Proof that Market Valuations Have a Negative Correlation to Expected Future Cash Flows… Welcome to Wonderland

Janet Yellen once again repeats that the economy is “looking stronger” although still it has yet to manifest into actual strength.  In fact, it is still so weak that the Fed cannot even suggest that rates will raise anytime over the next several FOMC meetings.  In short, the economy is still very sick.  But so let’s break down Janet’s point of view on the economy and respective policy decisions.

  • No rate increase in the foreseeable future.
  • Economy is looking stronger but fails to have any real strength or even signs of strength to predict when a rate increase may be forthcoming.
  • Agrees the U3 figure might be misleading and that U6 tells a more accurate story
  • Believes Congress has a major problem with the Federal Gov forecasted cash flows
  • Strongly opposes an audit of the Fed
  • Believes housing, albeit more likely via multi family construction, could improve
  • Wages and incomes are still weak

So essentially nothing has changed in 6 years.  In fact, absolutely nothing has changed in 6 years.  So then there has been no material improvement in the economy whatsoever.  Material meaning enough to even forecast when a rate hike may come.

The Pundits (Liesman) are suggesting Janet feels the economy is strong but that the “data just isn’t cooperating”.  What does that even mean??  “I’m a billionaire although my bank account just isn’t cooperating”.  Umm Steve Liesman, you are by all accounts and absolute ignoramus.  Like a monkey Mr. Liesman, you’re a mix of amusing for a few minutes and cute in an ugly way.  And according to Jim Lebanthal, of Lebanthal Asset Mgmt, “there was no bad news”.  Now remember, by ‘bad’ he means ‘good’.  Because bad means more QE, which has actually never stopped and you can see this in the duration of Fed assets, which Janet touched upon.  But again, the point being the economy is not strong enough to support even a forecast of a rate hike.  That means the economy is weak.  I don’t know how that gets confusing.

And so if the economy is weak, then the economy must have either no or a negative relationship to equity valuations.  Market is at all time highs and pushing higher on bad is good.  So in fact, there does seem to be a negative correlation between the economy and market valuations.  Interesting if not mind blowing.  The market has, after 6 years of the most extreme monetary easing in the history of the world,  traded to all time highs on an economy that is too weak to warrant even an indication that rates could move above 0%.  There is no other way to see this.  I’m sorry but there isn’t.  Seriously have a look!

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That giant X constitutes as a pretty solid negative correlation between market valuations and American’s ability to support future cash flows.  This is a very simple chart.  However, the implication of this chart is actually incredibly important.  What it suggests is that market participants have seen the detriment of the American working class as a financial market driver.  That is, the less able American consumers are to drive future corporate cash flows the higher the market valuations grow.  How could this ever be you ask given market valuations are fundamentally based on expected future cash flows??  Well, as I’ve discussed many times before, the Fed and only the Fed.

The market is addicted to easy money.  The Fed has done everything in its power to ensure the market is certain that the easy money train is to continue as far as market participants can see.  This becomes clear when we look at what happens when market participants believe the easy money train is running out of steam.

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So what we see in these two charts is that upon the easy money trains i.e. QE programs ending the market goes into a sharp negative repricing mode, which is then interrupted by a new QE program.  Now the second chart (data sourced from St. Louis Fed) shows that the ending of QE3 caused a 10% market sell off in just a matter of weeks, until James Bullard came out on October 15th and stated that QE4 was cocked and ready should the market continue to sell off.  The market then reversed (minutes after that comment) and shot higher.

Now basically what Bullard did was to say that if the market does anything but move higher the Fed will inject more money.  And so it essentially tells all those who see the market as fundamentally overvalued you are shit out of luck, don’t fight the Fed.  And with that, all fundamental traders either left the market or adjusted their paradigm.  And I’m not suggesting the Fed is simply doing this to steal from the poor to give to the rich.  Perhaps in the beginning there is a little truth to that, in that they felt this direction would both work and create excess wealth for those important folks at the top, of which they belong.  But at this point, the reason the Fed is so inclined to an upward moving market boils down to the market being the only thing preventing the wide spread realization that would lead to all out collapse.

The market is a red herring of sorts keeping our attention away from the reality of the economy.  And so, to give up the market strength would be synonymous to removing the one remaining support holding up that 100 story building that is otherwise completely rotted.  Only when the economy is able to withstand a market repricing will the Fed allow the market to reprice.

The Fed is overtly aware of the overvaluation but sees that as the lesser of two evils.  I disagree as the ultimate destruction is likely now more than recoverable and that would not have been the case had the right policies been implemented from the beginning.  That said, given where we are currently, I’m not sure what I would I do.  The devastation is going to be ubiquitous and perhaps one must delay such an event.  The crux is that this policy will never reverse the course of the economy and so we sail further and further into the storm with our fate set, only timing yet uncertain.

These charts really provide the proof that as long as the Fed feels the economy is weak it will manipulate an upward moving market.  Therefore as long as Janet comes out and says the economy is too weak to stand on its own, the market trades higher as market participants then know the Fed is still committed to manipulating the market moving higher.  This is why the big X exists.  That is, it is defining the relationship between upward moving markets and downward moving standard of living for working class Americans, i.e. the economy.  What else is there to say?

Market participants want to hear that Americans continue to do poorly enough in the eyes of the Fed so that the Fed will continue to fund their wealth appreciation.  Period.   Welcome to modern day America.  The land of debt, income disparity and easy money to those who don’t need it.  The entire system is completely out of whack.  But markets can have a negative correlation to the economy so long as the Fed is willing to print and inject money.  This is dependent on the USD of course, but currently there are no concerns of USD weakness.

So it appears that this unnatural and deviant dislocation between economic health or expected future cash flows and market valuations can continue for some time to come.  Just par for the course in a world that has lenders paying borrowers.  Fucking central banks are modern day fallen angels with the power to reverse gravity.  Who even 10 years ago would have ever imagined the perversion of finance the world now considers normal.  But, and yes there is always a but when nature is being distorted, make no mistake, whether it is tomorrow or 10 years from now, and you’d be wise to heed this next point, this is the last hurrah, the final transfer if you will and so to those that got ’em, smoke’em.

2 thoughts on “Proof that Market Valuations Have a Negative Correlation to Expected Future Cash Flows… Welcome to Wonderland

  1. I never did see the long term sense in QE, just a Band-Aid at best and now because of the overuse, it will be as you accurately described in your closing paragraph.

    If we closed the central banks in the US tomorrow, how would you suggest this country proceed forward?

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