During the past 18 months, I have contended the true underlying deficit is neither fiscal nor financial.
The real deficit is driven by values.
Societal values have been misaligned for many decades. To wit, materialistic possessions remained paramount to learning, education, and skill development.
1. Economic and financial dysfunction
2. Insidious distrust of institutions, financial and governmental, that enabled the dysfunction.
Economic and political uncertainties throughout the world have led investors to become more risk averse. Hence, equities, in general, have become less attractive.
According to Bloomberg, the New York Stock Exchange (NYSE) experienced the lowest daily trading volume since 1999 (50-day average of 838.4 million shares). Since 2008, daily trade volume at E*trade fell 35 percent and revenue generated trade volume at Schwaab dropped 14 percent. Average daily market value of traded stocks fell to $24.9 billion, the lowest 50 day average since 2005.
Thomas Lee, Chief Equity Strategist at JPMorgan Chase, notes equity mutual funds have experienced an outflow of $300 billion during the past 5 years. However, from 1990-2008, average annual inflow was $200 billion.
Despite the decrease in equity mutual funds and trading volume, equity prices have appreciated due to corporate purchases (buybacks of equity initially offered and sold to the public). Since 1990, equity buybacks by corporations were three times larger than equity mutual fund inflows.
Demographics play a large role as well in determining equity valuation.
From 1981-2000, a large number of baby boomers were age 40-49. This group saved a significant amount of funds that were available for investment. They chose to invest primarily in equities.
According to Zeng Liu and Mark Spiegel of the San Francisco Federal Reserve Bank (FRBSF), price relative to earnings (P/E) tripled during this time, from 8 to 24. They believe 61 percent of the P/E ratio is the result of demographic composition.
Currently, the baby boomers are aging. As a result, they will be saving and investing less, while consuming more. Hence, equity demand will fall.
It is unlikely that foreign demand will significantly offset this decline due to global uncertainties, aging foreign countries, and home bias in equities (citizens are more likely to purchase domestic securities). Zeng and Spiegel of the FRBSF anticipate an average P/E ratio of 10 within 10 years.
According to Bloomberg, the P/E ratio has declined to 14.1 from a five-decade average of 16. While prices have risen, earnings have risen faster. In fact, earnings of the S&P 500 companies reached a record of $104.40 per share. The difference between the earnings yield (E/P) and 10 year U.S. Treasury rates are near the 50 year record high.
Earnings have risen due to increased productivity, lower employment, and Federal Reserve Bank monetary policy that permits guaranteed returns on non-borrowed excess reserves.
In addition, the post-recession GDP growth rate is the slowest since the 1940s, when we exited the Great Depression.
The aging global populations poses a threat to global economic development due to lower rates of saving and investment.
However, innovative and creative entrepreneurs can fill this vacuum with brilliantly executed ideas.
© 2013 Moneynews. All rights reserved.