market is worrying Richard H. Thaler, the University of Chicago professor who this week won the Nobel Prize in economics.
‘We seem to be living in the riskiest moment of our lives, and yet the stock market seems to be napping. I admit to not understanding it.
I don’t know about you, but I’m nervous, and it seems like when investors are nervous, they’re prone to being spooked. Nothing seems to spook the market, and if the gains are based on tax-reform expectations, surely investors should have lost confidence that tax reform is going to happen.'”
These two points drive to the heart of the recent concerns I have expressed in both how companies continue to use accounting gimmickry to win the “beat the estimate game” each quarter and the risk of disappointment surrounding tax reform legislation.
But since markets have continued to advance due to the ongoing flood of liquidity from global Central Banks, no one is really paying attention to such “silly” things. However, while market analysts continue to come up with a variety of rationalizations to justify high valuations, none of them hold up under real scrutiny. The problem is the Central Bank interventions boost asset prices in the short-term, in the long-term, there is an inherently negative impact on economic growth. As such, it leads to the repetitive cycle of monetary policy.
- Using monetary policy to drag forward future consumption leaves a larger void in the future that must be continually refilled.
- Monetary policy does not create self-sustaining economic growth and therefore requires ever larger amounts of monetary policy to maintain the same level of activity.
- The filling of the “gap” between fundamentals and reality leads to consumer contraction and ultimately a recession as economic activity recedes.
- Job losses rise, wealth effect diminishes and real wealth is destroyed.
- Middle class shrinks further.