The Price to Book Ratio, a much discussed metric in the world of Graham-and-Doddsville, indicates the premium over tangible book value at which a given stock or index is trading. When analyzed over time, coupled with other economic and market indicators, it has notable worth as a predictor of stock market bubbles.
The S&P 500 P/B ratio, rocketing to 4.73, up ~57% from March of 2020, is approaching levels not seen since just before the April 2020 market crash—in which the total market, continuing to decline into 2001-2002, lost 75% of its value from its 2000 high. An increase in the gap between price and tangible book is often correlated with an increase in downward price pressure. That is, the further a given stock departs from its book value, the more likely it is to decline sharply in market price, particularly in response to market-wide adverse impacts, versus those securities trading closer to their book value. And so, the degree to which prices have deviated rapidly from overall book value, notably comparable to the increases in P/B just before the crashes of 2000 and 2008, is certainly cause for concern.
Other indicators, including the Shiller P/E (which previously surpassed 31 in 1929 and 2000), Reverse Repos, and Total Credit to Nonbank Borrowers strongly suggest that excess capital liquidity is driving most of these excess valuations which are not at all tracking corresponding growth in operating cash flows or tangible book value. In sum, cheap money is driving stock prices into the stratosphere disproportionate to actual performance. This would not be an issue if the capacity of institutional investors to borrow were unlimited, but of course it is not.
This tracks with Piketty's argument that when the return on capital exceeds the actual growth in the economy, income inequality widens and trends toward a bubble.
If the next FOMC meeting in September does not produce changes in monetary policy to more sharply curb the excess liquidity injected into global capital markets since the beginning of the pandemic, we could trend past the Shiller P/E high in 2000, which might suggest an even larger crash looming when policymakers have no choice but to respond to, e.g., inflationary impacts.
Submitted August 06, 2021 at 12:00PM by th3cr1t1c https://ift.tt/3fAxKSo
