The Albatross Of Debt: The Stock Market’s $67 Trillion Nightmare, Part 3

By David Stockman

Here’s why our mountainous $67 trillion of public and private debt matters. To wit, it has caused the historic relationship between trends on main street and Wall Street to go absolutely haywire.

A week or so back, they reported January industrial production at 107.24, which was only a tad higher than it had been three years earlier in November 2014 (106.61), and just 1.8% above where it had been at the pre-crisis peak way back in November 2007 (105.33). If you cotton to CAGRs, that’s a microscopic 0.18% per annum growth rate over the course of a full decade, and during the third longest business cycle expansion in history, to boot.

By contrast, the S&P 500 at the January 26th peak (2873) was up by 84% from its November 2007 level (1560). And let us make haste to squeeze out the inflation component so as to conform on an apples-to-apples basis that sizzling gain with the volume-driven industrial production index. As it happened, the GDP deflator rose by 17% over the same period, so in real terms the S&P 500 is up by 58%.

And that’s not from the horrid March 2009 bottom, but from the tippy-top of the “goldilocks” stock market fantasy a year before the roof fell in. Accordingly, the question at hand already has the benefit of the doubt factored in: Namely, how can the stock market rise by 58% from the dubious pre-crisis high, while the industrial economy has only expanded by 1.8%?

The answer most assuredly is not owing to a cornucopia of earnings. In fact, on an inflation-adjusted basis, real earnings growth has been just as punk as industrial production. Thus, at the goldilocks peak back in 2007, S&P earnings in present day dollars amounted to $99 per share. During the most recent LTM period (December 2017), they posted at $106.84 per share—thereby representing a mere 8% gain over the course of the entire last decade.

We’d say that a 58% gain in stock prices against a 8% gain in real earnings and 2% gain in real production couldn’t happen in a million years on the honest free market. And most especially not when the numbers are adjusted for inflation and when they traverse a complete peak-to-peak business cycle.

So what we have is a monumental and unprecedented decoupling of financial asset prices from the real main street economy. Nor is the cause of that dangerous divergence hard to identify.

The fact is, the massive monetary stimulus since the great financial crisis never really left the canyons of Wall Street. In combination, ultra-cheap debt and the price-keeping operations of the Fed and other central banks fostered an outbreak of speculation, financial engineering and pure wagering (e.g. short selling “vol”) that has no precedent.

And that includes the dotcom peak in March 2000. Most of the real crazy stuff back then was comparative small fry on a market cap basis. For instance, Pets. com had a peak market cap of just $400 million before it perished.

By contrast, here’s crazy: Amazon’s (AMZN) market cap has now hit $734 billion, where it trades at 246X LTM earnings and 115X operating free cash flow.

Now nearing its 30th birthday, AMZN is surely no rocket-ship start-up—nor even a modest grower of profits. To wit, its operating free cash flow in 2017 was a paltry $6.5 billion, representing the net from $18.5 billion of operating cash flow and $12.0 billion in CapEx. By contrast, in 2016 it cash from operations was nearly the same at $17.3 billion, while CapEx was substantially lower at $7.8 billion.

Accordingly, the arithmetic tells you all you need to know. Amazon’s free cash flow during 2016 was $9.5 billion, meaning that during the last 12 months its market cap has soared by $375 billion or 103%—-even as its free cash flow has declined by 32%.

There’s your poster child for 11th hour mania, if there ever was one. The raging algo-machines and day traders of the casino have apparently determined to reward a $3 billion plunge in free cash flow with a $375 billion gain in valuation.

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