The Wrong Compass

We  believe that the most dangerous miscalculation of investors and policy makers alike is the connectivity between equity prices and the economy. From a valuation standpoint (outside of the 1980- 2000 "special window") equities are pushing a high multiple. Reduction in earnings multiple could be the long trend mean reversion yet to take place in this cycle. The SP posted an annual average return of -.89% for the 1999 to 2009 decade. This period of healthy expansion, book-ended by 2 serious financial calamities, highlights the futile nature of equities as a guide to the economy.

The stand out characteristic of the US Lost decade was that it occurred at the  pinnacle of the credit mega-cycle. As Gerald Minack of Morgan Stanley Australia has shown, the commonly accepted idea that the high leverage cycle was used to fund consumption and physical investment is FALSE. The vast majority of debt was used to buy pre-existing assets. Greenspan's failure to identify this construct was a critical flaw in his "growth experiment" thinking.

As 10 year yields have fallen to 3% again, the pundocrisy has quickly reverted to the earnings/dividend yield argument for stock allocations (mind numbingly called "risk on"). The absence of distinguishing between real and nominal yields is only the most obvious flaw to this thinking. NO interviewer has ever pointed out that using the same metric stocks were deemed "rich" in 1980 and "cheap" in 2000. A  global monetary regime on a cocktail of Viagra and steroids is increasing the daily oscillations in capital markets in the name of Stability. The stock market is the wrong compass to use as a guide out of this mess.

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