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Rising Real Yields Are Inconsistent With Current Stock Valuations.

As before, Wall Street Earnings Estimates Are Likely To Be Wrong At The Worst Time To Be Wrong. The Last Twelve Months Earnings Decline Signal Has Triggered Again. The Record is already three for three.

Price-to-Fantasy Ratio: Self-Deception with Forward Operating Earnings
Chris Brightman, Rob Arnott

We really need to stop this #adjusted #earnings #BS and get back to #GAAP earnings. Operating (proforma) earnings is arguably one of the worst things we did to financial reporting in the last 30-years. You are overpaying for investments.”
Lance Roberts

I think we should be bearish on stocks and bullish on inflation,”
David Einhorn

The recent divergence between the real yield and the forward P/E is a red flag for US equities. The forward PE Ratio has never been this high compared to real yields for the last 7 years. With earnings growth likely to weaken further, and real interest rates continuing to rise, it’s the price of the S&P 500 that looks the most fragile in this equation. In 2023, retail investors have been buying, option speculation has made new records, but corporate insiders have been net sellers at the highest rate for two years.

The US equity market also faces record income competition from two year Treasuries. The spread between Treasuries and the S&P 500 dividend yield is as wide as it has been since 2007.

It’s not even clear that we are looking at the right earnings anyway. In aggregate pro forma earnings are inflated by as much as 15% relative to what companies have to officially report in GAAP eanings.

We really need to stop this #adjusted #earnings #BS and get back to #GAAP earnings. Operating (proforma) earnings is arguably one of the worst things we did to financial reporting in the last 30-years. You are overpaying for investments.”
Lance Roberts

Earnings are not just overstated, they are already declining year on year in Q4 2022.

According to Morgan Stanley’s model earnings are likely to experience the steepest decline in decades.

So Who’s Buying?

The quality of buying has been poor. Record options trading in 2023 has been increasingly concentrated in short expiry date option speculation.

Also retail buying of high beta stocks like Tesla has been remarkable, even as Tesla cuts prices with record inventory.

Notably, the most informed investors, the corporate insiders, have been selling at the highest pace since 2021.

What are so Many Retail Investors and Speculators Missing?

For the last 15 years the central bank reaction function to economic weakness or subsiding inflation lead to rapid and sizeable policy support. That policy response is no longer feasible in a world of 40 year highs in inflation and still negative real interest rates.

The Economic Slowdown Continues

Increasingly there are signs that the labor market could finally be slowing. Challenger Layoffs have correlated closely with jobless claims in the past.

Construction jobs look to be on borrowed time with a dramatic divergence between permits and units under construction.

Mortgage purchase applications are making new multi decade lows. Housing weakness is clear and at record levels.

The scale of further weakness considered possible by the Fed was made clear by Chairman Powell in Q&A following testimony this week.

Republican Sen. John Kennedy of Louisiana cited research suggesting that during the last 10 times the U.S. economy had “disinflationary periods” since the 1950s, for every 2% reduction in the inflation rate, unemployment went up by 3.6%.

Powell didn’t dispute that. So Kennedy did the math…

Based on current numbers, unemployment would have to hit 7% to get the consumer price index from its current 6.4% down to 4.4%. “That’s what the record would say,” Powell replied.

And to get inflation down to 2.2%, based on history, Kennedy said the unemployment rate would have to go to 10.6%, right? To which Powell said…

“I don’t think that kind of a number is at all in play.”

Write that down somewhere for posterity in the event it happens… And note that even after he agreed with the research that led to this conclusion, Powell didn’t even want to think about the idea of double-digit unemployment.

Kennedy’s point in bringing all this up wasn’t to make a good quote. He wanted to suggest that Congress should spend less money and stop racking up debt because “the more we help on the fiscal side, the fewer people you’re going to have to put out of work,” he said to Powell.

“It could work out that way,” the Fed chair said.

This signal is three for three and has now signalled again

Check out what happened before when the Last Twelve Month actual earnings declined, even as forward earnings were projected to go to new highs.

The last three times were recessions, where the stock markets collapsed. Wall Streets Earnings estimates have been wrong 3 times at the worst time to be wrong. Why not a fourth time? It looks likely. The track record is clear and repeats.

Transform Your Investment Experience

The room for policy manoeuvre, and the stability of the current system should not be taken for granted. Volatility has increased and is likely to continue to stay high. The outlook has rarely been this uncertain. Investment management needs Best Investor metrics and techniques as never before.

Market and economic events are moving fast at this stage. If you need a quick review of the issues that you may need to know about for your own circumstances, schedule a FREE consultation today.

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Chris Belchamber is an IRMAA Certified Planner

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