CAPE v PEMAX: How hot are market valuations?

Robert Shiller’s CAPE ratio is currently at 32.17, the second-highest peak in recorded history. According to, prior to the Black Tuesday crash of 1929 CAPE had a reading of 30. The only peak with a higher reading is the Dotcom bubble at 44.

Shiller CAPE - click to enlarge

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Shiller’s CAPE, or Cyclically Adjusted PE Ratio to give it its full name, compares the current S&P 500 index value to the 10-year average of inflation-adjusted earnings. The aim is to smooth out the earnings cycle and provide a stable assessment of long-term potential earnings.

But earnings have fluctuated wildly in the past 10 years, and a 10-year average which includes severe losses from 2009 may not be an accurate reflection of current earnings potential.

S&P 500 Earnings

The dark line plotted on the above chart reflects the highest earnings to-date, or maximum EPS. The market often references this as the current, long-term earnings potential, in place of cyclical earnings.

The chart below compares maximum EPS (the highest earnings to-date) to the S&P 500 index. The horizontal periods on max EPS reflect when cyclical earnings are falling.

S&P 500 and Peak Earnings

It is clear that the index falls in response to cyclical fluctuations in earnings (the flat periods on EPS max). But it is also clear that earnings quickly recover to new highs after the index has bottomed. In Q1 of 2004 after the Dotcom crash and in Q3 of 2011 after the 2008 global financial crisis.

The next chart plots the current index price divided by maximum earnings to-date. I call it PEMAX. When earnings are making new highs, as at present, PEMAX will reflect the same ratio as for trailing 12-month PE. When earnings are below the previous high, PEMAX is lower than the trailing PE.


What the chart shows is that, outside of the Dotcom bubble, prices are highest in the last 30 years relative to current earnings potential. The current value of 22.56 is higher than at any time other than the surge leading into the Dotcom crash.

The peak value during the Dotcom bubble was 30.19 in Q2 of 1999. The highest value in the lead-up to the GFC was 20.23 in Q4 of 2003.

Does the current value of 22.56 mean that the market is about to crash?

No. The Dotcom bubble went on for two more years after reaching 22.80 in Q3 of 1997. The present run may continue for a while longer.

But it does serve as a reminder to investors that they are paying top-dollar for stocks. And at some point values are going to fall to the point that sanity is restored.

The four most expensive words in the English language are “this time it’s different.”

~ Sir John Templeton

Australian banks under selling pressure

The ASX 300 Banks index are a major drag on the broad market index. Having respected resistance at 8500, a test of primary support at 8000 is likely. Twiggs Trend Index peaks below zero warn of strong selling pressure.

ASX 300 Banks

Return on equity is falling.

Australian Banks Return on Equity

A combination of narrow interest margins.

Bank Net Interest Margins

Soaring household debt.

Bank Net Interest Margins

And rising capital requirements as APRA desperately tries to protect their glass jaw.

Bank Capital Ratios

Don’t let the ratios fool you. They are based on risk-weighted assets. Common Equity Tier 1 (CET1) leverage ratio for at least one of the majors is as low as 4.0 percent.

China is the biggest credit bubble in the world today | Crescat Capital

From Nils Jenson at Crescat Capital:

History has proven that credit bubbles always burst. China by far is the biggest credit bubble in the world today…….

The Bank for International Settlements (BIS) has identified an important warning signal to identify credit bubbles that are poised to trigger a banking crisis across different countries: Unsustainable credit growth relative to gross domestic product (GDP) in the household and (non-financial) corporate sector. Three large (G-20) countries are flashing warning signals today for impending banking crises based on such imbalances: China, Canada, and Australia….

The trouble with credit bubbles is they always burst. The problem is we don’t know when. “Imminent” could mean next week or it could mean in 3 years time. Keep a close watch on the PBOC for signs that it has run out of options. They will kick the can down the road for as long as possible, but the time will come when that is no longer viable.

Great Analysis, worth reading the entire report: Crescat Capital Quarterly Investor Letter Q2 2017 | Crescat Capital

This oil price rally has reached its limit – On Line Opinion

Good summary of the oil market by Nicholas Cunningham – posted Friday, 4 August 2017:

There are several significant reasons why oil prices have regained most of the lost ground since the end of May….

  1. OPEC cuts;
  2. US shale expansion is slowing;
  3. Several OPEC members have promised deeper cuts; and
  4. Drawdowns in U.S. crude oil inventories suggest the market is finally rebalancing.

But inventories are still high, not just in the U.S. And the US (despite shale slowing), Libya and Nigeria are all expected to increase output.

Also, the recent rally is largely attributable to short-covering rather than hedge funds taking fresh long positions.

But there is a wild card:

The one variable that could upend all market forecasts is Venezuela, which has been in economic turmoil for quite some time but is entering a new phase of crisis. The involvement of the U.S. government, which is retaliating against Venezuela for what it argues is a step towards dictatorship, threatens to accelerate the oil production declines in the South American nation.

If Venezuela sees its exports disrupted in a sudden way, the ceiling for oil prices in 2017 could be quite a bit higher than everyone expects at the moment. Otherwise, there is not a lot of room on the upside for oil prices in the short-term.

…it could go up, it could go down, but not necessarily in that order.

Using fundamentals to predict short-term cycles is at best a 50/50 proposition. It’s normally best to stick to technicals (for short time frames). Looks like a secondary rally in a bear market.

Nymex Light Crude

Source: This oil price rally has reached its limit – On Line Opinion – 4/8/2017

Boris Johnson wrong to link Australia’s economic growth to the resources boom

In criticizing Boris Johnston, Ross Gittins at The Herald, unwittingly highlights the hubris of the economics profession:

When Boris Johnson, Britain’s Foreign Minister, visited Oz lately, he implied that our record 26-year run of uninterrupted economic growth was owed largely to the good fortune of our decade-long resources boom.

Johnson, no economist, can be forgiven for holding such a badly mistaken view – especially since many Australian non-economists are just as misguided. They betray a basic misconception about the nature of macro-economic management and what it’s meant to do.

It’s clear that Johnson, like a lot of others, hasn’t understood just why it is that 26 years of uninterrupted growth is something to shout about.It’s not that 26 years’ worth of growth adds up to a mighty lot of growth. After all, most other countries could claim that, over the same 26-year period, they’d achieved 23 or 24 years’ worth of growth.

No, what’s worth jumping up and down about is that little word “uninterrupted”. Everyone else’s growth has been interrupted at least once or twice during the past 26 years by a severe recession or two, but ours hasn’t.

That’s the other, and better way to put it: we’ve gone for a record 26 years without a severe recession.But now note that little word “severe”. As former Reserve Bank governor Glenn Stevens often pointed out, we did have a mild recession in 2008-09, at the time of the global financial crisis, and earlier in 2000-01.

So, yet another way to put the Aussie boast is that we’ve gone for a period of 26 years in which the occasional increases in unemployment never saw the rate rise by more than 1.6 percentage points before it turned down again.

What you (and Boris) need to understand about macro-economic management is that its goal isn’t to make the economy grow faster, it’s to smooth the growth in demand as the economy moves through the ups and downs of the business cycle.

This is why macro management is also called “demand management” and “stabilisation policy”. These days, the management is done primarily by the Reserve Bank, using its “monetary policy” (manipulation of interest rates), though both the present and previous governor have often publicly wished they were getting more help from “fiscal policy” (the budget).

When using interest rates to smooth the path of demand over time, your raise rates to discourage borrowing and spending when the economy’s booming – so as to chop off the top of the cycle – and you cut rates to encourage borrowing and spending when the economy’s busting – thereby filling in the trough of the cycle.This is why the economic managers find it so annoying when the Borises of this world imagine that the decade long resources boom – the biggest we’ve had since the Gold Rush – must have made their job so much easier.Just the opposite, stupid. Introducing a massive source of additional demand in the upswing of the resources boom made it that much harder to hold demand growth steady and avoid inflation taking off.

But then, when the boom turned to bust, with the fall in export commodity prices starting in mid-2011, and the fall in mining construction activity starting a year later, it became hard to stop demand slowing to a crawl.

We’re still not fully back to normal.This is why the macro managers’ success in avoiding a severe recession for 26 years is a remarkable achievement, and one owed far more to their good management than to supposed good luck (whether from China or anywhere else).

But what exactly is the payoff from the achievement? Twenty-six years in which many fewer businesses went out backwards than otherwise would have.

Twenty-six years in which many fewer people became unemployed than otherwise, and those who did had to endure a far shorter spell of joblessness than otherwise.

The big payoff from avoiding severe recessions – or keeping them as far apart as possible – is to avoid a massive surge in long-term unemployment that can take more than a decade to go away – and even then does so in large part because people give up and claim disability benefits or become old enough to move onto the age pension.

Dr David Gruen, a deputy secretary in the Department of the Prime Minister and Cabinet, has demonstrated that, though the US economy had a higher proportion of its population in employment than we did, for decades before the global crisis, since then it’s been the other way around.”The key lesson I draw from this comparison is that the avoidance of deep recessions improves outcomes in the labour market enormously over extended periods of time,” he concluded.

“What you (and Boris) need to understand about macro-economic management is that its goal isn’t to make the economy grow faster, it’s to smooth the growth in demand as the economy moves through the ups and downs of the business cycle.”

Well how’s that been working for ya, Ross, over the last three decades. Attempts at smoothing the global economic cycle (primarily led by the US Fed) have achieved two of the most severe recessions in the last century. Smoothing out the natural creative destruction of the capitalist system allows imbalances to build. Periods of uninterrupted growth may be longer, but when the dam wall breaks, as it did in 2008, the severity of the backlash when the economy tries to restore equilibrium (or “balance” as us non-economists like to describe it) threatens to break the very foundations of the financial system.

Not exactly a time for high-fives and self-congratulation for the economics profession. To me economics should focus on the study of unintended consequences, of which there are many examples in the last 30 years.

The presumption that macro-economists can improve on the performance of an economy by constant intervention has clearly been demonstrated to be a fallacy.

Mechanical engineers in the 1800s were confronted with a similar problem when building large steam engines that worked under variable load. Attempts to smooth the load using a governor, adjusting braking in response to detected acceleration or deceleration was the obvious solution. But these governors created a feedback loop — highlighted by James Clark Maxwell in his famous 1868 paper On Governors to the Royal Society of London — that made these giant steam engines prone to self-destruct.

Constant interference with market forces in an effort to smooth economic growth has a similar effect on the economy. The lag between an actual event and its measurement, reporting and subsequent monetary policy response is susceptible to creating a feedback loop that amplifies the cycle instead of smoothing it, causing the system to self-destruct.

Economists on graduation should be required to make a pledge similar to the Hippocratic oath of the medical profession which starts: “First do no harm….”

It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.

~ Mark Twain (Samuel Clemens)

Source: Boris Johnson was wrong to link Australia’s economic growth to the resources boom

Nasdaq and S&P500 meet resistance

July labor stats are out and shows the jobless rate fell to a 16-year low at 4.3%. Unemployment below the long-term natural rate suggests the economy is close to capacity and inflationary pressures should be building.

Unemployment below the long-term natural rate

Source: St Louis Fed, BLS

But hourly wage rates are growing at a modest pace, easing pressure on the Fed to raise interest rates.

Hourly Wage Rates

Source: St Louis Fed, BLS

Fed monetary policy remains accommodative, with the monetary base (net of excess reserves) growing at a robust 7.5% a year.

Hourly Wage Rates

Source: St Louis Fed, FRB

Our forward estimate of real GDP — Nonfarm Payroll * Average Weekly Hours — continues at a slow but steady annual pace of 1.79%.

Real GDP compared to Nonfarm Payroll * Average Weekly Hours

Source: St Louis Fed, BLS & BEA

The Nasdaq 100 has run into resistance at 6000. No doubt readers noticed Amazon [AMZN] and Alphabet [GOOG] both retreated after reaching the $1000 mark. This is natural. Correction back to the rising trendline would take some of the heat out of the market and provide a solid base for further gains. Selling pressure, reflected by declining peaks on Twiggs Money Flow, appears secondary.

Nasdaq 100

The S&P 500 is also running into resistance, below 2500. Bearish divergence on Twiggs Money Flow warns of moderate selling pressure but this again seems to be secondary — in line with a correction rather than a reversal.

S&P 500

Target 2400 + ( 2400 – 2300 ) = 2500

ASX banks spoil the iron ore party

I underestimated the strength of iron ore which has now broken resistance at 70, suggesting that a bottom is forming. Strength of the latest rally indicates that the next correction is likely to find support at 60.

Iron Ore

The Resources sector responded, with the ASX 300 Metals & Mining index headed for a test of its February high at 3200 after recovering above support at 3000.

ASX 300 Metals & Mining

Banks have been on the receiving end, however, with the ASX 300 Banks index testing short-term support at 8500. A Twiggs Money Flow peak below zero warns of strong selling pressure. Breach of 8500 would signal another test of primary support at 8000.

ASX 300 Banks

The ASX 200 continues to form a narrow line, consolidating between 5600 and 5800. Declining Twiggs Money Flow, with a peak below zero, warns of selling pressure. Breach of support at 5600 remains likely, despite the iron ore rally, and would signal a primary down-trend.

ASX 200

A new health insurance system in the United States | Catallaxy Files

By Lucius Quinctius Cincinnatus:

Donald Trump may be finding it difficult to repeal the Patient Protection and Affordable Care Act (aka Obamacare). But what is he trying to replace it with? It seems nothing that will contain costs and provide a reasonable level of health care to all Americans. Capitalist or socialist or communist one should not in a first world country accept a health care system which fails many people.

If Trump wants to look overseas for a new model, he could do worse than adopting the Australian system. While our Medicare and private health insurance system has a number of deficiencies and needs substantial reform, it is far and away better than the US system where an initial simple consultation to a doctor costs a minimum of USD 200.

According to OECD data, the cost of health care in the United States is $9451 per capita compared to $4420 in Australia. The World Bank has Australia’s health costs at 9.1 per cent of GDP while in the US it is 17.1 per cent of GDP. The European Union average is 10 per cent of GDP.

Think of the implications if the US could bring its health costs down to Australian levels. It would save USD 1.5 trillion each and every year. And by bringing in a Medicare-like system the US would give better access to health care by all Americans.

If Trump wants to go down as a hero in the United States he should work in that direction. No other President or Congress has been able to make such major health care reforms in the USA or to address the powerful lobby groups which work to maintain the status quo.

What caught my eye was this interesting comment posted by flyingduk:

I am a senior Dr working in SA. The health system has become Godzilla. It is a rampaging beast eating every resource thrown at it and producing little of value in return. Our hospitals and our ambulances are packed full of hopeless cases and self inflicted disasters. We are pointlessly throwing ever more $ at elderly people with complex, end of life medical conditions. We are spending enormous amounts on meth addicts, alcoholics and the morbidly obese. Most of this money evaporates with nothing to show for it. The ‘health’ system has ceased to be a health system. It has become an ‘illness’ system. It cannot go on like this. Its going to collapse.

So a state-funded system has its problems as well. But there is an alternative. From Margherita Stancati at WSJ online:

Like other European countries, Italy offers universal health-care coverage backed by the state. Italians can go to a public hospital, for example, without involving an insurance company. The patients are charged a small co-pay, but most of the bill is paid by the government. As a result, the great majority of Italians don’t bother to buy private health insurance unless they want to seek treatment from private doctors or hospitals, which are relatively few.

Offering guaranteed reimbursements to public hospitals, though, took away the hospitals’ incentive to improve service or rein in costs. Inefficiencies were rampant as a result, and the quality of Italy’s public health care suffered for years. Months-long waiting lists became the norm for nonemergency procedures—even heart surgery—in most of the country.

Big changes came in 1997, when Italy’s national government decentralized the country’s health-care system, giving the regions control over the public money that goes to hospitals within their own borders…..

In much of the country, regions have continued to use the standards of care and reimbursement rates recommended by Rome. Some also give preferential treatment to public hospitals, making it more difficult for private hospitals to qualify for public funds.

Lombardy, by contrast, has increased its quality standards, set its own reimbursement rates and, most important, put public and private hospitals on an equal footing by making each equally eligible for public funds. If a hospital meets the quality standards and charges the accepted reimbursement rate, it qualifies. Patients are free to choose between state-run and publicly funded private hospitals at no extra cost. Their co-pay is the same in either case. As a result, public and many private hospitals in Lombardy compete directly for patients and funds.

…..Around 30% of hospital care in Lombardy is private now—more than anywhere else in Italy. And service in both the private and public sector has improved.

State hospitals have improved their service levels while private hospitals have lowered costs in response to the increased competition. A win for the taxpayer and for patients.

Source: A new health insurance system in the United States | Catallaxy Files

ASX stalls

Iron ore is testing resistance at 70. Respect would warn of another test of primary support at 53, while breakout would suggest that a bottom is forming and the next correction is likely to find support at 60.

Iron Ore

The Resources sector remains wary, with the ASX 300 Metals & Mining index retreating after a false break above resistance at 3050.

ASX 300 Metals & Mining

The ASX 300 Banks index retraced from resistance at 8800, heading for a test of the rising trendline and short-term support at 8500. Twiggs Money Flow continues to warn of selling pressure despite indications from APRA that they are unlikely to require further capital raising. Reversal below 8500 would warn of another test of primary support at 8000.

ASX 300 Banks

The ASX 200 has stalled, consolidating between 5600 and 5800 over the last two months. Declining Twiggs Money Flow, with a peak below zero, warns of selling pressure. Breach of support at 5600 is more likely, with an ensuing down-trend, but a lot depends on how iron ore behaves in the next few weeks.

ASX 200

It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.

~ Mark Twain (Samuel Clemens)

Nasdaq soars

GDP results for the second quarter of 2017 reflect recovery from the soft patch in 2016.

Nominal GDP compared to Nonfarm Payroll * Average Weekly Hours * Average Hourly Rate

Source: St Louis Fed, BLS & BEA

Nominal GDP for Q2 improved to 3.71%, measured annually. This closely follows our intial estimate calculated from Nonfarm Payroll * Average Weekly Hours * Average Hourly Rate.

Real GDP, after adjustment for inflation, also improved, to a 2.1% annual rate.

Real GDP compared to Nonfarm Payroll * Average Weekly Hours

Source: St Louis Fed, BLS & BEA

Bellwether transport stock Fedex is undergoing a correction at present but selling pressure appears moderate. Respect of medium-term support at 200 is likely and would confirm the primary up-trend (and rising economic activity).


The Nasdaq 100 gained more than 20% year-to-date, from 4863 at end of December 2016 to 5908 on July 28th. Growth since 2009 has been consistent at around 20% a year but now appears to be accelerating. To my mind that warns sentiment may be running ahead of earnings, increasing the risk of a major adjustment. But there is no indication of this at present.

Nasdaq 100

The S&P 500 continues its advance towards 2500 at a more modest pace. Bearish divergence on Twiggs Money Flow warns of selling pressure but this seems to be secondary in nature, with the indicator holding well above zero.

S&P 500

Target 2400 + ( 2400 – 2300 ) = 2500