The Real Reason For The Stock Market Correction

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by: Paul Dietrich
Summary

Market pundits are spewing out complete nonsense in explaining the stock market pullback!

Otherwise reasonable stock market commentators have been completely baffled by the seeming paradox of a stock market dramatically dropping over the release of spectacularly good economic data.

It started last Friday, after the January Jobs Report. That report showed (1) unemployment dramatically improving and (2) average YOY wage growth increasing by 2.6%.

The jobs market is tightening and, after a decade of almost 0.0% growth, wages are starting to rise just slightly by historical standards.

Commentators Misinterpreted The Cause & Effect of the Stock Market Decline!

After looking into their crystal balls and their boiling Voodoo kettles of unicorn bones and entrails, the Pundits decided, with no actual economic evidence or historical data, that the “mythical institutional Wall Street investor” and the “computer algorithms” of high-speed computer traders were, all of the sudden, deeply concerned by the possibility of (1) inflation as the result of the tepid 2.6% YOY growth in wages, (2) the approximately net $100 billion in annual deficit spending caused by the Trump Tax Cuts (roughly $1 trillion over 10-years), and (3) this would cause the Federal Reserve to raise interest rates faster because of the ensuing inflation caused by the mediocre wage growth and the Trump Tax Cuts.

What utter nonsense!!!!!

The Truth About U.S. Inflation?

There is none!

The U.S. Inflation Rate is currently 2.11%, compared to 2.07% last year. This rate is lower than the long-term average of 3.26%. If you exclude energy price rises, the current inflation rate would be lower than last year.

It is also lower than the Federal Reserve’s 2.2% target for raising rates based on inflation.

The reason this “voodoo explanation” for the stock market decline has no merit are the following arguments:

  1. In January 2009, when President Obama was sworn in, the U.S. national debt was $10.626 trillion. On January 20, 2017, when he left office, it was $19.947 trillion. President Obama added $9 trillion to the U.S. national debt, more than any other president. What was the result? No inflation!!!!
  2. The historically mediocre YOY wage growth of 2.6% will have almost no effect on inflation in the next 18-months to two-years.
  3. The net effect on deficit spending of the Trump Tax Cuts of approximately $100 billion a year ($1 trillion over 10 years according to the Congressional Budget Office), will have little impact on the deficit over the next two-years, given that President Obama’s $9 trillion in deficits over 8-years had no impact on inflation.
  4. The current cautious and conservative Federal Reserve is not going to preemptively start raising rates while the current inflation rate is lower than their 2.2% target. The Fed typically makes their decisions on real economic data and not on Voodoo Economics!
  5. The dollar has been declining for over three months! This has traditionally been a long-term bearish signal for inflation. Even the Fed understands this!

So What Is The Real Reason For The Stock Market Decline? ANSWER: The Stock Market Is Overvalued!

There are actual, real economic data to measure this assertion!

One of the best ways to judge whether the stock market is over or undervalued is to look at the Price Earnings (P/E) ratio. That is the price an investor is willing to pay for a set multiple of a company’s earnings.

As of last Friday, according to FactSet, the current forward 12-month P/E ratio for the S&P 500 Index for 2018 is currently at 18 times earnings. That P/E ratio is above the 5-year average of 16 times earnings.

That would currently make the S&P 500 Index overvalued by as much as 11.1%.

One could argue, that a correction or pullback of over 10% would just bring the stock market back to its “fair market value.”

Stock markets never remain overvalued for long. As economists say, they always revert to their ‘mean’ or ‘fair market value.’ That is what they are doing right now!

One Last Thought…..

Many analysts believe that the S&P 500 Index performance usually grows in line with its annual earnings growth.

FactSet analysts are currently projecting that the earnings growth for the S&P 500 Index will be 16.8% in 2018.

Because of this year’s double-digit earnings growth and the strength of the underlying U.S. and global economies, I believe we will again see double-digit growth in the stock market by the end of this year.

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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Paul Dietrich is the CEO and Chief Investment Officer of Fairfax Global Markets LLC. Fairfax Global Markets LLC is an investment advisor registered with the SEC. For a detailed report about its investment advisory activities visit www.adviserinfo.sec.gov. The opinions and information provided are for illustrative purposes and are subject to change at any time and are not to be construed as advice for any individual or as an offer or solicitation of an offer for purchase or sale of any security.