You know that quick, sharp breath you take and that little anxious flutter in your stomach as you brace yourself for something painful or stressful?
I’ve been catching myself doing that more and more whenever I look at market news or my accounts.
At least I can take some cold comfort in the fact that I’m not alone. Check out some of the results of medical studies that looked at how the markets are literally killing us:
- A one-day drop in equities of around 1.5% is followed by about a 0.26% increase in hospital admissions on average over the next two days.
- The impact on psychological conditions such as anxiety or panic attacks is even stronger and more immediate, with admissions jumping twice that much in just one day.
- Equity-market losses appeared to induce 3,700 market-related hospitalizations a year in California. Applied nationally, it implies that these visits add roughly $650 million a year to U.S. health care costs.
- On Oct. 19, 1987, admissions jumped more than 5% after Standard & Poor’s 500 Index plunged 20% in the “Black Monday” crash.
- A “significant correlation between a period of stock-market decrease” and heart attacks during the 2008-2009 financial crisis was found and published in the American Journal of Cardiology.
Considering the state of the economy and markets going into 2014, I can imagine millions of investors wringing their hands and furrowing their brows as they stare at the buy or sell order they queued up on their screens.
The simple fact is, they won’t find any easy answers on whether they will miss gains if they don’t go all-in or be burned for a second time in less than a decade as an asset bubble pops.
But there are plenty of trends we can check out to see how much risk we should take. For now, let’s focus on three major trends that will have to change to prevent a major correction.
‘E’ vs. ‘S’
Earnings-per-share is about as straightforward as it gets. Take corporate earnings, divide them by the number of outstanding shares, and you get a basic idea of the return a company generates with stockholder money. The goal is to consistently improve EPS to attract higher stock values and more investors.
In a normal world, the best way to do this is to increase earnings. Make more money, grow faster than shares are issued, and entice investors to buy more shares at higher prices.
In the current bizzarro world of virtually free money, a second, easier path is available: Take on debt at historically low rates, use the debt to reduce the number of outstanding shares through buybacks in order to increase earnings-per-share, and then pay off the debt with future earnings.
2013 was second only to 2007 for the total value of share buybacks announced. $500 billion, or about half of the money the Fed used to juice the economy, was used this way.
Corporations capitalized on the low interest rates by issuing $18.2 trillion of bonds worldwide since 2008. Currently outstanding corporate debt has risen over 50% to $9.6 trillion over the same period.
This buyback trend cannot persist if the Fed continues to taper, which it must ultimately do. Interest rates will go up, corporate debt will become more expensive, and the debt must be paid or rolled over into more expensive corporate bonds.
Profit and Price Divergence
Stock prices have risen far faster than corporate profits. 2013 marked a divergence as profits and earnings sputtered out and the market kept sailing at full steam.
Meanwhile, the EBITDA margin (earnings before interest, tax, depreciation, and amortization divided by total revenue) operating profitability peaked at 25.6% in late 2007 and recently fell below 20%.
To put it another way: As the market soared, companies saw their operating expenses eat more and more of their earnings and limit profits. This did nothing to stop the advance of share prices.
Here is another way to look at it. Take the highest earnings result from the prior 12 months for all the companies listed in the S&P 500 index and compare it to their stock prices:
As you can see, we’re just now hitting the point that signals an inevitable drop in share prices. To nudge this measurement down under 18.5, either share prices need to go down or company earnings need to grow again.
The diverging trend between earnings, profits, and share prices has to stop or else the inevitable correction will just get worse and worse.
Scraps for the Poor
The final trend that will need to change is the complete disconnect between wages for the masses and profits for the 1% and corporations.
Take a look at the red line in the stock prices vs. corporate profits chart above. The average American household is pulling in less than when the markets hit their lowest point in the recession.
This is a politically contentious issue touching on many raging debates, especially unemployment and welfare, class disparity, etc. I’m not going to pick sides here.
What I will do is point out that the U.S. economy is still heavily dependent on consumer spending and house values.
Sure, consumer sentiment is up, but people have no way to consume more. The debt to income ratio for the three middle quintiles (top 20% to 80%) of households is just below 160%.
Principle residences account for nearly two-thirds of total assets for these people, on average.
For a vast majority of Americans, real estate appreciation drove real capital wealth gains over the last several decades.
It isn’t surprising that people are hoping for an extended rise in house prices to resume accumulation of wealth as soon as possible.
Unfortunately, that isn’t going to happen any time soon. Mortgage rates are going up and will continue to do so as benchmark interest rates rise. Those with less than perfect credit rarely find lenders now and will be it will get worse.
Home sales are faltering already. The National Association of Realtors reported that the month of September saw the single largest drop in signed home sales in 40 months. Home sales have fallen each month since. December saw mortgage applications collapse a shocking 66%, hitting a 13-year low.
Americans are making less now than in the depths of the recession. Year-to-year disposable income per capita dropped for the first time since Lehman Brothers collapsed. Yet the richest people on the planet got richer at an accelerating rate in 2013, adding $524 billion to their collective net worth.
To keep the U.S. consumer-driven economy from being crippled, wages for the masses will have to stop shrinking and start growing again. There is no way around it.
Road to Recovery
Sure, I’d love to see some major changes in these three trends. But for now, all I think we really need is for these widening gulfs in our distorted economy to slow their growth and show signs of shrinking.
And really, what it all boils down to is a return to some semblance of normalcy. As intervention and manipulation winds down through 2014, there are two paths ahead for the economy…
It can either remain irrational and fuel an increasingly volatile and risky asset bubble for investors, or it can shift back to a system that rewards meaningful corporate growth and stability.
If there aren’t signs of change that push us away from the former and towards the latter, odds are a whole lot of people are going to be put in the hospital by the market this year.
