“Eventually, Markets Have To Reflect Realistic Assumptions”

On Thursday in “Stop The Madness,” we highlighted some commentary that we think is broadly representative of how investors are thinking about markets these days.

In a nutshell, the message is this: there’s so much cash floating around and no one knows where to put it because yields on everything from German bunds to investment grade credit continue to collapse before our very eyes. Of course this was the whole point of QE and ultra low rates from the start: herd investors into riskier assets.

Well, it’s worked. But now we’ve reached a tipping point - a kind of conundrum. Stocks have been driven to nosebleed levels despite the protestations of those who say that compared to the runup from 1987 to the dot-com crash, equities appreciated by a factor of seven (compared to roughly three from the 2009 lows).

Meanwhile, on the credit side, the only point in buying anything besides high yield if you’re looking for income is the hope of capital appreciation because there’s a perpetual bid from the greatest greater fools of them all: central banks. They’ll buy your high quality bonds and they don’t care how much they have to pay. Which means you can almost play bonds like stocks. Buy them, then demand a premium from a central bank buyer. After all, they have to pay it otherwise they risk not being able to meet their purchase targets which would undermine the various QE programs operating across the globe.

But how much further can this madness go when it comes to stocks? We’re in a five quarter long earnings recession for God’s sake and we’re hanging our hats on these hockey sticks:

(Chart: Goldman)

Meanwhile, vol is just dead. R.I.P. Write the obituary.

Well against this backdrop we thought we’d send you off into a blissful weekend with some excellent new commentary from Goldman who, despite the hockey sticks shown above, is becoming noticeably incredulous about this entire enterprise. Enjoy:

“It is hard to overestimate the impact that falling bond yields and interest rates have had on financial assets in general. Even in countries where profit growth has been virtually non-existent (for example, Europe), equity markets have appreciated sharply from their lows. Indeed, the sharp rise in the equity markets from both their 2009 and 2012 lows has almost entirely been driven by valuation expansion.”

“Profits have been weak, particularly in Europe. Exhibit 2 shows that the 10-year rolling nominal earnings growth rate has collapsed to -1.8% in Europe and has fallen to record lows for the global equity market.”

(Chart: Goldman)

And it gets better:

“Some people argue that absolute valuations don’t much matter because, with a risk free rate of close to zero, why should equities not be much more highly rated - why should P/Es not reach 30x or even higher? While we have some sympathy for this, there are limits to how much yields alone can drive equity valuations, in our view. Eventually, they have to reflect a realistic assumption about long-term nominal growth.”

Ummm… yeah. They sure do. Or at least they should.

But guess who may be coming to the rescue to make sure we get to 30X? You got it:

Super Mario wishes you a happy long weekend.

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