The S&P 500 has seen a decline of 7.37 percent this year. What does this mean for investors?
For many, declining stock prices bring discomfort, even distress. However, it’s worth viewing this drop in a different light, similar to the benefits of a high-fiber diet—a necessary step for healthy financial systems.
Stock prices, propelled by speculative liquidity, have diverged significantly from the underlying economy. This disconnect has been evident, as the economy has lagged, incomes have stagnated, yet stock values have continually surged.
In this context, the recent, albeit slight, reduction in liquidity and the corresponding drop in stock prices can be seen as a cleansing mechanism. This process is likely to weed out marginal businesses and streamline larger ones.
As a result, owners, managers, and workers in lesser enterprises may need to redirect their talents towards more valuable endeavors. For instance, Walmart has recently announced the closure of 269 stores, affecting 16,000 employees. While we empathize with the laid-off workers, we believe many will discover new, more meaningful opportunities.
Although painful at times, the elimination of wasteful practices is essential for creating greater wealth. In contrast, sustaining insignificant ventures with cheap credit ultimately undermines prosperity.
Mean Reversion
The extent to which stock prices will continue to decline remains uncertain. They could very well have reached their lowest point, but it’s unwise to put all your financial resources on such speculation.
This is purely conjecture. However, it’s important to note that despite the 7.37 percent decline thus far, the S&P 500’s Cyclically Adjusted Price Earnings (CAPE) Ratio currently stands at 23.97, whereas its historical average since 1881 is 16.65.
Furthermore, we recognize that valuations eventually revert to their means. During this reversion, it is common for prices to overshoot both upwards and downwards. Such fluctuations are an integral part of how averages are established.
There are numerous ways for valuations to decrease. One straightforward approach is through an increase in corporate earnings; another is through a decrease in share prices.
Current projections suggest that fourth-quarter earnings for S&P 500 companies are expected to decline by 6 percent year-over-year. This marks the third consecutive quarter of annual declines. It seems probable that to approach historical averages, stock prices must decline further.
These are straightforward observations regarding stock valuations as we see them. It’s worth considering alternative viewpoints if they differ from ours, as there are many perspectives that we ourselves do not endorse.
Something’s Gone Horribly Awry
For instance, we find it troubling to witness the façade of prosperity amidst the blatant inequities in places like downtown Los Angeles. While shiny skyscrapers and upscale vehicles line Fifth Street and Grand Avenue, just a few blocks away, Skid Row reveals a stark contrast with makeshift tents and myriad empty stomachs outside shelters.
Clearly, something is amiss. While hard work and innovation contribute to the glistening cityscape, the detritus of sloth, addiction, and mental health struggles is evident on the streets below. We suspect that two decades of activist Federal Reserve policies have played a significant role in shaping both realities.
Undoubtedly, the stunning skyline has been nurtured by the availability of cheap credit. Currently, Korean Air / Hanjin Group is financing the construction of The Wilshire Grand Tower, poised to become the tallest building in Los Angeles when it opens in 2017. This tower will stand as a monument to the era of ultra-low interest rates.
Conversely, it might not be immediately obvious how artificially low credit has contributed to widespread poverty. Ironically, John Maynard Keynes, the architect of modern economic intervention, provided a succinct explanation of this insidious link in his 1919 work, The Economic Consequences of the Peace.
“Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method, they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security but at confidence in the equity of the existing distribution of wealth.
“Those to whom the system brings windfalls far beyond their merits become ‘profiteers,’ facing disdain from both the bourgeoisie and the proletariat whom inflation has impoverished. As inflation proceeds, and the real value of currency fluctuates dramatically, all permanent relations between debtors and creditors, which form the foundation of capitalism, become so utterly disordered as to be nearly meaningless; wealth generation transforms into a gamble and a lottery.
“Lenin was certainly right. There is no subtler, surer means of destabilizing society than to debauch the currency. This process engages all the hidden forces of economic law on the side of destruction, and it does so in a manner that is almost undetectable to the average person.”
In conclusion, while the landscape of wealth and poverty may seem at odds, they are intricately tied together by underlying economic forces. Understanding these dynamics is essential for fostering genuine prosperity.
Sincerely,
MN Gordon
for Economic Prism
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