EcPoFi's  Instablog

For the first time in nine bi-weekly periods (18 weeks), the monetary base actually contracted and ended the week 0.80% (USD 24.4 billion) lower than two weeks ago. The growth in the base this year remains substantial however, having increased by USD 333.9 billion, or 12.41%, since the end of last year. Compared to the same period last year, the base is up by 14.65%.

The M1 money supply continues to expand at a rapid pace increasing 12.69% on the same period last year, almost one percentage point higher than the 11.73% average change in year to date. The percentage change in recent weeks is however slightly below the 52 week moving average of 12.84%. To put the substantial increase in M1 seen in recent years in perspective: since 2011 the year on year (YoY) growth rate has averaged 14.63% while during 1985 to 2010 it averaged 4.73% - this means the growth rate since 2011 has more than tripled compared to the 1985 to 2010 period!

The M2 money supply for the week increased 7.12% on the same period last year, in line with the average so far this year. Although the current growth rate is high in a historical perspective (the average since 1985 is 5.54%), the average YoY growth rate in 2013 of 7.17% is is significantly lower than the 8.52% average growth rate in 2012. Also, compared to the end of last year, M2 has hardly increased at all this year (it's up by 0.33%). To the extent that broader measures of the money supply (M2, MZM, M2+IMF+LTD*, etc) drives stock markets (see for example here and here), investors would be wise to notice this slowing down of the growth rate and to keep an eye on it going forward.

The YoY growth rate for broadest measure of money supply in this report, the M2+IMF+LTD* money supply, has gathered pace this year. With an average growth of 5.93% in 2013, it has significantly outpaced the average growth rates in 2012 (4.27%) and 2011 (2.61%). However, much of this increase comes from expansions in the second half of last year as the level of M2+IMF+LTD money supply is virtually unchanged from the end of last year (up 0.03%).

Bank Credit continues to reach new highs, increasing 4.36% for the week compared to same period last year. As with M2 and M2+IMF+LTD, the level of bank credit is also virtually flat compared to the end of last year, signalling a slowing down of the growth grate.

Treasury yields remain low in a historical perspective with both the 1-year and the 10-year yields decreasing on two weeks ago, with the latter decreasing the most (-0.07% points vs 0.03% points) resulting in a narrowing of the spread.

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*The Federal Reserve stopped publishing its M3 Money Supply series back in 2006. As an incomplete substitute, the M2+IMF+LTD money supply is a broader measure than M2 and consists of M2 + Institutional Money Funds + Large Time Deposits, data series which used to be included in the M3 series and which are still reported on a regular basis by the Fed.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Earnings - and dividend yields as of 7 May 2013

Based on the closing price of the S&P 500 index of 1,625.96 on 7 May 2013 and data from Professor Robert Shiller's home page, the current 10-year average earnings- and dividend yields for the S&P 500 index are as follows (please refer to the June 2012 analysis for background information):

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Following a 4.1% increase in the S&P 500 since our last report on 2 April, the 10-year average earnings yield dropped further. At the current 4.22%, it is the lowest earnings yield recorded since May 2008, five years ago. Compared to the average earnings yield since 1978 of 5.95%, the current yield is 28.99% lower. If we exclude the 1998 to 2000 period (a period when the stock market was extraordinarily high compared to fundamentals) the current earnings yield is 32.68% lower than the adjusted average earnings yield.

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The 10-year average dividend yield dropped to 1.64% for the month and is now 38.37% lower than the average since 1978. Removing the 1998 to 2000 period, the current yield is 41.45% lower than the adjusted long term average. As the S&P 500 climbed higher during the last month or so, the dividend yield also hit the lowest level recorded for five years.

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The current 10-year average earnings- and dividend yields therefore indicate the market is valuing the S&P 500 index substantially higher than it on average has based on those measures.

The Spread as of 7 May 2013

The spread, the difference between 10-year average earnings yield and the 10-year treasury yield (GS10), was 2.42% as of 7 May. The spread still remains considerable higher than the average negative spread of 0.89% since 1978. One (of many) likely reasons for this, as reported many times before, is that bond yields are still artificially low due to the support from the Fed through keeping the Federal funds rate close to zero and buying treasury and mortgage-backed securities. In a historical perspective, the spread indicates the current market valuation of the S&P 500 index is substantially lower than average and that equities as measured by the S&P 500 index appears attractively valued relative to 10-year treasuries. But, we must highlight, the relatively high spread is due to artificially suppressed treasury yields and not due to a historically high earnings yield, which would be preferable (if price inflation was the same).

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Conclusion

Last month we concluded that the stock market had become even more expensive and pointed out, in addition to the S&P 500 which had set a new all-time high, that other stock market indexes in the U.S. had rallied even more (read it here). Well, the U.S. stock market measured by all the major indexes (S&P 500, DJIA and the Wilshire indexes) have climbed higher since so it follows that the conclusion now is that the U.S. stock market is even more expensive. For example, the Wilshire 4500 Total Market Index to current GDP (Q1 2013, annualised) hit the highest level since Q1 2000 on Monday ("Approaching Bubble Territory: Wilshire 4500 to GDP Ratio Hits New All-Time High!").

The more expensive any stock market becomes relative to fundamentals, the lower the future probable returns become (ceteris paribus). The current 10-year average earnings yield of 4.22% equates to a Price-Earnings (P/E) ratio of 23.68. Cliff Asness, in his paper on the Shiller P/E, documents that a P/E (where E is 10-year average earnings) at the time of investing in the range of 21.1 to 25.1 (based on data from 1926 to September 2012) has historically yielded an average real return per annum for the next 10 years (including every possible rolling decade) of +0.9%, a worst case real return of -4.4% and a best case real return of +8.3%. On the same basis, but starting with a P/E of between 5.2 to 9.6, the average real return over the next decade is +10.3%, with a worst case of +4.8% and a best case of 17.5%. According to Asness,

"...as starting Shiller P/E's [which is based on 10-year average earnings] go up, worst cases get worse and best cases get weaker (best cases remain OK from any decile, so there is generally hope even if it should not triumph over experience!)

In conclusion, the U.S. stock market is expensive in a historical perspective and has become even more so this year. This means the probability of a downward correction and low future returns are lower than it otherwise would have. This does not mean the stock market will not move up from here as the momentum is definitely on the stock market's side, together with the Fed (see here). But buying into the U.S. stock market in general now for the longer term resembles speculation more than prudent investing based on fundamentals. In any case, you should not expect a high return from a buy and hold strategy of the S&P 500 index (or any other U.S. index) over the coming years.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Here is some news that appears to have eluded financial reporters: On Monday the Wilshire 4500 Total Market Index compared to the most recent quarter annualised GDP hit the highest level ever recorded, even beating the previous record from Q1 in 2000.

The same ratio, but based on 10-year average GDP, is now slightly higher than it was in Q2 2007, but remains lower than Q1 2000.

After the peaks in the ratios in Q1 2000 and Q2 2007, the U.S. stock market (and most other stock markets) plummeted. We are now at one of those peaks once again, and what do you know, we are approaching the end of another seven year cycle (2000 to 2007, 2007 to 2013/14?).

Yet another sign the U.S. stock market is becoming richly valued and approaching "bubble" territory.

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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.