Irrational Exuberance

I hate to spoil the party, but I do think this is worth considering because I’ve been reading cautionary warnings from Paul Krugman and Robert Reich lately.  We haven’t seen this steep of a slope on the S & P 500 since the last 2 times we felt painful crashes in 2000, and 2009.

S_and_P_500_chart_1950_to_2016_with_averages

Having gone through a few of these and felt the pain, it got me to thinking about the new tax legislation just passed by the GOP.  Stock prices are in large part a function of earnings, and expected earnings.  When the markets have crashed in previous years, there have been signals from price/earnings ratios getting too far above the average.  Note that in the chart below, the 10 year average P/E for the S & P is 16.4.  We are currently at 20.5 before the tax cuts have taken full effect.

SP-500-PE-Ratio-history-tactical-investment-management-589x328

Additionally we’re at what is considered peak employment (around 4%) so it’s a fairly tight labor market.  The tax reform plan was sold as a ‘jobs creation’ package.  But who pray-tell, will be filling all these new jobs?  Certainly not immigrants.

What concerns me the most is the well-known practice of CEO’s boosting their own annual compensation by employing stock buy-back programs of their own company’s stock.  This temporarily boosts the prices of the stock, but the problem is, it can’t hold because stock prices are fundamentally based on earnings.

So does this mean that salaries will finally be boosted because of the tight labor market?  Could be.  But I’m being extra cautious about the fantasy that the S&P will continue to rise at this pace.  Historically there’s always been a correction.  All it takes is one world event to trigger it and the next thing you know, your 401k is down 30%.  Boom.

The current run started during the initial stages of the recovery from The Great Recession of 2009.  We’re on a 9 year run.  Obama gets credit for 8 of those years, Trump one year.  We are due for a correction.  In my mind it’s just a question of when.  My vote would be about 6 months before the 2018 mid-terms to ensure justice is served to the architects of this massive giveaway to corporations — who do not need it, and are there’s no incentive tied to getting the tax break.  They just get it whether they create jobs here, ship jobs overseas, or use it to buy back stock.  One of the most idiotic schemes ever legislated.

Hold on to your shirt-tails.

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