Bubble of Bubbles
The deflating bubble of everything has taken the spirit out of this years seasonal Santa stock rally. Nevertheless, for stock investors every week probably seemed a bit like Christmas with the Dow setting 86 new record highs since 2016 and with it, the bubble of bubbles is getting bigger and bigger.
But the Fed is fully aware that asset prices, particular stocks are in a bubble of bubbles. Indeed, the Fed has alluded to frothy asset prices more than once over the last six months in their Fed minutes. With each month passing Fed minutes confirms that they are more than concerned about the bubble of bubbles.
For the record here are some snippets…
Fed minutes, July 2017:
“Since the April assessment, vulnerabilities associated with asset valuation pressures had edged up from notable to elevated, as asset prices remained high or climbed further, risk spreads narrowed, and expected and actual volatility remained muted in a range of financial markets.”
Fed Minutes, October 2017:
“In light of elevated asset valuations and low financial market volatility, several participants expressed concerns about a potential buildup of financial imbalances,”
Janet Yellen response to a question from IMF Panel, October 2017:
Market valuations “are at high level in historical terms” when assessed on metrics akin to price-earnings ratios,
Janet Yellen during Fed presser December 13th, 2017:
Stock valuations are at high end of historical levels.
Now keep in mind that the role of the Fed is to maintain financial stability and downplay the risk. In other words, don’t expect the Fed to issue investors with a warning to head for the hills. Put another way, the Fed will always be reluctant (and be the last) to highlight risks in the system. Fed policy is “98% talk, 2% action,” said the Former Fed Chair Ben Bernanke.
So if the Fed is publicly making a statement which is alluding to frothy valuation it might be prudent for investors to take note. Perhaps the Fed (with its mask off behind closed doors) is really panicking about the bubble of bubbles.
Moreover, it would explain the 5th rate hike since the Fed embarked on its policy of tightening in December 2015. I don’t buy the view that the economy is overheating and Fed tightening is to keep demand-pull inflation under control.
The bubble of bubbles could be due to hyper-inflationary monetary policy (the devaluation of the currency caused by a system flooding with too much liquidity).
But just how bloated is this bubble of bubbles, how can investors gauge the bloatedness of this stock bubble?
Stocks earnings can be fudged using accounting tricks (different levels of depreciation, tax loopholes, write-offs) which means that Price to Earnings (P/E) may not give investors a true picture. So astute investors are now turning to the Price to Sales (P/S) ratio instead. Sales revenue is more difficult to fudge (either a sale was made or it was not)
So P/S multiple has smashed its former all-time peak from 1999: a period that is now widely considered to be the single largest stock bubble in history. In short, this current bubble of bubbles in stocks (and almost every other asset) is unprecedented.