Stocks are the Last to Know

Stock markets are the last instrument you should use to predict the future.

Good morning - Stocks are the last to know, usually.

Stocks are not forward projections, they are mirrors into the unconscious tug of war churning in the emotions of the masses. As Americans we are indoctrinated in Anglo-economy - the “free market” - a religious faith in the “invisible hand” or Mr. Market.

We believe Animal Spirits always equilibrate, and in the grand expanse of time that may be true, may be true. What is definitely true from what I gather, however, is that most of the time stocks tend to ignore fundamentals. Stressed bank balance sheets, credit addled consumers, and overheated fiscal budgets matter not until they suddenly do and then markets crash like a drunk charged with a DUI on his way to rehab. Stocks may be close to such a jarring wake up call.

We have been here before. During a recent interview with renowned investor Jeremy Grantham, he emphasized the alarming precedents of stock market bullishness ahead of catastrophic downturns.

“If you look at the broad sweep of history you have to be impressed with how incredibly bad the marketplace is as a judge of the future.”

“If you look at the broad sweep of history you have to be impressed with how incredibly bad the marketplace is as a judge of the future,” Grantham said. John Kenneth Galbraith named his book on market mania for this reason: A Short History of Financial Euphoria. Short carries a double meaning, used for the brevity of the book (about 100 pages) and short for the memories of investors, the majority of whom barely remember much beyond a quarter, never mind the past decade or last century.

So what does history say about the present moment? Does the last decade+ of a bullish stock market portend ever-stronger economic growth? Does the AI craze, like electric vehicles or Metaverse stocks before it augur the next productivity miracle?

Good Times Before Bad Times

Well, if Price-to-Earnings (PE) is your metric, there is reason to be skeptical if not scared. The third highest trailing Price to Earnings (PE) in market history occurred in Fall 1929. As Grantham points out, the stock market crash was only the beginning of a broad-based collapse in the economy that lasted well over a decade. Stocks did not recover to similar levels for twenty years around the time when the young enterprising Warren Buffett began his investment career.

Fast forward to Japan in the late 1980’s. The NIKKEI reached a PE of 25x in 1987 when Grantham’s group exited Japanese Stocks. It was a terrible call until it wasn’t.

What followed was a gravity-defying climb up to a PE of 65x by 1989. The whiplash made the NIKKEI’s rise “the Mother and Father of all bubbles” according to Grantham. From its peak in ‘89, the Japanese economy went into a vegetable-state and for over twenty years saw no growth. One could argue Japan never recovered.

A gravity-defying climb up to a PE of 65x made the NIKKEI’s rise “the Mother and Father of all bubbles”

The Global Financial Crisis (GFC) in ‘08 placed third in highest PE in history, only behind 1929 and 2000’s tech bubble. The fallout, as we know well now, is what some have called the Great Recession, a prolonged period of sluggish “below trend” growth that broke the streak of ever higher standards of living for succeeding generations. Millennials and Gen Z have experienced generational disruption on a scale unseen since the Depression as a result, especially young men. Such dislocation set in motion the forces that inspired the Men and the City Blog and Neo-Masculinity.

Where do we stand today? By many measures today’s PE is “slightly higher than 1929 and 2021” so Grantham describes stocks today as “the most vulnerable market” we have ever experienced. Every cycle unfolds differently but every crash is a familiar whipsaw. Eventually, markets wake up to reality and throttle investors spectacularly when they do. Many are wiped out, but economies suffer even more.

Grantham describes stocks today as “the most vulnerable market” we have ever experienced.

Alarm Bells

There are alarm bells, especially in the banking sector. Ally Chief Financial Officer (CFO) Russ Hutchinson stoked still muted but amplifying concerns that borrowers are under pressure. “We’re clearly dealing with a cohort of borrowers who have been struggling with cost of living and now are struggling with an employment picture that’s worsened.” He continued: “As that pool of struggling borrowers in those later-stage delinquency buckets has grown, it gives us pause.”

It should give us all pause because banks are the sounding board for the economy. Borrowers are having issues paying credit card debt, auto-loans, and shifting their spending habits to absorb higher cost-of-living for groceries. Credit losses are piling up as banks desperately try to outmaneuver Commercial Real Estate (CRE) losses and who know’s what else (derivatives like CLOs for example)?

For many reasons beyond trailing PEs and recessionary symptoms this time seems far more precarious than past stock market bubbles.

For many reasons beyond trailing PEs and recessionary symptoms this time seems far more precarious than past stock market bubbles. Proxy wars in Ukraine and Israel are heating up so any day the US could find itself in a major war against important creditors like China. BRICS continues to grow alternative payment networks, supply chains, and attracting new member nations. A second assassination attempt against President Trump shows how explosive the November election could be.

Then there is US fiscal crisis. Neither POTUS candidate is taking the ongoing fiscal emergency seriously beyond talking points about sovereign wealth funds or further sanctions against countries fleeing the dollar. Yet another debt ceiling will be pierced by December 2024 and who knows how rancorous DC will be by then.

Clearly something bigger is coming and stocks will be the final straw to break before full on panic ensues. Roaring stocks fooled everyone before the crash in 1929, then in 1989, and in 2008. Despite popular opinion governments did not save people then either: investors were wiped out, millions of families lost homes, and the most powerful economies in the world were stopped in their tracks. Recovery took decades if it came at all.

Bottomline, stocks at nosebleed levels tend NOT to predict prosperous futures.

Welcome to End-of-Cycle.

Stay safe, stay liquid.