»The Daily Reckoning by Bill Borner

Negative earnings for the next decade...
10 OCTOBER 2014

New York, New York

Wow...Dow down 334 yesterday. Volatility is back. Things are getting interesting.

Meanwhile, what's wrong with the Bowery? We search high and low, we can't find a bum or an alcoholic. The area no longer looks anything like the old down-and-out Bowery of the '60s and '70s. Everywhere you look, you see the latest fashions...chic people...and $600-a-night hotel rooms.

Last night, at dinner, our companion nodded towards a nearby table and said "Look, there's Michelle Pfeifer."

The name sounded familiar, but we couldn't place her. So we were not as impressed as we should have been. But the Bowery has definitely gone up town.

"Credit," explained our researcher, Stephen Jones. The whole US economy has lived on credit for nearly 30 years. It has distorted everything. Even the Bowery."

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Credit has seeped into all sectors of the economy. But there are two places where it has wrought most 'growth' - Washington DC and New York City. The two biggest borrowers - government and Wall Street. The money leaks into all the surrounding counties and boroughs.

Stephen has just written a paper in which he demonstrates a better way to judge the real price of a market. After all, if you're going to follow the 'buy low, sell high' rule, you need to know where high and low actually are.

"Is this market as high as we think," we asked him? To bring dear readers back into the picture, our Macro Timing system calls for selling stocks when the P/E goes over 20. And buying back in when they go under 10.

We asked Stephen to take a look at our system to see if he could improve and refine it.

"The problem is the quality of earnings. If you normalize earnings, the P/E is well over 20...and you should definitely be out of the stock market if you're following your rule.

"Earnings are thought to be good things....and on a micro level, of course they are...so we don't look at them too hard. But we should. Because they have to come from somewhere. And if you have an economy where the typical household has less money to spend than it did 15 years ago, you have to wonder where those extra earnings are coming from. And this is where it gets interesting....and it's why my way of valuing the stock market is better than Tobin's Q ration or Shiller's CAPE. I begin with the value of stocks as they compare to GDP. This gives you a better picture.

"The earnings of US corporations have never been higher. But growth is running at half the rate of the '80s and '90s. Employment is actually going down (I don't meet the rate...I mean people with real jobs compared to the population). And incomes are stagnant. How is it possible for corporate earnings to rise?"

As Stephen suspected, we already knew the answer.


"Since '08 debt has not gone down; it's gone up."

This not the Great Deleveraging that it was advertised to be. In 2007. there were a total of $69 trillion worth of debt-backed securities in the world. Now, the total is $90 trillion. This new debt has added a lot of purchasing power and profits throughout the economy. But it's temporary. It's not normal. And it has to go away when the debt bubble pops.

"Take out the debt-driven sales, and the profits shrink back to normal. But of course, P/E ratios go up because there's less E."

What does that mean for stock investors?

"It probably means negative earnings for the next 10 years..."

We think it might mean something else. Earnings depend on debt. So do stock prices. And so does the economy. It took $21 trillion of extra debt to jack up stock prices to today's level. If the credit were to dry up, the economy and the stock market would both be hit hard.

And then? For nearly 30 years, the message from the Fed was the same: 'we have your backs.'

How likely is it that central banks would forsake speculators now? Not very.

The last two bear markets took 40% and 50%, respectively, off stock prices. Each time, the Fed was quick to react with more cash and credit. How likely is it now, that Janet Yellen will stand aside as the market delivers its bitter correction?

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