The stock market has advanced sharply over the past five years no matter what geopolitical situation has blown up or how tenuous the economic foundation may be. This is because Investors have simply been forced to throw money at the market with a reckless disregard of logic due to the lack of interest provided through the holding of cash.
But if one looks objectively and the true market fundamentals, it is clear to see that the stock market has blown into yet another bubble, except its total magnitude has been masked by the central bank’s engineering of corporate earnings growth.Â
Unfortunately, the sobering truth is stock values are highly extended at this time. And, it is silly to ask the question if these values are justified because of strong earnings growth or because of the Fed’s easy money policies–because you can’t separate corporate profitability from the record-low interest rate environment provided by the Fed.
The Price to Earnings ratio of the S&P 500 as of this writing is at 19.5. That is about 4 points above historic levels. But, inflated PE’s are only part of the story. For most companies in the SP 500, top-line revenue growth has been anemic since the Great Recession ended in 2009. Earnings growth (expected to be 5.4%) is coming primarily from corporate engineering facilitated by the Fed’s zero interest rate policy.Â
There has been so much talk about corporations’ pristine balance sheets. But, the truth is non-financial corporate debt is up $3.5 trillion since 2009. Businesses have refinanced much of their $13.8 trillion in outstanding debt at vastly reduced levels, which lowers debt service payments and improves EPS. Nearly 90% of this new debt was used to buy back stock and increase dividends. Less shares outstanding, reduces the denominator of the Earnings per share (EPS) calculation—also boosting EPS and making the PE ratio seem less out of balance.Â
