The Tyranny of Groupthink
August 22, 2020
The broad market (S&P 500) is trading at the highest forward PE multiples since November 1999, but the financial press is rife with mendacious piffle claiming there is no bubble. For example, in celebration of Tuesday’s all-time high on the S&P 500, one James Mackintosh of the Wall Street Journal minced no words:
Except, the Everything Bubble is in the imagination of the many investors complaining about it. First, it isn’t everything. Second, it isn’t a bubble….
Right. Supposedly, the above statement is true because energy sector stock prices are in the tank, but
the market is being rationally led by the tech giants where allegedly solid prospects for earnings growth are being rewarded with higher PE multiples owing to ultra-low interest rates.
…. Lower rates mean profits further in the future matter more to the share price, so companies with steady earnings no matter what the economy does are worth more. Those that are sensitive to the economy are worth less, because future earnings are expected to be hit. Growth stocks do incredibly well, because their future earnings are expected to be higher and, at least for those thought immune to economic weakness, worth more as well thanks to lower rates.
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Apply this framework and there’s no bubble. U.S. stocks are more highly valued than in the past because they are dominated by big growth stocks, themselves justifiably more highly valued thanks to low rates.
The sheer laziness and conformism of today’s so-called financial journalists is a wonder to behold. When the leader of the tech growth stocks, Apple, crossed the $2 trillion market cap barrier for the first time today, thereby embodying more market cap than the entire Russell 2000 of small cap US companies, Mackintosh’s colleague at the Wall Street Journal spewed the same groupthink:
The stock has more than doubled from its March 23 low, boosted by steady demand for the company’s devices and better-than-feared results in its core iPhone business as millions of Americans work from home.
Steady sales growth is driving the string of achievements. Apple’s sales rose to $260 billion in the fiscal year ended in September from $216 billion three years prior. The company has even grown sales during the pandemic: For the quarter ended in June, they rose 11% from a year earlier to nearly $60 billion, exceeding Wall Street expectations. Earnings surged to $11.25 billion.
Apple is not a growth stock. Period.
The three-year sales gain cited by the WSJ amounted to only 6.4% per annum, but also reflects what amounts to journalistic malpractice.
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That’s because the starting figure of $216 billion for Apple’s FY 2016 sales actually reflected a 7.8% decline from sales of $234 billion in FY 2015. So the four-years growth rate of sales through FY 2019 was, well, a mere 2.67% per annum.Likewise, the 11% sales gain during the June 2020 quarter versus prior year is completely misleading. During the past four quarters, the year-over-year sales gains have been all over the lot, posting at 10.9%, 1.0%, 8.8% and 1.8% respectively. Accordingly, for the LTM period ended in June, the sales gain was just 5.7% – hardly a barn-burning growth figure.
Likewise, the purported June quarter earnings “surge” to $11.25 billion was nothing of the kind. During the 2018 June quarter, for instance, net income posted higher at $11.52 billion. The surging at issue, therefore, was one of backward motion.
In fact, the only thing about Apple which has been in a growth mode during the last five years is the company’s PE multiple, which has essentially doubled from 14X to 35X at today’s record share price.
As to the actual 5-year trend of sales and earnings growth, not so much.
Back in June 2015 Apple was valued at $715 billion on the strength of its unparalleled tech product franchise, which was reflected in $224 billion of annual sales and $50.7 billion of LTM profits.
Still, there was a reason for the modest implied PE multiple of 14.1X: Namely, the tech behemoth’s growth rate was rapidly slowing – freighted down by the inherent limits embedded in its enormous scale and the then modest expectations for earnings expansion in the immediate years ahead.
Those modest expectations were accurate. Five years later, the LTM figures for June 2020 came in at $273.9 billion of sales and $58.4 billion of net income.
Yes, the latter figure represents a lot of profits, but it embodies hardly a modicum of growth. In fact, Apple’s five-year sales growth rate was just 4.1%, while its net income growth rate clocked in at only 2.9% per annum.
Moreover, there has been no recent growth spurt to accelerate these five-year trend rates of growth. The two-year growth rates are even slower, with sales posting at 3.6% per annum and net income rising by just 2.03% per year.
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Needless to say, the doubling of Apple’s PE multiple has nothing to do with its punk five-year net income growth rate of 2.9% per annum; it’s about the Fed’s radical repression of interest rate and the resulting diversion of trillions of borrowed capital into the inflation of risk asset capitalization rates.
Nor is Apple some kind of outlier, albeit it is the monster of the tech midway. Overall, the so-called Fab Five (Amazon, Apple, Microsoft, Facebook and Google) reflect the same multiple inflation story; and they are obviously the pile driver that is pushing the heavily ETF and indexer-driven stock market up into the nosebleed section of history.
Thus, back in June 2014, the Fab Five’s combined market cap weighed-in at $1.63 trillion and accounted for 9.5% of the overall S&P 500’s market cap of about $17.0 trillion.
Fast forward six years, and the Fab Five were valued at today’s close at $7.1 trillion, which accounts for 26% of the $27.7 trillion total market cap of the S&P 500.
So, yes, the term “pile-driver” is probably an understatement. Fully 50% of the S&P 500’s $10.7 trillion market cap gain since June 2014 is attributable to the Fab Five.
At the same time, the combined net income of the Fab Five has risen from $76.3 billion to $170.7 billion, meaning that the already frisky PE multiple of 21.4X for the group as a whole in June 2014 has now stands at 42.0X.
Obviously, averages can be misleading, but they do not lie. The composite net income growth rate of the Fab Five “growth stocks” has been just 14.4% over the past six years.
In a world which is literally unwinding at the seams owing to the Covid pandemic and a $260 trillion burden of debt, a valuation multiple equal to 42X or nearly three times the trailing growth rate makes no sense whatsoever.
That’s because the James Mackintosh groupthink cited above is marred with a mighty flaw. To wit, you can’t value earnings into the indefinite future owing to today’s ultra-low interest rates that are definitely not sustainable.
The Fed’s policy of radical interest rate repression simply defies the laws of finance and common sense because real yields are negative, and in the long-run negative real yields are an oxymoron.
The chart below is the smoking gun. Once upon a time there was meaningful daylight between the brown line (nominal yield on the benchmark 10-year UST) and the purple line (running inflation rate measured by the 16% trimmed mean CPI).
That is, even so-called risk-free US Treasury debt had a real yield of 200-400 basis points to account for taxes and a real return on investment.
But after the final leap into monetary madness commencing with the financial crisis of 2008-2009, the real yield had virtually disappeared; and then after the massive $3 trillion Fed bond-buying spree commencing in mid-March, the benchmark security of the entire global fixed income market went deeply negative in real terms.
As of the latest month, the running inflation rate clocked-in at 2.27% (June LTM) compared to an all-time low yield on the 10-year UST of 52 basis points a few weeks back.
Needless to say, when the real cost of risk-free benchmark debt is negative 175 basis points, you are not in an indefinitely sustainable steady state. You are actually courting financial disaster.
That’s especially because fiscal policy in the US and elsewhere around the world has become completely unhinged.
So unless the Fed and other central banks continue their massive bond purchases in response to this tsunami of public debt, the bond pits are heading for a train-wreck some time soon; and if the central banks continue to print at current lunatic rates, the monetary system itself will go into meltdown.
Still, the misbegotten idea that the stock market isn’t overvalued because bond prices have been massively inflated by central bank money-pumping is just one instance of the present tyranny of groupthink – called to attention by Apple’s crossing the $2 trillion market cap barrier.
In fact, groupthink is omnipresent in the the mainstream narrative and so-called news. The nearly universal belief that the Covid-lockdowns were necessary and effective and that the coronavirus can be stopped by brute-force economic and social regimentation is another case in point – underscored by a new analysis of the Swedish outcome.
The mainstream narrative, of course, is that Sweden’s no lockdown policy – the schools, restaurants, movies, gyms, malls etc. remained open – was a disastrous failure, thereby vindicating the universal quarantine approach of Dr. Fauci, Governor Cuomo and the rest of the Blue State Virus Patrol.
But that’s based on the irrelevant observation that Sweden’s overall WITH-Covid mortality rate of 56 per 100,000 is far higher than that of Norway, Finland and Denmark.
The truth is, Sweden’s mortality rate happened in the long-term care facilities, where 75% of the country’s 5,800 WITH-Covid deaths to date (August 18) have occurred, and which is neither here nor there when it comes to lockdowns of the non-elderly population.
Fortunately, a breakdown of Sweden’s WITH-covid deaths by detailed age brackets is readily available and it puts the kibosh on Dr. Fauci’s Lockdown Nation folly.
Number of WITH-Covid deaths/ Population/Rate per 100,000 by age cohort:
- 0-9 years: 1/1.22 million/ 0.08 per 100,000;
- 10-19 years: 0/1.19 million/ 0.0 per 100,000;
- 20-29: 10/1.31 million/ 0.77 per 100,000;
- 30-39 years: 16/1.37 million/ 1.16 per 100,000;
- 40-49 years: 45/1.31 million/ 3.42 per 100,000;
- 50-59 years: 162/1.27 million/ 12.8 per 100,000;
- 60-69 years: 398/1.14 million/ 34.8 per 100,000;
- 70-79 years: 1,250/.917 million/ 128.7 per 100,000;
- 80-90 years: 2,408/.425 million/ 567.0 per 100,000;
- 90 years plus: 1,512/.119 million/ 1,271.0 per 100,000.
Similarly, 67% of the deaths were among the population 80 years and older and 93% were among those aged 65 or more. By contrast, persons 65 and older account for just 19% of Sweden’s population, and the preponderant share of the latter, who have suffered serious illness or death from the Covid, were already in long-term care facilities and programs.
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Needless to say, locking down the schools, gyms, restaurants and malls does nothing for the institutionalized population of the vulnerable elderly and co-morbid. Sheltering and treating the latter in place, rather than quarantining the younger, healthier populations, is the self-evident answer.
Indeed, the virtue of Sweden’s anti-lockdown strategy virtually screams out from the schedule above. Sweden did not close its schools, yet there has been just one WITH-Covid death among its 2.4 million school age children under 20 years.
Likewise, there have been just 71 deaths among its 4.0 million prime working and consuming age population (age 20-49). That’s a rounding error mortality rate of 1.77 per 100,000. Who in their right mind would want to shutdown the economy based on such infinitesimal risks?
Stated differently, the risk of death from Covid in Sweden has been 720X higher for the largely institutionalized 90 and over population compared to the prime working age group (20-49 years); and has also been 157X higher for the entire population 65 and over than for prime workers and the population that is the preponderant patron of the social congregation sectors of the economy.
Fortunately, Sweden also has readily available data on normal, year-in-and-year-out mortality, which rate is about 862 per 100,000 for the total population. But when you breakdown these normal mortality rates by age cohort and cause of death, the insanity of Lockdown Nation become all the more apparent.
Specifically, there are about 3,429 deaths per year in Sweden from auto crashes, falls, drownings, electrocutions, poisonings and other accidents, and these account for about 4% of Sweden’s 2019 death total from all causes of 89,000.
However, when you look at mortality rates per 100,000 from accidents alone, the starling result is that the existing risk of death from accidents is far higher than from the Covid for the entire 8.4 million population under 65 years of age, and for the young and middle-aged decidedly so.
Mortality rates per 100,000 for accidents versus Covid and ratio of accident/Covid risk:
- 0-14 years; 1.38 versus 0.06=25X;
- 15-44 years: 12.3 versus 1.2=10X;
- 45-64 years: 20.6 versus 15.4=1.34X;
- 65 years & older: 115 versus 257=0.45X.
Due to enlightened leadership by Sweden’s health professionals and leading epidemiologists, they got it right, and now both new cases and WITH-Covid deaths have virtually disappeared.
And that’s to say nothing of the fact, that Sweden’s Q2 GDP decline of just 8.6% was far better than the double digit declines in the US and most European countries, which imposed far more draconian lockdowns.
In America, by contrast, the tyranny of groupthink on the matter has become so great that college football and in-person college classes are being closed from coast-to-coast when the risk of serious illness or death among the college age population here, like in Sweden, is virtually nil.
Reprinted with permission from David Stockman’s Contra Corner.
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