High earnings will soon revert to normal - The Daily Reckoning
The Daily Reckoning by Bill Bonner
On This Day - 26 September 2012
High earnings will soon revert to normal A  A  A

Sao Paolo, Brazil

Goodbye QE boom...we hardly knew ye.

And good riddance! You were never reliable. Never real. Never worth a damn.

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US stocks fell a little more than 100 points on the Dow yesterday. Most foreign markets headed down too - scarcely a week after the biggest money-printing announcements in history...

Europe's doing it. Japan's doing it. America's doing it. Even Brazil is doing it... sort of. Brazil recently announced 'stimulus' measures to help boost growth.

But debt-financed stimulus doesn't work...not in this economy. This is an economy with too much debt already.

And that's why the stock market has had a rendezvous with disaster...ever since the crisis began in '07-'08. This is a Great Correction. And in a real correction, stocks should sell off until they're cheap. Why? Because that's what happens in a correction. Prices correct. They go down to levels that are so low the mistakes and bad investments are wiped out. At the bottom, the survivors are bargains again.

In the 30s, for example, US stocks fell below 10 times earnings. And again in the early '80s, the Dow traded as low as 5 times earnings.

And in Japan stocks lost about 75% of their value...and stayed down. They're still down 22 years after the crisis began.

So why haven't US stocks kept their appointment with doom and gloom? Two reasons.

First, because the feds flooded the roads and tunnels leading out of Wall Street. There was so much cash and credit, stocks couldn't get where they were supposed to go.

Second, because the companies used the crisis to cut overhead, staff, and expenses leaving them with the highest earnings in years.

We're down in Brazil today...where the economy really has been growing. Economists say Brazil's growth is slowing, but over the last 5 years this economy has produced 2 new jobs for every job the US lost.

Sao Paolo is like downtown LA...but many times larger...busier...more chaotic...faster-moving...and growing. There are skyscrapers every direction we look, hundreds of them. There aren't many construction cranes, but there are plenty of new buildings. And helicopters, you see them overhead all the time.

We went over to the gleaming new headquarters of Facebook today.... The Facebook has 50 million users in Brazil, one fourth of the population. And last year, computers passed TV sets as the #1 Christmas gift.

"The story here is a middle class success story," our contact explained. "There are millions of people who are entering the middle classes. They've got decent jobs, good wages, rising household incomes, cars...and computers."

Very different from the US, where the middle class is shrinking. Household earnings for middle class families have been stagnant for nearly 20 years. Household net worth has gotten whacked too - first by the stock market...and then by housing.

The idea of the America dream was that if you got a good education and bought a house you couldn't miss. But it twere'n't so. Here Robert Samuelson explains:

A study from economists at the Kansas City Federal Reserve reports: Fewer than 60 percent of college freshmen graduate within 6 years; student debt now totals about $1 trillion; for 25 percent of borrowers, annual repayments exceed $4,584; default rates are almost 9 percent. "Defaulted borrowers may be sued, tax refunds may be intercepted, and/or wages may be garnished," the report notes.

The plugging of homeownership - the quintessential symbol of "making it" - is another perverse pathway. True, homeownership is a laudable goal; it stabilizes neighborhoods, for example. But the promotion went overboard. Lax lending standards lured people into buying homes they could not afford, contributing to the 2007-09 financial crisis. Again, victims were the intended beneficiaries; since 2007, at least 5 million Americans have lost homes through foreclosure, reports CoreLogic.

A collapsing middle class and a Great Correction are not good for the stock market. According to John Hussman, the outlook for stock prices - according to his proprietary model - has never been worse. QE money printing doesn't really improve the economy. And real companies depend on the real economy to grow.

Don't expect to make any money on your stocks over the next 10 years, he says.

And this week, Jeremy Grantham told the world that today's high earnings are "freakish." Abnormal, in other words. And what we know about abnormally high earnings is that they soon revert to normal...and then abnormally low.

The combination of a funky, correcting economy, shrinking middle class and mean-reverting earnings is likely to hit the stock market like an iceberg hitting the Titanic.

Our advice: stay close to the lifeboats.

Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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