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The financial media is nothing if not predictable. Barron's didn't even wait for the ink to dry on the Dow Jones Industrial Average's 20,000 print before declaring in a new cover story: "Next Stop, Dow 30,000." Barron's argument is that "[t]he Dow hitting 20,000 was no fluke. Today's stock prices are well supported by corporate earnings and economic growth. In fact, if President Trump can avoid stumbling into a trade war – or a real war – the Dow could surpass 30,000 by the year 2025."
Leaving aside that this National Enquirer-style headline is little more than a desperate attempt to pump up readership and is followed by an extremely thin article lacking any analytical substance whatsoever, let's take a serious look at Barron's claims that corporate earnings and the economy are strong. You can wipe the rear end of a cow with these claims.
The Dow Frenzy Ignores These Very Real Numbers
Corporate earnings were weak the last two years. According to FactSet, the estimated non-GAAP earnings growth for S&P 500 companies in 2016 was a paltry +0.1% (and GAAP earnings growth was sharply negative). Revenue was up roughly 2.0%, which is zero growth once you back out phony government inflation data, and negative if you use real-world inflation. In 2015, S&P 500 earnings declined year over year on both a GAAP and non-GAAP basis. But even this doesn't really tell how poorly businesses are performing because GAAP and non-GAAP earnings are inflated by low effective corporate tax rates, low interest rates on the money borrowed to buy back stock and pay higher dividends, and low wage growth. In reality, U.S. corporations are more leveraged than they were in 2007 on the cusp of the financial crisis, a condition disguised by record low interest rates that are now rising. And most of the money they borrowed wasn't used to enhance their businesses but was paid out to shareholders in stock buybacks, dividends, and M&A.
With almost half of companies reporting so far, the full-year estimate for 2016 S&P 500 non-GAAP earnings are $108.66 and S&P GAAP earnings are $97.98. This puts the market multiple at 21.1x trailing non-GAAP earnings and 23.4x GAAP earnings. This is just below the 24x price/earnings (PE) ratio that prevailed during the Internet Bubble. As Peter Boockvar points out, non-GAAP earnings grew by 10.7% in the last four years beginning in 2013 while the market multiple expanded by 47% (from 14.4x non-GAAP and 15.9x GAAP earnings in 2013). The reason for this is that central banks reduced the price of money to zero through QE and ZIRP (zero-interest-rate policy), radically affecting the discount rate used to calculate the price at which equities theoretically should trade. Rather than being supported by earnings, stock prices are levitated by cheap money and an absence of intellect on the part of investors. Money is becoming less cheap but investors are not becom…
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Prominent money manager. Has built top-ranked credit and hedge funds, managed billions for institutional and high-net-worth clients. 29-year career.