This is a just a quick mid-week interjection. As you know, I recently issued a crash alert. There are literally dozens of reasons I did that. However, here are three more charts that should hit home and make the point that being a very, very patient buyer right now is the play.
The lead chart is the Shiller CAPE ratio. What is that? It is the cyclically adjusted price-to-earnings ratio. Basically, it adjusts for normalized earnings over a ten-year period. It does this to represent the cycles that earnings go through from peak to trough to peak again.
The normal CAPE is around 15 or 16, but it can go a few points higher or lower with no real consequence. Right now, earnings are just coming off of peak that was the fourth highest in history. Certainly, with enough central bank money or government stimulus, the ratio could climb to challenge all-time highs. However, given global debt and general mood, the odds of central banks and governments printing and borrowing without a crisis to rally around seems remote.
The more plausible scenario is that the earnings cycle plays out, meaning that earnings, which are already heading down, fall more. So, if earnings do indeed fall, then we would expect prices of stocks to follow suit. I think this is especially true for a few reasons I mention below.
I have mentioned that buybacks are the leading reason that stocks have not had a big correction yet. See this Bloomberg article for more details. Here’s a reason to believe those buybacks won’t hold up.
What you can see is that operating earnings are starting to turn over and fall. While I don’t anticipate a financial crisis level trough in earnings, it is not unreasonable to expect that we reach a level about half way between the recent high and the financial crisis low. In fact, that would make a lot of sense given the amount of money that’s been printed and that millennials are beginning to form households.
Here is another piece of the puzzle. And it underscores just how important the buybacks are. For years, from the early 1980s to 2007, the baby boomers drove the economy and the stock market by spending and investing. We know that boomers are spending less, and also now, in the past year, we know they are withdrawing from their investments.
The chart on the left is the money flow into investments the past year. It very clearly shows a declining trend into equity investments. This occurred during a time when Japan’s government was buying stocks and Chinese families were funneling money out of China into American assets.
This year is the first year that the boomers must take money out of their retirement plans. The first few months of the year should really jump out at you. We are going to see tremendous pressure on stocks in the next year or two or three years as the required minimum distributions pile up. This pressure will remain until the younger boomers hit age 70 in fifteen years.
Now, there are offsets to the outflows of money. The main organic offset are the millennials who are as bit a generation as the boomers. The problem is that although they are saving more than the boomers did at the same ages, they just don’t have much money yet. It’ll be years before millennial buying of investment assets exceeds the boomer selling. In fact, I would encourage millennials to buy boomer houses on the cheap before buying their stocks. Better to have a piece of property for the coming stagflationary times and buy stocks on corrections only.
The other offset to declining flows into investments will be easy money from the central banks. As I mentioned above though, the central banks are hamstrung right now. There is a lot of opposition to more money printing and debt generation. In my opinion, it will take at least a mini-crisis and accompanying stock market correction to get central banks to act again. I expect that mini-crisis and correction to happen soon. Maybe as soon as this year – the next seven months – or certainly by next year.