So why are stocks so high?

Imagine Macro Man's chagrin when he saw that yesterday's readership was the highest in three weeks- on a day when the daily post was a couple of paragraphs typed with one hand.  Was this a stinging indictment of his normal, ostensibly more thoughtful efforts, or a perverse desire of his audience to gloat over his misfortune?  As it turns out, neither- the previous day's post had been linked in a couple of prominent places, which had generated the traffic.  Anyhow, the hand feels much better and normal service is henceforth resumed.  Readership will no doubt drop accordingly.

Yesterday's post touched upon the bemusement of Mr/ Hilsenrath, ostensibly at the prompting of the Fed, as to why stocks appear to be bulletproof despite the secular stagnation story.   Macro Man's brief rejoinder can be summarized as "read the Fed balance sheet and Piketty."  On the latter, is it any wonder that stocks are at their highs when corporate profits as a percentage of GDP are as well?*  As is corporate cash as a percentage of GDP?   It's a well-known aphorism (except, perhaps, at the WSJ- zing!) that the market is not the economy.

As for the Fed, it is true, as one poster noted, that one cannot simply take bank reserves and use them as margin to buy SPX futures.  However, it is very much the case that the Fed's assorted piss-taking policies have significantly impacted overall liquidity conditions as well as the volatility environment.  With ample liquidity and low vol, is it any wonder that punters and long term investors have been dragged into buying stocks despite the sluggish topline growth in the economy?  Was the Great Rotation really all that long ago that people have forgotten?

Long-time readers may recall that Macro Man has a proprietary model that seeks to project 12 month forward returns for the S&P 500.**  The absolute levels are not to be taken as gospel (if they were, you wouldn't be getting them for free- or at all!); rather, it's the relative shape of the line that is of interest.  The model uses a number of fundamental factors and updates once a month.   As you can see from the chart below, the forecast has tailed off recently after an unprecedented period of super-bullish readings, but is still quite high.

Drilling down further, Macro Man can break the factors into two segments:  what he would term as "growth" and "liquidity" drivers of forecast return.  Separating the two cohorts and normalizing the two readings generates some illuminating results that would appear to justify the first half of the flippant "Fed and Piketty" response to Hilsenrath.  As you can see from the chart below, the liquidity factors have been very consistently high during the past few years' bull market.  For most of the past several years, however, the growth components have been somewhat below average- that's the "secular stagnation" bit.

The contrast to the start of the last tightening cycle is quite telling; at that juncture, liquidity was fairly neutral but growth factors were highly supportive of stock returns.  This time around, liquidity is very clearly driving the bus with respect to stock market returns, at least in the US.

When liquidity withdrawal finally begins, readers are invited to judge for themselves what this is likely to mean for stocks.  Until that juncture, however, the strategic trend in stocks (as opposed to shorter-term tactical developments) looks to be head-scratchingly higher, floating on a liquidity tide that lifts all boats (and more than a few turds.)





*Q1 included a large hit to profits related to the expiry of some favourable capex tax provisions.   Without the CCA and IVA adjustments, profits were still at their highs

** Before you ask, no you cannot know what's in the model.  This is how Macro Man makes his living!