The peak S&P 500 price of 3316.81 was reached on January 16, 2020. The current price is 2376.48, a decline of 28.35 percent. At the peak price, the dividend yield was about 1.7 percent, and now it’s about 2.33 percent. What’s the norm? More like 4.3 percent. In order to provide a 4.3 percent yield with its current cash payouts, the index would have to sell at 1288. It would have to decline another 45.8 percent from its current already-lower level. The total drop would be 61 percent, peak of 3316.81 to 1288. Mind you, 4.3 percent is only a long-term average:
“During the 90 years between 1871 and 1960, the S&P 500 annual dividend yield never fell below 3%. In fact, annual dividends reached above 5% during 45 separate years over the period.”
It used to be rare for the S&P 500 even to yield as low as 3 percent. If the current bear market falls in price enough to provide a 3 percent yield, it will fall to 1846, which is 22 percent below the current price.
All of this arithmetic assumes that companies in the index do not cut their dividend payouts. That can happen too, and it will happen.
The drop in prices is establishing a higher expected return over future holding periods. To personify the process, the market is trying to right itself by making prices drop enough such that at those prices investors will anticipate a more normal or more typical rate of return consistent with the risks of stock ownership. For example, suppose that 7 percent is an adequate compensation from holding stocks. It could be made up of a 4.3 percent dividend yield added to a 2.7 percent growth rate, which a normal economy might deliver over a long period.
The stock market is more or less a free auction market. That doesn’t mean that it always sets prices according to risk and other conditions. It can go astray in its pricing for any number of reasons, including market manipulation stemming from the FED. The market’s setting a price for cash payouts over the indefinite future, and no one knows what’s going to happen in that future. This factor alone means that the market cannot get it right all the time, even if it didn’t have to contend with uncertainty introduced by the FED and governments. But the market “tries” to discount the future properly.
That’s what the market is trying to do right now. It’s trying to price in the new situation, the new risks and the old, and the new government and FED policies. The market’s price discovery process is as rational as any alternative can be, involving as it does innumerable bits of information and assessments, all of which are influenced by profit motives that induce care and respect for accurate facts and theories. By contrast, the handful of FED governors does not know anything in comparison, and what they do know is usually hogwash and nonsense. The FED is a political organization heavily influenced by politics and mandated by Congress to achieve certain objectives. There is no sanction for FED governors who select politically-expedient policies that move prices far away from where they would settle if markets were free. If the FED causes a boom-bust cycle and widespread misery, no one fires those responsible. Instead they demand and get even greater powers. They expand their meddling far beyond any sensible bounds. They promulgate senseless policies.
The FED stands in the way of free-market pricing. It is fighting the market in the fixed-income arena.
The FED went more and more deeply into the business of market manipulation starting in 1987:
“Two major changes contributed to the collapse of dividend yields. The first was Alan Greenspan becoming chairman of the Federal Reserve in 1987, a position he held until 2006. Greenspan responded to market downturns in 1987, 1991 and 2000 with sharp drops in interest rates, which drove down the equity risk premium on stocks and flooded asset markets with cheap money. Prices started climbing much faster than dividends. Despite evidence that these policies contributed to then-recent housing and financial bubbles, Greenspan’s successors effectively doubled down on his policies.”
These proposals that some economists are making for the FED to enter stock markets directly are a way to triple and quadruple down on the existing market manipulation, which occurs via controlling interest rates. Clearly, such proposals make a mockery of and completely undermine free market capitalism.
As matters stand now, even without a FED that buys and sells stocks, the free market in interest rates has already been heavily compromised. The banks still independently make their loans and investors still decide their own portfolios, but within an environment in which all sorts of distortions are introduced by the FED’s control and by government spending and policies. The whole economy is now held hostage by the FED and the government. The socialists and their communist brethren have no solutions, but it’s understandable that they rail against “financial capitalism” and “state capitalism” and “fascism”. These socialists have no answer in their brands of democratic totalitarianism, but they are right, at least sometimes and partially and on a hit or miss basis, to point out the failures of the existing institutions of state control. Now, if the FED starts trading in stocks by dealing in index futures, the pretense that this is a free country and not run by a fascist state will be completely shattered; and this will have the effect of making these socialists appear to be “right”. It will augment their standing politically.
Before this sort of policy is introduced, and we hope it never is, the FED is fighting the market’s attempt to right itself and return to sane valuation levels. The bond market cannot right itself and provide free-market determined yields with the FED constantly in the market and controlling key short-term rates. The FED is enabling the government to issue its bonds at exceedingly low rates, thereby expanding itself beyond any bounds of rational economic comprehension. Would there have been a War on Terror without the FED? It couldn’t happen. It’s inconceivable. There would not have been the political capacity to fight a bunch of useless and highly expensive wars in places like Afghanistan and Iraq without the financial enabling that the FED made possible.
When we read that the FED has “lost control”, it means that despite its fighting to keep asset prices up and high, it’s failing to do so without having to produce incredibly immense increases in the monetary base.
Let us have done with it! The time is long overdue to reform the monetary system. The fixed-income markets need for their yields and interest rates to be FLOATED. That means the FED has to have its power to deal in these markets brought to a complete end, without hope of restoration. The country cannot possibly be a free country as long as these markets are manipulated by the FED.
12:49 pm on March 18, 2020
