'Funny Money’ Is Flooding the Market. Will It All Go Down the Drain?
I remain cautious as excess fiscal deficit spending helps distort valuations.
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The market continued to hit all-time highs last week, even as small caps sat out the rally as the Russell 2000 fell on the week. But it is hard to like this market from the point of a value investor.
In fact, when looked at from a myriad of traditional valuation metrics, the market has a lot to be wary of. Equities continue to be distorted by several factors. First, we have enthusiasm about all things artificial intelligence. Stocks have also got a nice boost in anticipation of the first cut to the Fed Funds rate since 2020 this month. Growing certainty of a coming "soft landing" has also bolstered investor spirits.
Then we have what I call all the "funny money" flowing throughout the economy and the markets from the massive amounts of continued fiscal deficit spending, even as the economy is in an economic expansion. The federal government is spending more than $5 billion daily on average more than it is taking in from taxes, fees and other revenue. That total will amount to north of $2 trillion when the government's fiscal 2024 year closes today. This amounts to nearly 7% of U.S. gross domestic product. Obviously, this is unsustainable as is trying to calculate what the markets and economy would look like if the government were running a more normalized deficit of 2% to 3% of GDP. I have given up on ever seeing another balance budget in my lifetime, at least on the federal level.
Now we have China getting into the act. The Chinese government announced last week its strongest stimulus package since the pandemic to help address its increasingly moribund property market. The measures sent the Chinese stock market to its biggest one-day gain since 2008. The actions included slashing interest and mortgage rates as well as lowering the minimum down payments for new home purchase. They also authorized state-controlled commercial banks to increase their lending capacities.
That prompted famed billionaire hedge fund manager David Tepper to announced he is going "all in" on China. Of course, this is the same guy who traded up into the number pick in the draft last year to select Bryce Young over C.J. Stroud, hired Urban Meyer as head coach and has sent the Carolina Panthers to the NFL basement. I hope his financial instinct remains sharp; his instincts during his first few years of NFL ownership have been anything but.
Despite new Chinese stimulus measures and U.S. GDP in the second quarter of 3%, crude oil is near 14-month lows. That's not something we would expect amid solid economic growth, especially as fighting in the Middle East continues to escalate. Nor would one project that consumer sentiment would have its largest one-month plunge in three years as happened last week.
What all the global governmental largess is helping to do is send the markets to extreme valuations. The S&P 500 now trades at around 26-times its trailing 12-month earnings. More concerning is the S&P 500 trades at a price to sales ratio of over three. The median over the years is around 1.6-times and the index has reached this lofty level only once before it its history, in late 2021 and early 2022, just before the Nasdaq lost a third of its value in 2022.
This is the main reason I continue to be cautious around the overall market. My No. 1 focus is to consistently find new covered-call opportunities for my portfolio in growth at a reasonable price or "growth at a reasonable price" equities. They remain few and far between within a market pumped by excessive governmental spending that is helping to distort valuations.
At the time of publication, Jensen had no position in any security mentioned.
