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 clichÃ© 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.