Friday, 13 September 2013

Lack of Bank Credit Growth Could be Bad News for the Stock Market: 10-year Average Earnings- and Dividend Yields, S&P 500 (as of 12 Sep-13)

Earnings - and dividend yields as of 12 September 2013
Based on the closing price of the S&P 500 index of 1,683.42 on 12 September 2013 and data from Professor Robert Shiller's home page, the current 10-year average real earnings- and dividend yields for the S&P 500 index are as follows (please refer to the June 2012 analysis for background information):

The 10-year average real earnings yield increased somewhat from last month due primarily to a 0.63% drop in the S&P 500 index (you can access the report from last month here). The current yield of 4.22% remains however among the lowest reported since December 2007 and is 28.86% and 32.51% lower than the average and adjusted average (which removes the 1998-2000 period as valuations were extremely high during those years) since 1978.

The 10-year average real dividend yield also increased slightly since last month to 1.61% (up from 1.59%) as a result of the slight decline in the S&P 500 index. Similar to the earnings yield, the current dividend yield is also among the lowest reported since the end of 2007 and is currently 39.27% and 42.26% lower than the average and adjusted average since 1978.

The Spread as of 12 September 2013
The spread, calculated as the difference between the 10 year real earnings yield and the 10-year Treasury Yield, narrowed further since the last report as the latter increased by 22 basis points (8.12%) from 2.71% to 2.93%. The Treasury Yield has now increased 121 basis points, or 70.35%, since September last year which has helped drive the spread lower. As a result, the spread is today 158 basis points, or 55.10% lower than it was back in September of last year. The spread however remains substantially higher than the negative 0.87% average since 1978. As we've explained many times before in this report, a contributing reason for the relatively high spread in recent years has been the artificially low level of interest rates in the U.S. (due to Fed policies).

As the S&P 500 index is only down slightly since the previous report and the S&P 500 index remains richly priced in a historical perspective, I see few reasons to change the conclusions from the report issued last month (which you can read here). I must add however that since the last report, the growth rate for U.S. bank credit has dropped even further. In the latest U.S. Money, Credit & Treasuries Review issued on 2nd September I wrote,
The plummeting of the growth rate in bank credit is clearly a factor in the reduced growth in money supply. After expanding 6.0% in 2012, the YoY growth rate has now dropped to just 2.1% - the lowest growth rate since the bi-weekly period ending 16 November 2011. Looking at the longer term trend, the 10 year annualised growth in bank credit hit a new record low last week at 6.81%, a direct result of the declining growth rates in recent months.
To the extent credit growth (and money supply) fuels the stock market (see here for some links), this could be very bad news indeed for the U.S. stock market going forward. In addition, there are signs the U.S. consumer is running out of gas which could negatively affect GDP and earnings growth. Secondly, a similar thing is happening in the euro area with bank credit, but to a much larger degree. The growth rate in total loans (bank credit) issued by euro area monetary financial institutions (MFI) as of July (most recent figures) dropped to negative 3.1%, the lowest on record on a year on year basis! This could also prove bad news for the U.S. stock market.

Finally, there have been some big stock market crashes in the past during the September/October period (e.g. 1987, 2008) which is worth keeping in mind. One thing that is different this time though compared to five years ago is that U.S. banks are flush with cash which serve, at least partially, as a buffer should some sort of a financial panic strike. 

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