Unhinged… And Then Some!
Jerome Powell puts you in mind of the boy who killed both of his parents and then threw himself on the mercy of the court on the grounds that he was an orphan!
That’s what JayPo essentially did in his presser yesterday while trying to explain that the most hideous equity market bubble in history is actually not that at all:
“If you look at P/Es they’re historically high, but in a world where the risk-free rate is going to be low for a sustained period, the equity premium, which is really the reward you get for taking equity risk, would be what you’d look at,” Powell said.
“Admittedly P/Es are high but that’s maybe not as relevant in a world where we think the 10-year Treasury is going to be lower than it’s been historically from a return perspective,” Powell said.
Right. The Fed has essentially murdered the bond yield. So relatively speaking, grossly inflated stocks are a bargain compared to dead-in-the-water bonds.
Bloomberg even has a chart to prove all this based on the so-called “Fed model”:
The S&P 500’s earnings yield – profit relative to share price – is 2.5 percentage points higher than the yield on 10-year Treasury notes. The comparison, loosely labeled the Fed model, sits well above what the spread was before the burst of the internet bubble, when bonds yielded more than equities by that measure.
Then again, the “earnings yield” is not exactly cash you can take to the bank, unlike a bond coupon as meager as it might be at present. The former is just a computational hope that today’s vastly inflated stock prices relative to earnings stay inflated indefinitely, world without end.
Stocks still looks appealing when compared to bond yields
More fundamentally, where is it written in the annals of sound finance that the purpose of owing bonds is to lose money forever and ever?
For want of doubt, here’s the 10-year bond yield that has been suffocated by the Fed’s massive bond buying spree. Relative to inflation, which the Fed relentlessly strives to promote at 2.00% per annum, there is no real yield left at all.
So what Powell is apparently saying is that since bonds are for suckers, please have some 40X PE stocks instead.
As is evident from the chart, prior to the year 2000 there tended to be 200-400 basis points of daylight between the inflation rate as measured by the Y/Y change in the 16% trimmed mean CPI (blue line) and the 10-year UST note yield (black line). But after the dotcom crash, money-printing got serious and, as JM Keynes himself might have said, the real yield got euthanized.
As of the most recent reading (October 2020), in fact, the 10-year UST yield at 0.88% was fully 134 basis points lower than the Y/Y inflation rate at 2.22%. At the rate, of course, the purchasing power of your principal would essentially vanish after a few decades.
In truth, even a blithering idiot should be able to see that the current bond yield is a false and dangerous benchmark for the valuation of equities. The fact that JayPo has taken to citing it with alacrity is just another sign that today’s money-printing central bankers have become completely unhinged.
Euthanasia of the Real Bond Yield: 10-Year UST vs. Inflation, 1994-2020
Indeed, the sheer gall of justifying sky-high stock prices based on absurdly low bond yields is underscored by the chart below.
Thanks to more than $30 trillion of central bank balance sheet expansion since the year 2000, the global bond market is completely broken, as attested to by the now all-time record of $18 trillion of global bonds trading at negative nominal yields.
For crying out loud, bonds should never trade at negative nominal yields; it amounts to financial masochism – paying someone to lock-up your own money for an extended period. The only theoretical exception might be in a financial environment of deep and long-lasting deflation.
But in the world as we have known it, where’s the deflation?
Indeed, ever since Nixon crossed the monetary Rubicon in August 1971 and ripped the dollar from its last anchor to real money (gold), the general price level has risen by 540%. Yet these cats at the Fed do not even notice that the global bond market is completely kaput and is priced for an alternate deflationary universe that is the opposite of the real world tracked below.
Even in the most recent period, yields on US treasury paper are stupidly low compared to the current 2.22% Y/Y inflation rate. Not a single point on the treasury yield curve is close to being near or above the inflation rate. Thus, at the end of last week:
- Three-month Treasury bill rates ended at 0.0625%.
- Two-year government yields declined three bps to 0.12%:
- Five-year T-note yields fell five BPS to 0.37%:
- Ten-year Treasury yields dropped seven BPS to 0.90%;
- Long bond yields sank 11 BPS to 1.63%;
- Benchmark Fannie Mae MBS yields fell six BPS to 1.35%.
Yet it is the above lineup of ridiculously underwater real yields that JayPo avers are proof that there is no stock market bubble. About the only consolatio
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