US Government Hands Investors a Free Gift

US Government Hands Investors a Free Gift

Today’s Daily Reckoning Australia should be like a cold beer on a hot day — refreshing and satisfying. That’s because it carries good news.

That might be surprising. No doubt you’re hearing a lot of negative press around the US at the moment.

Higher yields threaten to trash the stock and bond markets over there — or so we are told.

Trump might be about to spark a trade war with his tariffs.

But there’s a little-known fact that’s getting lost in the noise…

Free travel back to 2016 prices

It’s the fact that US stocks are currently as cheap as they’ve been since early 2016.

You see, ‘the Donald’ did investors a huge favour when he signed major tax cuts into law in December last year.

US companies are going to be paying less tax. That means their forward earnings estimates took a big jump.

The S&P 500 — the major index in the US — currently trades on a forward earnings estimate of 17.

It was 23 at the end of September last year.

That’s not to say US stocks are dirt cheap. That would be too much to ask after a 300% rise since March 2009.

But you can see how the US market could have one last big push as that price to earnings (P/E) ratio expands again, as investors bid up stocks.

This Trump ‘reset’ gives the US market much more upside than many people currently think.

That’s not to say it’s guaranteed to happen — only that the potential is there.

In the tech boom of 1999, the market P/E ratio went over 30.

The idea here is that we’re going to see a ‘melt up’ in the US stock market before it finally tops out.

It reminds me of something investment legend Jim Rogers once wrote…

Rogers said all big bull markets end in a bubble. Jim is a keen student of financial history….and one of the most successful speculators of all time.

Jim can tell you, for example, how the price of cotton soared during the US Civil War, which ended in 1864. Or why oil boomed in the 1970s — and why it had nothing to do with OPEC.

And there’s no doubt US stocks have enjoyed a major bull market since 2009. It’s now the second longest on record in US history.

But there’s no bubble here…

Telltale bubble signs are absent

There’s no euphoria around the US stock market.

There’s no psychology of a new era happening. There are no tales of windfall profits enriching day traders and amateur investors.

The commentary around the market is mostly fund managers arguing about valuations and risks.

That suggests the market can continue to climb, despite the worries we all hear about.

We know that fund managers are now going to be watching the yields in the US like hawks.

Any inflation data will likely dominate the discussion in the near term.

But note one thing here…

The yield on a 10-year note hit a high of 2.95% on 21 February.

It’s dipped slightly since.

It’s currently 2.86%.

It might just be that things settle down here for the upcoming quarter…and stocks catch a strong bid again.

And let me put another myth down…

The stimulus that may not be

Investors are getting concerned that higher inflation will cause the Fed to jack up interest rates faster than the market is currently pricing them in.

One reason is because the US government is going to run higher deficits to fund its spending.

This is automatically assumed to be ‘stimulatory’.

I don’t agree. It depends entirely on how these deficits are financed.

If new money is created to finance it, then yes, it’s a genuine stimulus. If no new money is created, it’s not.

And we know already that the Fed is not going to buy the extra government bonds issued. In fact, it’s the complete opposite. The Fed is deliberately letting its bond portfolio run down.

So the central bank won’t be ‘monetising’ the deficit. That means it won’t be printing new money to give to the US government.

That would be stimulatory if it was happening — but it won’t be.

That leaves the private sector to finance the deficit mostly. That means the spending power is merely transferred from one group — say pensions funds — to the US Treasury.

There’s no extra stimulus, if that’s the case. It’s why Japan never saw huge growth last decade, despite record government deficits.

There’s one major exception to this general guide to the US right now. That’s if US banks buy a lot of bonds. But I’d put that probability as low.

The big bank traders will know that the bond market is a low risk/reward bet right now. I can’t see them loading up on bonds. If anything, they’d be getting out of Dodge.

Let’s see how things pan out in the short term. For my money, the US is still on track to see higher stock prices in 2018.

Australia too.


Callum Newman Signature

Callum Newman
Editor, The Daily Reckoning Australia

PS Today’s Daily Reckoning was focused on the US stock market.  However, I suggest you pay attention to the crypto market as well. After bitcoin’s 50% fall in January, it’s now bounced back to US$11,000.

I think the entire sector could be brewing for another strong run. I just released my 2018 edition of the $20 Bitcoin Blueprint. See the latest analysis by going here now.