Following my last comments on the decline of the U.S. monetary base:
The latest report from the Fed released on Thursday shows a further considerable quantitative contraction (QC) as QE is reigned in. From its peak in August 2014, the total monetary base has declined US$0.535 trillion or 13.1% from US$4.075 trillion to US$3.45 trillion. Excess reserves are down 27.3% or US$0.736 trillion from US$2.7 trillion to US$1.964 trillion. A drop almost as much as was the total monetary base in August 2008 at US$0.844 trillion. This is much more important than a quarter point hike in the funds rate whether it be in December or in 2017.
While both the total monetary base and the excess reserves fell substantially in the latest report, the Actual Working Monetary Base (AWMB) remained virtually unchanged at US$1.58 trillion. This points to the Fed alone sucking money out as it continues to play the didgeridoo.
As expected the draining of the total monetary base has resulted in the relative strengthening the U.S. dollar, a weakening of gold and commodities measured in U.S. dollars with the exception of oil which, of late, has been influenced more by the actions of OPEC and Russia. The bond market has been held in check by its more attractive yields than those available abroad and should remain so.
With the yields of long-dated bonds being held in check the DJIA continues to be extremely attractively priced with its record dividend per share yielding more than the U.S. 30-year T Bond. A situation that has happened only three times over the past 40 years and more. It would appear that would be equity market participants have stayed away in droves fearing a repeat of the Lehman collapse and a deep recession.
Starting with the assumption that at 848 yielding 6.58% the DJIA was fairly priced relative to the 30-year T Bond yield when it peaked at 15.2% on September 29, 1981, and working forward from there using the dividend discount model the value of the DJIA today is 43.225 but its price closed at only 18,162 last night.
The decline in the 30-year T Bond yield pushed its price up 6.06 times and the dividend increased by 8.48 times. The increase in the dividend per share of 8.48 times alone should have pushed up the price of the DJIA up by that amount had there been no change in the 30-year T bond yield. However, the 30-year T Bond yield did change dramatically. Accounting for this change, the dividend discount value of the DJIA increased from 848 in 1981 by 8.48 times 6.06 times to a value of 43,225.
That the price of the DJIA is at only 18,162 is testament to the magnitude of the fear that still abounds amongst market participants. It is also the reason why I have been a raving bull on the DJIA since its nadir in early March 2009 and continue to be. For the pressure on the DJIA is up towards its dividend-discount value.
In the following chart each of the daily plots of value have been calculated using the dividend-discount model using the DJIA dividend for each day over the past 35 years along with the corresponding yield of the 30 year T Bond for each day over the same period. As long as the value exceeds the price of the DJIA fear of a market collapse is misplaced and the result of the pessimism of the majority of the market participants who have been so distraught since Lehman.
From what I can see there is no need to be negative. All that is needed is patience until earnings stop deteriorating and stabilize. This should be sufficient to show that the dividends of the DJIA are safe at a 50% payout ratio. Once this is accepted there should be a substantial improvement the price of the DJIA and the updraft should gather pace as earnings start to recover through Q4 2016 and particularly Q1 of 2017 when the earnings of the oil majors should be very positive compared to Q1 2016.
Santa Clause should be very kind to all equity investors who are long yet again this year. So fear not and invest the money.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.