‘Classic Toppy Signs’ In An Insane World

The next US president, whether Donald Trump (again) or Joe Biden, will inherit one of the most expensive stock markets in modern history.

In fact, as far as I can tell, it’s one of the most expensive stock markets in all of history, it’s just that taking the chart (and analysis) back too far risks uneducated extrapolation — most of us simply aren’t old enough to say anything meaningful about what it “felt like” to invest in the aftermath of the Great Depression or World War II.

Currently, the S&P is trading over 25 times earnings, putting valuations not too far from levels seen in and around the dot-com boom.

There’s a sense in which this sets either man (Trump or Biden) up for “failure” if your measure of “success” is the stock market.

This week served as a rather stark reminder that when valuations get as stretched as they are, de-rating becomes the closest thing to inevitable.

“Priced to perfection” is a somewhat cringeworthy cliché we use far too often, but in the case of US tech, it appears to have been apt.

Market participants spent Friday retrofitting rationalizations, but the fact is, earnings for the big four were solid. It didn’t matter though. Not when, to quote a short Bloomberg summary, “the premium for tech stocks relative to the S&P 500 is 20%.” The same linked piece notes that “even excluding the largest companies, the sector trades more than two standard deviations above average.”

With the exception of September’s mini-meltdown (when August’s blow-off tech top de-frothed into a correction), Friday was the worst day for the FANG+ gauge since March.

Leaving aside tech, there are myriad additional red flags that suggest the “big top” (to quote BofA’s Michael Hartnett) may be in, or close to it anyway.

In a note out late this week, Hartnett cited Ant’s IPO (poised to be the largest ever) alongside the following list of what he calls “classic ‘toppy signs'”:

  • IPO ETF +163% since March
  • M&A (October 2020 acquisition premium 124% versus 23% long-term average)
  • Record $3.2 trillion funds raised in investment grade, high yield, bank loans, equity, SPACs
  • US housing prices up 15%
  • Narrow equity leadership
  • Greedy investment grade and tech inflows

He also mentions “bearish narratives flipping to bullish.” By that, he of course means the market’s begrudging, half-hearted embrace of a blue sweep US election outcome.

The market doesn’t “love” the prospect of a Biden win given the read-through for “punitive tax hikes and re-regulation,” Nomura’s Charlie McElligott wrote midweek, before explaining that investors are nevertheless “marginally at peace with it under the rationalization that an outright blue sweep would at least clear a path for a much-needed COVID stimulus program, as well as set [the] table for a multi-trillion dollar infrastructure plan” while laying the groundwork for a “persistent” fiscal impulse tied to “a future-state paradigm shift in federal government deficit spending.”

All of that is critical. The irony is that while BofA’s Hartnett calls the market’s embrace of what would normally be a bearish, blue sweep a “classic ‘toppy sign’,” there are only two ways for stretched valuations to “correct.” Either stocks fall or profits (and profit expectations) rise. You can make a very good argument that the only realistic path to robust profit growth coming out of the worst downturn since the Great Depression, is a policy conjuncture that leans on aggressive fiscal stimulus to turbocharge demand and reflate the economy.

While it’s true that corporate tax hikes will exert a mechanical drag on earnings (figure below), a sane world would prefer a genuinely robust economic backdrop to a situation where bottom line beats have to be engineered through tax cuts and debt-funded buybacks.

Everyone complains about an upside down world where the surest path to rising stock prices and better earnings outcomes are lower taxes, rising leverage, and trillions in share repurchases. But it seems like nobody on Wall Street or in the C-suite actually wants the situation to change.

“Biden has been clear his focus is not the stock market, it’s the economy,” Bloomberg quotes DWS Group’s David Bianco as saying this week. “Inheriting the equity market at these levels is a big challenge to drive it substantially higher.”

That quote really captures a lot, doesn’t it? We all know that the stock market “isn’t the economy,” but in a sane world it would be. Stocks aren’t poker chips. They’re ownership stakes. They turn the holder into a partner in a business enterprise. The business thrives when the economy thrives. Or at least that’s the way it should be.

The quote from Bianco is accurate, but only in the context of the upside down world we live in.

Let me just put this as simply as possible: We shouldn’t be aiming to “drive” the stock market higher in a vacuum. We should be implementing policies that “drive” the economy, which, in turn, should create opportunities for the businesses that operate in and otherwise comprise that economy, to generate more sales and earn more money.

But, alas, we don’t live in a sane world.

Goodbye Goldilocks


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16 thoughts on “‘Classic Toppy Signs’ In An Insane World

  1. “We shouldn’t be aiming to “drive” the stock market higher in a vacuum.”

    This sums up the problem with Trump in a nutshell. Everything to him is about the headline, the ratings, the Dow Jones industrial average. There’s no long-term view about what creates a strong and sustainable economy and society.

  2. The world is upside down because the inverventionista mentality has taken over every aspect of government and central banks. Intervention has put the world “upsidedown” as you put it, not lack thereof.

    The massive gap in knowledge on complexity theory among “Economists” reached extremely dangerous levels in 2008, and hasn’t stopped increasing since.

    1. Oh, really? Take a look at inequality trends since the conservative revolution in the early 80s and tell me what you see. And it’s supremely ironic that you would cite 2008, an event that was in no small part attributable to lax regulation and capitalism run amok. No sane government would allow banks to accumulate that kind of leverage. More intervention would have gone quite a ways towards preventing that.

      1. And what’s with the scare quotes around “economists?” I quote real economists. You know, the ones with the PhDs. The Trump administration quotes folks like Larry Kudlow and Stephen Moore. You know, the supply-side, non-interventionist sock puppets without PhDs who parrot the same trickle-down theories that have never worked and never will work, because the idea that “generous” (see? that’s how you properly use scare quotes) billionaires and corporations will turn around and invest the windfall in workers and capex is so manifestly absurd that anyone espousing it is either being disingenuous or else is so naive that it’s a miracle they can make it through a single day in a capitalist economy without someone taking everything they own from them.

        1. This railing against any person(economist, pandemic expert etc.) who spends better part of a lifetime acquiring skills and knowledge seems to be straight from the Kingdom of Unreason. I suggest not getting worked up over it as the word salad is simply too perverted to make any sense of. We can either get worked up or wait for the truck.

          1. People habitually mistake my responses on the site for me being “worked up.” I gather this is due in part to the fact that “editors” (if that’s the right word) never respond to comments on sites that receive any kind of respectable monthly traffic. I don’t generally follow that template. I mean, I kind of feel an obligation to respond sometimes, even it’s to disagree with a reader. I think it’s somewhat disrespectful to my readers if I never, ever respond — like I’m just writing to write and I don’t care what anybody thinks.

            I say this all the time: If I’m responding in what seems like an abrasive way, you should consider that evidence that I actually care what my readers have to say. Which is what you want in an editor, I hope.

          2. To the comment below… I hope none of your readers get worked up over such comments. We have a duty to ourselves to remain humble and to keep our nose within our work while expanding our minds. Those that do not respect this are really and truthfully in the minority.

        2. These “PhDs” you quote as masterminds of economic thought are the intervenionistas I refer to. Central banks are full of this linear thinking, yet their models and interventions have only led to massive asset bubbles and increased inequality. Their ability to predict is only matched by their obvious disregard for the consequences of their actions.

          Anyone who’s ever taken an econometrics class with an functioning brain will till you we don’t have enough information to make accurate predictions, yet financial media keep referring to their opinions as if they’re clairvoyant when they have repeatedly failed at every goal they have set themselves, except for Mr.Volker which I do honestly respect.

          GFC’s foundations were laid by the all mighty Maestro. His wannabe linear terrorist Bernanke made it his masterpiece. They don’t understand money because they don’t know what money is and don’t know how to measure it.


          QE1,2…,QE Infinity yet they somehow can’t reach their targets.

          Remember the Phillips Curve? I do. They don’t.

          You just have to look.

          1. You refer to me like I’m outside of academia. lol

            I’m not “the financial media,” my friend. You’ve been around these parts long enough to know that.

            And no, central banks are not deliberately creating inequality.

            The problem is a lack of a persistent, strong fiscal impulse to complement monetary policy. When you put monetary policy on its own and refuse to abandon objectively false notions of deficits and debt in advanced economies in favor of manifestly insane (not to mention cruel) austerity policies, you get what you get.

            Finally, since you seem to be keen on taking a combative approach, I’ll just go ahead and put this out there: I’m reasonably sure that I’ve taken more econometrics classes than you have, although that’s not necessarily something I would typically brag about.

            “Mr. Volcker” (with a “c” in there) is no hero, by the way. And if you think he is, then you might consider learning how to spell his name correctly. I’m sure he’d posthumously appreciate it.

            Drops mic.

          2. Apologies as for some reason I can’t reply directly to your post.

            I don’t consider you or this site financial media, if I did, I would spend one second reading it.

            The fiscal impulse has been there, you just have to look at how deficits and debt to GDP has exploded throughout developed economies. This is gross mismanagement, not lack of resources. Its clear as day government entities, including central banks, cannot produce what a free market society can, which is innovation and productivity. Both GFC and COVID crisis have made the Central Bank charade as obvious as it has ever been.

            The Fed PhD army answer to everything is throwing trillions at it and the comically named ‘forward guidance’, which basically translates to injecting more liquidity whenever there’s a market tantrum. They have made the financial system increasingly fragile to volatility as I’m sure you’re aware of.

            As you point out, they take action without accountability, which leads to consequences perhaps they didn’t know would happen, but are nevertheless guilty of causing them

            If I respond in an abrasive way is because I care about your opinion, which is why I pay for it lol. Don’t take this personally. We’re just discussing ideas.

            Volcker (thanks for the correction) is the one central banker who truly accomplished his goal, something Greenspan, Bernanke, Yellen and Powell can’t say.

            Picks up mic and hands it back

          3. Yeah, I mean as I said above, you’re a regular reader, so I know that you know that I’ve been pounding the table on central bank asset bubbles and how QE exacerbates inequality for years. That’s one of the main reasons people come here: to hear me complain about that. But at a certain point it just gets frustrating because you have, you know, this handful of central bankers who are, ultimately, just technocrats. And then you have hundreds of elected legislators whose job it is to make citizens’ lives better. It’s long past time that the elected representatives take some responsibility for their failures in that regard. It’s an abomination, for example, to have millions of people living in poverty or homeless in the richest country on Earth.

            And no, the fiscal impulse has not always been there. And it damn sure isn’t sufficient. Sure, mismanagement is part of the problem, but this notion that a “free market society,” unimpeded, everywhere and always produces optimal outcomes (and I certainly hope that’s not what you’re saying, because that is obviously not the case) isn’t true. You have to have government intervention in some places. Especially for the provision of goods and services that the free market wouldn’t be inclined to provide on its own. That is a basic economic principle that everyone (literally everyone, no matter what school of thought you come from) agrees with. If you don’t agree that the government has to provide certain kinds of goods and services because the free market wouldn’t, if left on its own, then you are espousing your own school of thought. Nobody sane argues for the complete absence of government intervention in the economy.

            Also, your characterization of “debt” vis-a-vis currency-issuing, advanced economies isn’t correct. That’s not me being abrasive, it’s just a fact. You can’t “owe” a sum denominated in a currency you issue. Period. If Japan wanted to pay off the entire stock of outstanding JGBs tomorrow, they could. With one keystroke. That isn’t an opinion. It’s a fact. The opinion part comes in when you start discussing what would happen next. There is no such thing as a “national debt” for currency-issuing, advanced economies. It’s not “debt.”

            In any case, the broader point is that the educated public needs to put at least some of the blame on the people they elected, as opposed to pointing at these (admittedly arrogant) PhDs and saying: “Look, devils!” I mean, come on. In some cases, these are elderly old women (Yellen), seemingly good natured folks (Mary Daly), balding Depression scholars (Bernanke), affable Peter Pan fans (Kuroda), etc. And you’re calling them “terrorists” (as you did above). Give me a break. That’s absurd. These aren’t nefarious people. They’re just academics who have been asked to save the entire world. Of course they’re doomed to fail. That’s my overarching point. Show me a group of people that, if asked to save the entire world by themselves, wouldn’t fail. The Avengers, maybe?

  3. “Remember the Phillips Curve? I do. They don’t.”

    Actually they clung to that totally outdates academic theory for far too long. Especially at the ECB.

    It was created and suited to a long bygone era when unions actually had some bargaining power.

    Academic and central bank economists are loath to examine the theories they were taught 40 years ago. The Phillips Curve is one of them.

      1. Alas they are human.

        Exhibit One was their “dot plot” forecasts in recent years.

        However when you talk to retired central bankers “off the record” they mostly are rather humble about their skills and abilities. Except for old-time Bundesbankers!

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