Why are US stocks trading at twice the intrinsic value (as indicated by PE10)?
The total amount of newly printed money injected into the global economy from all central bank’s Quantitative Easing (QE) programs in the past 10 years has been about $13.5Trillion, not counting some done by Japan before the 2008 GFC crash. Assuming global investors were reluctant to invest in the EU and Japan then this new money went into the U.S. stock market. The U.S. market has about $30Trillion in stocks; it was about half of that in 2013. Taking an average of 2013 and 2018 values implies over the past six years on average US stocks were priced by the market at $22trillion. About a fourth of that is allegedly not “free float” because they are shares held by wealthy founders who don’t want to sell. This has left $17Trillion of US stocks to be chased after by investors seeking to invest the $13.5Trillion in QE cash they received for selling bonds to central banks.
Of course many investors probably changed their minds and decided to go back to bonds 6 or 12 months after they sold their bonds to central banks and after they realized QE wasn’t going to cause consumer price inflation. And QE in Japan and Switzerland included buying domestic stocks (The Swiss bought some U.S. stocks). Even if only half of the QE new cash went into U.S. stocks that is about $7Trillion, equivalent to 40% of the free float.
When an extra 40% of funds enter an auction market this can act to push prices higher than a 40% increase since buyers at an auction can become emotionally stampeded into buying in a competitive manner.
The $4Trillion used for US corporate buybacks and funded by $4Trillion new corporate borrowing (or funded by repatriation from offshore subsidiaries) also acted to push stock prices higher. Ned Davis Research said in May, 2019 buybacks made prices 21% higher.
The funds freed up by the 2018 corporate tax cut for foreign subsidiaries of U.S. companies were another source of cash that could be used for stock buybacks. The Federal Reserve published an article saying: “U.S. firms repatriated $777 billion in 2018, roughly 78 percent of the estimated stock as of end-2017 of offshore cash holdings. This was about four times as much per year for the period 2006-2017.”
The funds repatriated are owned by very successful companies that don’t need to use borrowed money, although they may have chosen to borrow simply to lock in low rates.
The article in Financial Analysts Journal Volume 74, 2018 – Issue 4 “Net Buybacks and the Seven Dwarfs” said: “… net buybacks explain more than 80% of the cross-sectional dispersion of stock market returns.”
Assuming no more QE occurs and stock buybacks are reduced then this will undermine stocks, making them vulnerable to a crash. Investors need independent financial advice about the risks of a stock market bubble.