High Valuations and Declining Earnings… Trouble Ahead?

by | Aug 19, 2019

“The prediction of economists are often dismally wrong because they’re based on theory instead of reality.”

– Ed Yardeni

Predicting the Markets, pg. 539

July’s last day Fed actions has reset the stage for increased market drama with more likely to come. 

Did last month’s rate cut signal that something is wrong in the economy or was it trying to erase the mistake from last December? 

Last year’s rate hike should have signaled to the equity markets the presence of a healthy economy and that monetary policy normalization was well underway.  That message was lost in a hurry.  Maybe the Fed is trying to appease the equity investors but that doesn’t seem to be working either.  They’re always one step behind and trying to make equity investors happy is like trying to make happy a spoiled child.  It’s an impossible task.  Bond investors on the other hand seems to be running to safety.  Bond prices have been pushed to very high levels and yields to the point of inversion. 

I see trouble down the road.  Earnings are expected to decline by almost 3% this quarter.  Valuations are high and a reset of the price multiple could also reset investor expectations.  I’ve opined in the past about a US and world economy built upon credit.  Borrowing and lending are the grease in the wheels of our economy and with rates at such low levels will lenders continue to lend?  Will borrowers lose their appetite to fund assets at extended valuations?   When either declines, so will our output. 

Piecing together what happens after that is not the happy ending you were looking for.  As the world tries to unwind itself from the policies implemented during Great Recession, returning to a more normal monetary framework seems less likely and more difficult.  Low interest rates will prevail for now.  The great monetary experiment continues.

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