The disconnect between the economy and the equity markets continues to widen.
Under the best of circumstances, the level of the stock market relative to the economy today would be unprecedented. Under current circumstances, the level of the stock market is simply bizarre.
Take a look at the chart below, which tracks the value of the broad stock market relative to GDP…
As you can see, the value of the broad stock market relative to GDP has exploded way beyond every historical level over the past 50 years. In fact, the stock market bubble of 2000 looks modest in comparison.
The fact that this explosion is happening under such difficult economic conditions makes it even more mind-boggling.
But if we are concerned about the level of the current bubble, we should be horrified by the magnitude of the bubble Wall Street is forecasting.
Take a look at this next chart. It shows S&P 500 projections from investment banking giant Goldman Sachs…
Goldman Sachs raised its 2020 year-end price target for the S&P 500 to 3,700. By the end of 2021, Goldman forecasts a nearly 19% rise from current levels. By the end of 2022, it expects an additional 7% rise.
These forecasts would imply a 2022 market valuation above 200% market cap-to-GDP. That’s if we grow at 5% GDP per year, as Goldman expects, but that’s extremely unlikely. (Consensus estimates put GDP growth at 3.8%.)
Sure, things may look better now than they did a few months ago… But the economy has received gigantic supplementary assistance, and that assistance can’t continue indefinitely.
The Federal Reserve’s bullets are largely spent, as the benefits from additional monetary stimulus are limited and uneven. So far, as I wrote about in the November 3 Money Trends, the Fed’s measures have only expanded the bubble even more, and they’ve fostered ever-larger economic disparity.
Further economic growth needs spending and the purchase of goods and services. But the Fed doesn’t spend – it just provides liquidity.
The economy will likely have a very uneven recovery until a vaccine has been broadly disseminated and taken by the super-majority of the population. That means fiscal spending and more government debt are going to be sorely needed for quite some time.
If the markets were getting crushed now – in other words, if they could reflect reality instead of fantasy – perhaps the authorities would drill down and try to solve the many structural issues.
But as things stand, people have been sucked into the illusion that things are fine – thanks to more than $3 trillion of government deficit spending and more than $3 trillion of Fed money printing.
These actions have propped up and boosted the markets, but they are not without serious consequences.
You see, there are existential risks that go far beyond whether stock markets are rising or falling. We are not living in a period of good times and normalcy. It doesn’t take a genius to realize that what we are experiencing is without precedent.
Consider that, going into the year, we had the highest stock market valuations ever. Then, as you know, we experienced a terrible recession.
Now, more than one-third of all adults are struggling to pay their utility bills. They need to choose between which essential family need will be cut out.
Unemployment, meanwhile, remains around 7% – twice as high as it was around this time last year. (The Bureau of Labor Statistics says the real unemployment rate is even higher, at 8.4%.)
And yet we have even higher stock market valuations today than we did going into the year! But don’t be fooled. This is hardly a boom time for the American economy.
The chart below is a perfect illustration of the disconnect between the real economy and the stock market…
You can see that corporate profits have been flat to lower even as the stock market has surged to new all-time highs. Something must give soon.
Already, the euphoria over the Covid-19 vaccine announcements seems to be cooling down. As the reality of millions of coronavirus cases collides forcefully with the hope of a wonderful vaccine, I expect that euphoria to morph into major disappointment.
At that point, investors chasing unsustainable market valuations will have to face the harsh reality that is now hidden.
This makes all my previous warnings for caution all the more pressing, as the market could quickly shift from greedy to fearful. On the plus side, it would be a trader’s market…
All the trades that worked in the currencies in February and March would come back into vogue with a vengeance. Specifically, the Aussie, Kiwi, and Canadian dollar should all weaken considerably in this kind of “risk-off,” or bearish, environment.
Overall, we expect to see a big pick-up in volatility across the board. So stay nimble.
Editor, Money Trends
P.S. At my Big Trades advisory, I identify the key moves in the currency markets… And I give subscribers precise entry and exit points to play them. If you’re not a paid-up subscriber yet, learn more about how to get my latest trades delivered to your inbox, right here.
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