A few weeks ago in Stocks Next Leg Down I called for the bear market in stocks that began in February to resume. As I noted in a followup to that post (I frequently follow up posts in the Comments section), that was clearly early and, as also noted, potentially outright wrong if the selloff didn’t resume promptly. It did, so let’s just say that call was a narrow escape.
That followup had a higher confidence level because it did an end run around a confounding variable – the dollar. In general, stocks do not “go up”. Rather, the dollars in which we price them go down. During inflationary periods, stock prices may rise more than enough to compensate for the depreciation of the currency unit, because they embed a short position in currency. In other words, most corporations are leveraged by virtue of being partially capitalized by debt, not just equity. But as we discussed in another recent post, The Key To Endless Prosperity Revealed, that’s not a genuine source of returns … despite central banker fantasies to the contrary, we cannot all prosper by shorting a declining currency. The principle source of real stock returns is in their yield. Dividends represent the sustainable excess of stock returns over gold.
My followup analysis took advantage of the fact that the distortion due to changes in the value of the dollar can be algebraically eliminated by changing the pricing unit to gold. Some might call this a “stock:gold” ratio, but that misses the point a bit … in fact all prices are ratios. The popular stock indexes, for instance the S&P 500, are not “absolute” stock values either, merely the ratio of the values of stocks to that of the US dollar.
So what next? This particular short term trend is moving fast and could be halfway done by the time you finish lunch. But it’s likely part of a larger or higher degree downturn that has much longer to play out. Look for further follow up as developments warrant.
6 thoughts on “Overdue, but not Overdone”
Good call. I think it has a way to go ,,,,, down. First, there is the danger, probable from what I understand, of a Covid rebound. That will only exacerbate continued social distancing and dis-interest in getting on planes, staying in hotels, going to concerts, dining at restaurants, etc., which will be the case even without a Covid rebound. We are and will be in recession through year-end at least. Earnings prospects are not good overall, and the market is rich by valuation metrics.
Yes, although I call the economy in a state of depression. Would anyone really claim economic activity isn’t depressed? Of course how long the depression lasts is another question, but if economists say a depression must exactly match the Great Depression in order to qualify, then all they’ve really done is define depressions out of existence. Economics would have been converted into semantics. Not exactly a good excuse for science!
Are we fighting the Fed? (to use a cliche)
To quote Len Penzo:
“People who say the Fed has everything under control need to explain how that can be when it took the Fed seven years to add $3.7 trillion to its balance sheet during and after the Great Financial Crisis of 2008 but only 10 months to add nearly another $3.7 trillion since the repo market broke last September. Does anybody else see a problem here? Anyone? Anyone?”
Are we fighting the Fed? Yes and no. The Fed can make stock prices go up, but it can’t make stock values go up.
The difference? Price of stock = value of stock / value of dollar.
The Fed certainly has a lot of control over the value of the dollar – the dollar is a security issued by the Federal Reserve. No need to take my word for it – just take one out of your pocket and read the inscription.
But stocks are securities issued by corporations. Corporations own the balance sheets, earn the earnings, and pay the dividends. The value of those things is not determined by the Fed.
So in a nutshell, the Fed can’t make stocks worth more, it can only make the dollar worth less.
This is a good blog, happy every day