Seven Reasons Why Markets Have Almost Overdosed On The Fed's Liquidity

Today, Dallas Fed President Richard Fisher gave seven reasons why the Fed's liquidity has created an "intoxicating brew" in markets in a speech given to the National Association of Corporate Directors. Read his full speech transcript titled "Beer Goggles, Monetary Camels, the Eye of the Needle and the First Law of Holes (With Reference to Peter Boockvar, the Book of Matthew, Sherlock Holmes, ‘The Wolf of Wall Street’ and Denis Healey)" at the Dallas Fed's website.

Free and Abundant Money Changes Perspective

Boockvar is right. When money available to investors is close to free and is widely available, and there is a presumption that the central bank will keep it that way indefinitely, discount rates applied to assessing the value of future cash flows shift downward, making for lower hurdle rates for valuations. A bull market for stocks and other claims on tradable companies ensues; the financial world looks rather comely.

Market operators donning beer goggles and even some sober economists consider analysts like Boockvar party poopers. But I have found myself making arguments similar to his and to those of other skeptics at recent FOMC meetings, pointing to some developments that signal we have made for an intoxicating brew as we have continued pouring liquidity down the economy’s throat.

Among them:
  • Share buybacks financed by debt issuance that after tax treatment and inflation incur minimal, and in some cases negative, cost; this has a most pleasant effect on earnings per share apart from top-line revenue growth.
  • Dividend payouts financed by cheap debt that bolster share prices.
  • The “bull/bear spread” for equities now being higher than in October 2007.
  • Stock market metrics such as price-to-sales ratios and market capitalization as a percentage of gross domestic product at eye-popping levels not seen since the dot-com boom of the late 1990s.
  • Margin debt that is pushing up against all-time records.
  • In the bond market, investment-grade yield spreads over “risk free” government bonds becoming abnormally tight.
  • “Covenant lite” lending becoming robust and the spread between CCC credit and investment-grade credit or the risk-free rate historically narrow. I will note here that I am all for helping businesses get back on their feet so that they can expand employment and America’s prosperity: This is the root desire of the FOMC. But I worry when “junk” companies that should borrow at a premium reflecting their risk of failure are able to borrow (or have their shares priced) at rates that defy the odds of that risk. I may be too close to this given my background. From 1989 through 1997, I was managing partner of a fund that bought distressed debt, used our positions to bring about changes in the companies we invested in, and made a handsome profit from the dividends, interest payments and stock price appreciation that flowed from the restructured companies. Today, I would have to hire Sherlock Holmes to find a single distressed company priced attractively enough to buy.

Here are manually selected related posts on these indicators.
  1. S&P 500 Stock Buybacks at Their Highest level Since the Fourth Quarter of 2007 (S&P);
  2. November 2013 YTD Leveraged Loan Volume Surpasses 2007 High on Refinancings and Dividend Recaps, Less Mega-LBO Deals (U.S. Leveraged Loan Market Analysis by S&P Capital IQ/LCD)
  3. Investors Haven't Been This Bullish Since The Market Peaked In 2007
  4. Hussman: The S&P is Overvalued Based on the Shiller P/E, Price/Revenue Ratio, and Market Value of Non-Financial Stocks/GDP (Charts)
  5. Market Value of Equities/GDP Chart Shows How Stocks Haven't Been Undervalued Since The 1950s, 1970s and 1980
  6. AAII's Equity-Cash Allocation Spread At Widest Level Since 1998-2000 With Margin Debt 0.7% Below Its Real All-Time High
  7. NYSE Margin Debt Approaching 2007 High, Look How the S&P Reacted at Previous Extremes (Analysis)
  8. Fitch: Low Default Rate, Growing Risk Receptivity (Covenant-Lite Loan Volume is Growing)

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