David Stockman writes in today's New York Times:
The Dow Jones and Standard & Poor's 500 indexes reached record highs on Thursday, having completely erased the losses since the stock market’s last peak, in 2007. But instead of cheering, we should be very afraid.
Over the last 13 years, the stock market has twice crashed and touched off a recession: American households lost $5 trillion in the 2000 dot-com bust and more than $7 trillion in the 2007 housing crash. Sooner or later -- within a few years, I predict -- this latest Wall Street bubble, inflated by an egregious flood of phony money from the Federal Reserve rather than real economic gains, will explode, too.
Since the S&P 500 first reached its current level, in March 2000, the mad money printers at the Federal Reserve have expanded their balance sheet sixfold (to $3.2 trillion from $500 billion). Yet during that stretch, economic output has grown by an average of 1.7 percent a year (the slowest since the Civil War); real business investment has crawled forward at only 0.8 percent per year; and the payroll job count has crept up at a negligible 0.1 percent annually. Real median family income growth has dropped 8 percent, and the number of full-time middle class jobs, 6 percent. The real net worth of the “bottom” 90 percent has dropped by one-fourth. The number of food stamp and disability aid recipients has more than doubled, to 59 million, about one in five Americans.
So the Main Street economy is failing while Washington is piling a soaring debt burden on our descendants, unable to rein in either the warfare state or the welfare state or raise the taxes needed to pay the nation’s bills. By default, the Fed has resorted to a radical, uncharted spree of money printing. But the flood of liquidity, instead of spurring banks to lend and corporations to spend, has stayed trapped in the canyons of Wall Street, where it is inflating yet another unsustainable bubble.
I have a few comments:
1. Banks are lending, at all-time record levels (see chart below). The volume of commercial and industrial loans at America's top 100 banks (by assets, see data here) has been steadily rising for the last three years, and reached a new all-time record high of $1.2 trillion in the last quarter of 2012.
2. The chart below shows the historical relationship between the S&P 500 and after-tax corporate profits on a quarterly basis back to 1990. Between about 1990 and 1995 there was a pretty close one-to-one relationship between the S&P 500 and corporate profits -- for every increase of $1 billion in after-tax corporate profits, the S&P 500 increased by about one point. But starting sometime around 1996, after-tax corporate profits flattened out for the next five years, while the S&P 500 approximately doubled, reflecting the dot-com bubble that was not supported by an equivalent increase in corporate profits and was therefore unsustainable.
Then between about 2002 and 2006, the one-to-one relationship between increases in corporate profits and stock market values was re-established. But then corporate profits stated declining in 2007, but stock prices continued to rise to unsustainable levels and fell in 2008 as the recession and financial crisis brought about a major 40% stock market correction. Starting about 2009, a one-to-one relationship between stock prices and after-tax corporate profits has once again re-emerged, and the all-time highs for the S&P 500 in recent months are being driven by record-high corporate profits.
The last two market crashes that David Stockman refers to came about because stock prices "got ahead" of corporate profits, and rose to levels that weren't sustainable because they weren't consistent with the underlying corporate profits. In the current bull market rally, at least so far, corporate profits are consistent with stock market levels. If that one-to-one trend between profits and stock prices continues, the current bull market is sustainable as long as profits continue to rise. Larry Kudlow reminds us frequently that "profits are the mother's milk of stocks, and for that matter business and the entire economy." Therefore, as long as corporate profits continue to increase, we've got a bull market stock rally that could continue for a long time.