Blind(er) spots

A former colleague had sent me an Op.-Ed. by Prof. Alan Blinder who had also served in the Federal Reserve. He is commenting on the gyrations in the stock market and calling them unnecessary, in effect. I could not believe it. How could a learned Professor set up his own strawmen and knock them down.

Stock markets begin to decline when their valuations become utterly indefensible. They need some trigger or excuse. It is utterly wrong and ignorant to try to link specific news as triggers for the market correction. The US stock market is not correcting because of China or because of lower oil prices.

If lower oil prices are supposed to be helping US consumption spending, the question to ask is why it has not done so far. Are there other factors at work? Second, given that the oil industry boom played such a big role in driving US investment spending and employment growth, a learned professor would try to take into account both the downside and the upside of the collapse in the price of crude oil. If his students wrote what the PRofessor wrote, they would lose marks for an incomplete and partial evaluation of facts.

US stocks are richly valued. The Russell 2000 index has a P/E multiple of over 100. The S&P 500 index has a P/E multiple of over 21. The median Price/Sales Ratio of a S&P 500 stock is higher than it was in the year 2000! Some people prefer to see this ratio than the conventional P/E ratio because earnings are so wildly manipulated so as to be utterly devoid of content.

Recall the recent words of the Oppenheimer analyst on the Citigroup results. See here.

The high-yield bond market (junk bonds) had been screaming problems in Corporate Revenue and Earnings quality for some months. Stock markets usually remain in denial for long and wake up only when it is too late. Stock markets take long excursions away from fundamentals. That is why in short to medium horizons they resemble a random walk. Given sufficiently long horizons, they return to their senses.

Probably, after six years of living in a lah-lah or cuckoo land, stocks are beginning to price in the reality of low growth, high debt, low and falling earnings. For an occasional market pundit to tell investors that there is nothing to fear at this late stage of both the market and economic cycles is nothing short of preposterous.


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