2 weeks ago

On the afternoon of March 15 Eastern time, the Federal Reserve announced a 1-0.25% cut in interest rates, and launched another $700 billion "quantitative easing" program. However, on March 16, the three major U.S. stock indexes plunged by more than 7% at the beginning of trading, triggering a primary circuit breaker mechanism. By the end of trading, the Dow Jones industrial index, NASDAQ index and S & P 500 index had dropped 12.93%, 12.32% and 11.98% respectively. On March 9, a week ago, the U.S. stock market also fell sharply at the opening. The decline of the three major U.S. stock indexes expanded to 7% in less than 5 minutes of opening, triggering the circuit breaker, which is the second time since the introduction of the circuit breaker mechanism in 1988. The first time the fuse broke was back in 1997. On October 27, 1997, the Dow Jones Industrial Average plunged 7.18% to close at 7161.15, the biggest decline since 1915. Three days later, March 12, the three major stock indexes triggered another circuit breaker. 

As of March 16, the S & P 500 index has fallen 26.14% since the beginning of 2020 and 29.53% since its high on February 19. The Dow Jones Industrial Average and the NASDAQ are moving similarly. 

The global spread of the new crown epidemic is undoubtedly the cause of the U.S. stock crash. However, in China, where the epidemic first broke out, the stock market performed much better than the US stock market. For example, the Shanghai and Shenzhen 300 index rose all the way after falling 7.88% on February 3, and soon recovered the decline, only falling 9.00% since the beginning of the year, while the gem even rose 6.26%. 

In fact, since the financial crisis of 2008-2009, American stocks have been rising. Since 2020, the three major stock indexes have reached record highs, and the valuation of American stocks has been at record highs. At the same time, although the U.S. economy is still in the longest growth period in history, its fundamentals are not as good as expected. The growth rate of GDP and personal disposable income and the profitability of non-financial enterprises are not satisfactory. Finally, the monetary and fiscal policy space of the U.S. government is not large and the effect of economic stimulus policy is weaker and weaker. This is also an important reason for the sharp decline of US stocks. 


 the valuation of US stocks is already very high 


A measure of whether a country's stock market is overvalued or undervalued is the ratio of the total market value of the stock market to GDP. GDP is the total wealth created by the country in a period of time, so the ratio of the total market value of the stock market to GDP is similar to the ratio of the stock price and profit of the company. The ratio measures the overvaluation or undervaluation of the stock market price. 




Figure 1 shows the ratio (%) of total market value of U.S. stock market to U.S. GDP in each quarter of 1971-2019. The market value of the stock market is measured by the sum of the market value of the constituent stocks of the Wilshire 5000 index, which covers all the actively traded stocks in the U.S. stock market, with a total of 3473 constituent stocks at the end of 2019. The ratio is unit based on the actual value of Q4 2007, that is, the whole series is divided by the actual ratio of Q4 2007, so the ratio of Q4 2007 after unit based is 100%. 
The ratio of 
 was 179% at the end of 2019, not only higher than the 101% of the subprime crisis in 2007, but also higher than the 118% of the 2000 Internet bubble. 

Another measure of overvalued or undervalued stock price is the price earnings ratio, that is, the ratio of stock price to earnings per share. Chart 2 shows the Shiller P / E ratio of the S & P 500 from February 1871 to February 2020, which is the sum of the stock market values of index components divided by the sum of earnings. The minimum price earnings ratio is 4.78 in December 1920. The maximum value is 44.19 in December 1999 before the Internet bubble burst. The average and median are 16.70 and 15.76 respectively. 




After entering 2020, the three major stock indexes of the United States have repeatedly set new highs, and the city's profits are also rising. The price earnings ratio of the S & P 500 at the end of February was 31.59, almost two times the historical average, also higher than the peak before the Great Depression of 1929 and the subprime mortgage crisis in 2007, only lower than the maximum before 2000 Internet bubble burst. Although it fell 8.8% in a week, the S & P 500 index reached a high of 25.71 on March 13, 2020, which is still at an extremely optimistic level. 

One of the shortcomings of P / E ratio is that it does not consider the growth of the company. The P / E ratio of company a and company B is 30 times. If the EPS of company a is expected to increase by 5% every year, and the EPS of company B is expected to increase by 50% every year, then compared with company B, the overvalued share price of company a is obviously higher. 

The price earnings growth ratio (PEG) is a ratio derived from the price earnings ratio. It is calculated by dividing the future price earnings ratio of stocks by the estimated future growth rate of earnings per share, in which the future earnings per share of the company is the market consistent expected value. This index makes up for the deficiency of P / E ratio in estimating the growth of the company. The higher the peg value is, the more likely the stock price is to be overvalued, while the lower the peg value is, the more likely the stock price is to be undervalued, similar to the P / E ratio. 




Chart 3 shows the weekly peg value of the S & P 500 index from the beginning of 1995 to March 11, 2020. The growth rate of earnings per share is based on the consensus expectation of the market for the growth rate of earnings per share in the next five years. The latest value of PEG is 1.6 on March 11, slightly lower than the highest value of 1.8 at the end of February 2020. 

Compare chart 2 and chart 3 to see the difference between PE and PE. During the Internet bubble in 2000, because many of the stocks were high-tech companies, many companies did not earn a lot of money and some even lost money, so the S & P 500 had a very high P / E ratio in 2000, but PEG was not high, just the same as the historical average. 

No matter from the ratio of the total market value of the stock market to GDP, or from the price earnings ratio and PEG value of the S & P 500 index, the valuation level of the US stock market is at a historical high. Even after nearly a month's (mid February to mid March) plunge, valuations of U.S. stocks remain extremely optimistic. 


 the fundamentals of the U.S. economy are not as good as they think

Every economic cycle can be divided into two stages: up and down. The rising stage is also called the expansion stage, and the highest point is called the peak. However, the peak is also the turning point of the economy from prosperity to decline, after which the economy will enter a declining stage, that is, a recession. The lowest point of recession is called the low point. Of course, the low point is also a turning point for the economy to turn from decline to prosperity, and then the economy enters another rising stage. From one peak to another, the economy is a complete economic cycle. 

The National Bureau of Economic Research (NBER) determines the economic cycle of the United States, i.e. the start and end time of recession and expansion period, according to economic activities, including the real GDP, real domestic income, employment, industrial production value, wholesale and retail sales. 

Generally speaking, the starting and ending time of the economic cycle determined by NBER is months, but many economic indicators only publish quarterly data, so the starting and ending time of the economic cycle is the quarter in which the starting and ending months are located. For example, the first cycle in Figure 4 starts in April 1960, and in terms of quarterly data, it starts in the second quarter of 1960; this cycle ends in December 1969, namely, the fourth quarter of 1969, and the whole cycle lasts for 117 months or 39 quarters. 




Figure 4 shows the growth rate (%) of real GDP in each quarter of different economic cycles relative to the real GDP in the beginning quarter of the cycle. For example, the starting time of the 2007-2019 cycle is the fourth quarter of 2007, and the fifth quarter is the first quarter of 2009 relative to the starting quarter. Therefore, the value of the horizontal axis scale 5 in Figure 4 corresponds to the growth rate (%) of the real GDP in the first quarter of 2009 relative to the real GDP in the fourth quarter of 2007. 

We calculated the cumulative growth rate of real GDP in each cycle, that is, the growth rate of the peak in the current economic cycle relative to the previous peak, corresponding to the height of the curve in Figure 4. The higher the height of the curve, the greater the cumulative growth rate in the cycle; and the annual average growth rate in the cycle, corresponding to figure 4 The slope of the middle curve, the greater the slope of the curve, the greater the annual growth rate. Taking the 1960-1969 cycle as an example, the real GDP in the fourth quarter of 1969 increased by 51.7% compared with the second quarter of 1960, corresponding to an average annual growth rate of 4.5% (39 quarters are equivalent to 9.75 years). 

In an economic cycle, the change trend of real GDP is to decline to a low point first and then rise to a peak, while the real GDP of the next peak is higher than that of the previous peak. With a long economic cycle and a relatively long period of economic expansion, the cumulative growth rate of real GDP in the whole cycle will also be high. For example, the cumulative growth rate of the three long cycles (1960-1969, 1981-1990, 1990-2001) is higher than that of the three short cycles (1969-1973, 1973-1980, 2001-2007). 

Although the whole cycle of 2007-2019 lasts the longest, its cumulative growth rate is only slightly higher than that of the other three short cycles. For example, the cycle of 1973-1980 has only 26 quarters, with a cumulative growth rate of 19.4%. However, the cycle of 2007-2019 (up to the fourth quarter of 2019) has lasted for 48 quarters, with a cumulative growth rate of 21.9%, far lower than the cycle of 1960-1969 of 51.7%. Its annual growth rate is the lowest in seven cycles, only 1.7%, far lower than 4.5% in 1960-1969 and 2.6% in the previous cycle. 

Real GDP measures the real output of an economy over a period of time, while real personal disposable income measures the sum of the final consumption expenditure and savings that an individual can use in an economy, that is, the income that an individual can use at his or her own disposal. Figure 5 shows the growth rate (%) of real personal disposable income in each quarter of different economic cycles relative to the real personal disposable income in the beginning quarter of the cycle. 




Except for the first few quarters of the cycle, the curves of 2007-2019 are basically below the curves of other cycles, which is similar to the real GDP growth rate. According to the average annual growth rate of real personal disposable income, 2.3% of the current 2007-2019 cycle is only higher than 2.1% of the 1973-1980 cycle, which is the lowest level, lower than 3.4% of 1981-1990, 1990-2001, 4.5% of 1960-1969 and 4.9% of 1969-1973. Although the duration of 2007-2019 cycle is the longest of all seven cycles, its cumulative growth rate is only 29.9% due to the low annual growth rate, which is higher than three short cycles, but lower than the other three long cycles, namely 1981-1990 (34.7%), 1990-2001 (41.4%), 1960-1969 (54.9%). 

Another measure of economic fundamentals is the profitability of enterprises. Fundamentals of the economy

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