The U.S. Stock Market Mega-Bubble - Jeff Nielson

by Jeff Nielson, Sprott Money:

Dow Hits Record High as Street Rallies on Strong Q2 Results

July 31, 2017

That’s a nice message, isn’t it? U.S. markets are higher because of “strong Q2 results”. Move along people, no bubbles to see here. The Dow had eight straight record closes because of (supposedly) “strong Q2 results”.

There is just one problem. It’s 100% fiction. There are no strong results. However, before looking more closely at this blatant falsehood it is necessary to provide some context, especially for readers who do not follow U.S. markets closely.

Going into the second quarter earnings season, stocks in the S&P 500 were trading at 18X “forward 12-month earnings” (i.e. projected earnings for the next 12 months). This doesn’t simply make stocks in the S&P 500 expensive, it makes them insane.

Market experts claim that the “historical average” for this earnings multiple is around 15:1. But this overlooks the fact that U.S. markets (in particular) are perennially pumped to absurd valuations, versus almost anywhere else on the planet.

What is a rational valuation level for the market, as a whole? Ten-to-one. Understand what this ratio means. If you were wealthy enough to purchase an entire company, at a 10:1 earnings ratio it would take you ten years just to get your money back.

This is an acceptable level of risk for investment. There is no guarantee that the company you buy will continue making profits for one more year – let alone ten. You may never get your money back.

Skeptics will scoff at such prudence. “Invest in a blue-chip company like Coca-Cola and you’re guaranteed to make a profit.”

We’ll return to that argument later. How did U.S. markets reach a valuation level (going into Q2) which was already extreme, even by U.S. standards? It’s the “beat expectations” game, played by the lying prostitutes who are dubbed market experts.

The game goes like this. Before earnings are released, the experts predict “earnings growth”, collectively, for the S&P 500. They prance in front of the cameras and claim that this (predicted) higher earnings justifies U.S. markets in going even higher.

But then these sleazy double-talkers change their tune entirely when it comes to predictions for individual companies. Individually, they predict terrible results for these companies. Then, when the results are slightly-less-than-terrible, the experts crow that those results “beat expectations”, and thus the higher valuations of U.S. markets are supposedly justified.

Notice the bait-and-switch.

Before earnings season, the experts claim (rightfully) that higher earnings would justify higher valuations. Then, after the results are released, these sleazy liars claim that higher valuations are justified because individual companies simply beat their dismal “expectations”.

Suddenly earnings are irrelevant. This allows U.S. markets to go higher and higher, even if earnings go lower and lower.

Observe these prostitutes in action in Q2. This is what they were saying at the beginning of earnings season:

Goldman Sachs pegs the consensus estimate of S&P 500 earnings growth at 7%...The real 'winners' among sectors could be tech and financials, which have led the stock market's gains this year. They are estimated to report 10% and 6% earnings growth respectively, according to Goldman Sachs.

It seems like a fairly impressive target – until you look at recent quarterly results for U.S. companies.

The first quarter ended a five-period streak of S&P 500 earnings declines that were worsened by the energy sector's turmoil. Analysts expect a repeat of earnings growth, even if it's not by as much.

U.S. earnings have declined in five of the last six quarters, as the U.S.’s market bubbles have spiraled higher and higher. Earnings levels going into Q2 of 2017 weren’t much higher than they were in 2011 – when valuations were much, much lower. Even if earnings were to rise by 7% in Q2, this wouldn't come close to recovering to where they were a year-and-a-half ago.

However, such earnings growth has not occurred. Observe the bait-and-switch. Let’s use JPMorgan as an example, since the banks were supposed to be a leading sector in Q2. JPMorgan “beat expectations”. But let’s take a closer look at those expectations.

In Q1 2017; JPMorgan reported earnings of $1.65/share. What were the prostitutes predicting for JPMorgan for Q2? Earnings of $1.58/share.

The same prostitutes who were predicting robust profit growth for the market at a whole, and robust profit growth for the banking sector as a whole, were predicting that JPM’s profits would fall. Beating expectations means nothing when those expectations are usually at some rock-bottom level.

Coca-Cola “beat expectations” in Q2. Sounds good, right? Wrong. Profit for Coca-Cola fell 60% -- but the prostitutes were expecting even worse (or so they claim). Keep in mind that this 60% plunge in profit comes immediately after a 20% plunge in profit in Q1.

That’s a 60% drop in profit on top of a 20% drop in profit, and the prostitutes claim they were expecting even worse from this Dow Jones bellwether. Is there anyone still willing to step up and pay 18X forward 12-month earnings for a company like Coca-Cola? Eighteen years to get your money back – if you’re lucky.

It’s not just Coca-Cola that has reported terrible results so far in Q2, as the U.S. stock bubbles keep rising. General Electric? Profit down 60%. Amazon? Profit down 77%. And the NASDAQ has been leading the spiral higher in recent months.

How secure would shareholders feel who paid 18X Q1 earnings for Amazon stock, after hearing this news? That would have increased the Amazon multiple to over 70:1.

Then there are U.S. department stores: terrible results almost across the board. This comes following quarter after quarter of terrible results for these companies. This comes after the largest spike in U.S. retail sector bankruptcies since the Crash of ’08. These are supposed to be the survivors in the dying U.S. retail sector.

What excuse do the prostitutes have for the terrible performance of U.S. department store chains? They say they are losing business to Amazon and Walmart. Hello? Amazon’s profit was down 77%. This is a consumer economy. Where are the consumers?

It doesn’t matter. The bubbles keep going higher anyways.

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