The Market has started the year extremely well; however, I think investor euphoria is myopically focused on only half the value equation. Investors are fixated on a Fed rate hike pause or perhaps pivot to lower rates. Yet, the value of money is not based on nominal interest rates, but rather on a comparison to an alternative.
I like to value Money as a comparison to S&P 500 earnings…essentially looking at it as a risk/reward ratio by asking the question:
What’s my profit potential in the Market, compared to remaining safely in cash?
The risk premium is simply a comparison of S&P 500 earnings to short term interest rates…essentially looking at value for value.
The Market benefit of stable or declining interest rates which investors are so enamored with, could easily be offset by declining corporate profits. [Not even taking into consideration the restrictive monetary impact of massive Fed balance sheet reduction.]
So…the bottom line:
Cheap Money drives the Market higher, while expensive Money moves the Market lower.
The below chart illustrates the comparative value of Money (~S&P 500 PE x short term interest rates) over the past 30 years. The important takeaway is that the comparative value of Money is rising rapidly and that generally leads to a severe Market correction. I’m not an alarmist, but I’ve become increasing concerned about a Market selloff since October 2022, when the Money indicator surpassed the 2019 high.
Money is the most expensive in 16 years and the 3rd highest in over a generation.
Regardless of Fed monetary policy, if corporate profits continue to decline, then just as during the DotCom Bubble and the Housing Bubble, the Stock Market would be extremely likely to have a hefty decline. [-50% peak-to-trough]
So ignore the zeitgeist of FOMO (fear of missing out) and pay attention to S&P 500 earnings. There’s no upside to the Market if earnings are down.
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