Author Charles Dickens’ classic, A Tale of Two Cities, begins this way: “It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness”
According to one stock market analytical firm, GMO, today’s market behavior resembles Dickens’ book, which was published in 1859 and was set during the time of the French Revolution some seven decades earlier.
As the firm noted, in recent days much of the investing and financial world was focused on a meeting in Jackson Hole, Wyoming, attended by Federal Reserve chairperson Janet Yellen. But GMO analysts were watching other things and events happening in the market.
In August, the firm noted in its monthly report – reproduced in part by Zero Hedge – that Shiller P/E, a respected metric for measuring U.S. equities valuation, surpassed 27. Given that normally its range is somewhere slightly above 16, it appears that valuations are looking a bit larger than they should be.
What’s more, GMO noted, the last time the Shiller P/E was above 27 was in October 2007, “and we all know how that movie ended,” the GMO report said.
‘A tale of mediocrity, at best’
And though no one at the analytical firm is saying that the nation and the world are set to experience another Great Recession and near-meltdown of the global economic order – and nothing is written in stone saying that stocks are not allowed to become more expensive – “we continue to maintain our bias against U.S. stocks,” the firm said in its report.
At the same time, the firm said, it was tracking a widening disconnect between fundamentals of the U.S. economy, corporate America and their stocks. “It really is a tale of two cities,” the analytics firms said, “one of mediocre fundamentals versus a meteoric rise in markets.”
In assembling some relevant metrics pertaining to the overall health of the economy and some top-line/bottom-line figures from the S&P 500 index, the firm looked at gross domestic product growth, productivity and household income, in addition to some others like revenue and earnings for U.S. stocks, just to round out the assessment.
“It is a tale of mediocrity, at best,” the firm wrote in its report.
After that, analysts contrasted those metrics with actual market returns of the S&P 500 Index spanning the past five years. “Truly meteoric,” the firm wrote, adding this caveat: “As an aside, we at GMO have always been leery of drawing too many investment conclusions from staring at economic data–we are more valuation-oriented, after all–but even we are struck by the divergence.”
The metrics don’t add up and neither do the facts
All of which circles back to the Shiller P/E. A lot of the increase over the past few years has come largely from multiple expansions. What is especially troubling about those multiple expansions, however, is that they are consistently mean-reverting and if they run too far, the market always takes it back and often in a big way. Right now, GMO analysts say, “we are currently almost 70% too far.”
Far too many Americans, however, are totally oblivious to this, for a number of reasons.
You have those Americans who are working and doing okay, so they don’t see any financial crisis – now or anytime in the near future.
You have those who believe the Obama administration and the president when they lie and say that the economy is doing great, even though actual economic growth is nearly zero, and a record number of Americans are out of the workforce.
But then you have those Americans who have been hard-hit by the Great Recession that supposedly ended some years ago, who are chronically unemployed or underemployed, reeling under higher costs for practically everything (especially their healthcare, which wasn’t supposed to happen after Obamacare became law). They know what kind of economy we really have. And they know that the GMO folks are exactly right to be worried about a crash.