Just Plain Pathetic

We are speaking, of course, of the Fed's decision to punt yet again, and for a reason that is not mysterious at all. To wit, our financial rulers are petrified of a stock market hissy fit, and will go to any length of dissimulation and double-talk to avoid triggering a crash of the very bubbles their policies have inflated.

So now the money market rate will be pinned to the zero bound for 96 months running-----through at least December. Indeed, hell itself could freeze over before these cowardly fools would raise rates at their next meeting a week before the elections-----and most especially not when the Donald is remonstrating loudly and correctly that the whole thing is rigged.

Not that any more evidence was needed, but today's decision surely proves that our financial rulers have wandered so deep into their monetary puzzle palace that they have now lost touch with every vestige of the real world. That's because there is not a shred of evidence that more free money for the Wall Street gamblers will do anything except further inflate financial asset values that are already tottering in the nosebleed section of history.

So the entirety of what they are doing is simply paving the way for an even bigger crash. Yet to hear Janet Yellen tell it, they decided to keep their Big Fat Thumb on money market rates because "there is still slack coming out of the labor market" and because the Fed is still "undershooting our inflation goals".

But so what!

There is not a single thing the Fed can do about either of these macroeconomic conditions. The massive amount of true slack in the US labor market is owing to structural, not cyclical factors, and is powerfully impacted by global wage rates and domestic welfare and regulatory policies over which the Fed has no sway whatsoever.

Likewise, what in the world is Yellen's beef about undershooting inflation? The core CPI was up 2.3% on a Y/Y basis during the most recent month, while the headline undershoot is due to deflationary pressures arising from the world oil and commodity markets which are actually a boon, on net, to the US economy.

Besides that, Flyover America doesn't need any help on the "moar inflation" front from the Fed, even if it could deliver it, which it self-evidently can't. To wit, the cost of shelter as measured by asking rents is up by 5.6% during the past year; and on top of that you have medical services up by 5.1%----along with a 6.3% rise in prescription drugs and 9.2% gain in the cost of health insurance.

Yet, Yellen rattled on repeatedly during her presser about deferring a rate increase for the Wall Street gamblers on the grounds that inflation has been insufficient. As we said, the Eccles Building morphed into a monetary puzzle palace cut off from the real world long ago.

So what our dithering money printers are actually doing is fueling a monumental orgy of corporate bond issuance. Yet it serves no purpose other than to enable companies to speculate in their own stocks with borrowed money, while heaping windfall gains on the fast money traders who hound corporate boards into strip-mining their own balance sheets.

As shown below, the level of high grade corporate debt outstanding has gone nearly parabolic in the last few years and now stands at more than 2X its pre-crisis peak. Yet even Yellen admitted during her mindlessly meandering presser that business CapEx has been extraordinarily weak.

In fact, non-defense CapEx orders excluding aircraft peaked in mid-2104 and are now down by 10%. Even more to the point, real net fixed business investment after depreciation is still 20% below the level it each way back in early 2000.  That is, two bubbles ago.

Perhaps the question about where all this hand-over-fist corporate borrowing is going might have occurred to at least one of the nine geniuses who voted to stand pat. But apparently it didn't because once again Yellen insisted that despite constant surveillance no one in the Eccles Building has spotted any sign of bubbles, and that "valuations are largely in line with their historical trends".

What in the world is our clueless school marm talking about? At the closing price today, the S&P 500 traded at 25X the $87 per share reported for the LTM period ending in June. And that was in the face of earnings that have plunged 19% since peaking in the September 2014 LTM period.

Yellen is right about the historical trends, of course, but not at all in a good way. In fact, on the eve of the last crash when the market peaked in October 2007 at about 1550, S&P 500 earnings during the most recent LTM period had posted at $79 per share, meaning that the peak pre-crash multiple was substantially lower than today at 19.7X.

Even when S&P earnings peaked at $54 per share in September 2000, the trailing multiple was only a tad higher than today at 26.5X. So, yes, the market is in line with history. That is, the history of crashes!

Then again, Yellen is undoubtedly getting her "normal" valuation nonsense via the Wall Street two-year forward ex-items hockey sticks. At the present time, for example, the "operating earnings" consensus for CY 2017 is about $133 per share, implying a PE multiple of 16.3X. Apparently, there is nothing bubbly about that.

There is nothing credible about it, either. Back in March 2014, the two-year forward ex-items estimate for 2015 was also $135. It actually came in a $100 per share or 25% lower.

Likewise, in March 2015, the two-year forward ex-items estimates was, yes, also $135 per share. By contrast, the actual number for the June 2016 LTM period was just $98.33.per share. Even if S&P 500 earnings grow by 10% in each of the next two quarters-----which is wholly improbably given current guidance and recent profits warnings----CY 2016 would come in at just $103 per share on an ex-items basis---or about 24% below the year ago hockey stick.

It would also amount to a PE multiple on the broad market of 21X, and that's anything but historically normal.

So is Janet Yellen professing a capacity to see way out to the end of 2017 and divine that the third time is a charm for profits? Has she even fathomed that to be "normal" at the 16.3X PE multiple cited above, 2017 operating earnings would have to rise by 36% from the level they posted for the June LTM, and in a purportedly 1.8% growth full employment economy, at that?

The truth is, the Fed is inherently, relentlessly and radically in the financial bubble business, but the Keynesian school marm who runs it wouldn't know a bubble if one transported her to the moon and back.

In the meanwhile, she blathers on professing to see signs that 93 months of ZIRP are beginning to coax some "slack" out of the labor market.  In fact, the question is why the labor force participation rate for prime age adults at 81.3% is still lower than it was in late 2012 and far lower than the 83.3% level on the eve of the recession.

Worse still, in the case of prime-age male workers there has been no upward blip at all. Despite massive intrusion in the financial markets and falsification of asset prices by the Fed, their participation rate has been marching downhill for decades, and for one good and substantial reason.

To wit, in today's globalized, technologically dynamic, gig-based economy, labor market participation rates and labor slack" is not a monetary problem in the first place; its structural and rooted in global economics and domestic policies. Yet Yellen and her posse keep banging the money markets with their interest rate hammers because that's the only tool in their chest.

Image result for images of male labor force participation rates

Finally, we offer proof that the Fed is witlessly fueling another crash by referencing today's announcement by Microsoft of another $40 billion stock buyback program. Apparently, the last $40 billion "investment" in its own vastly inflated stock has already been completed.

The point here is that this exercise in Ponzi economics is being funded with cheap debt, compliments of Yellen and her ship of fools. In fact, Mr. Softie is sitting on a giant pile of cash, but has chosen to increase his balance sheet debt from $23 billion a decade ago to $54 billion today in order to what?

That would be to help fund massive stock buybacks and dividend payments, of course. After all, even this dying once and former monopoly is not earning enough to make ends meet. To wit, during the last 10-years Microsoft earned net income of $178 billion, but paid out to shareholders even more----$186 billion----in stock buybacks and dividends.

Needless to say, flooding Wall Street with this deluge of cash did wonders for its stock price. In fact, between June 2013 and the present, its market cap soared by $175 billion or 65%. And that was no inconsiderable feat because in no way, shape or form has Microsoft recovered its earnings mojo during the last 40 months.

To the contrary, its LTM net income of $16.5 billion for the period ending in June 2016 was down by 27% from three years ago. Indeed, it as only marginally higher than the $10 billion it earned way back on the eve of the dotcom crash in the year 2000.

The magic, of course, was in the PE multiple expansion. Gorging the Wall Street gamblers on these massive amounts of cash---some of it borrowed-----its PE multiple soared from 15X to more than 35X recently; it still stands at better than 28X.

In short, MSFT is a beached, no-growth old tech whale trading at the valuation multiple of a high growth youthful disrupter. In that capacity, it is just one more example of the bubbles that are invisible to the inhabitants of the Eccles Building.
MSFT Net Income (TTM) Chart

MSFT Net Income (TTM) data by YCharts

Let's be very precise. There is a massive arb trade underway in which trillions of term debt and bonds are being funded with free overnight money gifted by the Fed and other central banks.

In turn, these speculative carry trades have driven benchmark debt prices to insensible heights, thereby unleashing a stampede for yield among fund managers and homegamers alike that knows no bounds.

To satisfy this relentless demand for yield, of course, corporate balance sheets have been strip-mined and leveraged like never before. Yet as all this cash flows into the stock market, it surely does not increase the productive capacity of American corporations by a whit; it simply inflates the stock market bubbles even further.

In short, instead of scrutinizing the "labor market" through the clouded lens of the BLS statistical mill, Yellen should spend a little time studying the bond market, and tracking down the flows of the trillions upon trillions of new cash that has been raised there.

Even she might then discover that valuations are not "normal" at all, and that the financial markets have, in fact, between transformed into bubble-ridden gambling dens.





David Stockman's Contra Corner is the only place where mainstream delusions and cant about the Warfare State, the Bailout State, Bubble Finance and Beltway Banditry are ripped, refuted and rebuked. Subscribe now to receive David Stockman’s latest posts by email each day as well as his model portfolio, Lee Adler’s Daily Data Dive and David’s personally curated insights and analysis from leading contrarian thinkers.

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