The Clearing Price

Not investment advice.

Man, being the schmuck he is, will get used to anything.

Crime and Punishment, Dostoyevsky, 1866.

A few things are shifting in the story.

1. The US swing toward authoritarianism has been stopped.

2. The swing back to the center solves one problem (breakdown of rule of law), but creates another—how to turn a collective hatred of inflation (which in part decided the election) into an economic plan? Part of the election platform—data centers are bad—hit a reality wall Wednesday when stocks fell sharply on fears of exactly that. Around half of voters have 401(k)s and don’t want the market to tank, and the data center build is a key part of the valuation of the stock market.

3. The US deficit is around 6% of GDP. If tariffs are rescinded or reduced, spending on Medicare increased, tax increases are proposed but vetoed and data center spending slows, the deficit will widen, driving long-term yields up and further pressuring P/Es on the stock market down.

4. The US economy is strong, and unemployment is low and inflation is high, in part because of robust credit creation. As a result, the Fed needs to tighten rates. This is mostly independent of oil prices. The kinetic part of the war might be over or close to over since domestic support for such activity is tepid.

5. This tightening of money is occurring at a time when demand for money is high. This pressures the cost of capital higher, as you can see below (investment-grade spreads), which then squeezes the weakest borrowers.

   

   Source: Bloomberg, November 6, as are the other charts and data.

6. The parts of the economy that are not part of the boom face both higher inflation and higher borrowing costs and understandably don’t like either, thus the vote.

7. Because stocks are selling off and the regulatory regime is in flux, forward prices for parts of the boom, like, say, Korean memory maker SK Hynix, are at their lowest level in years, 3. On the other hand, in 2008, the P/E fell to 1.5 times, which would be 50% lower from here.

8. Numbers, like P/Es or free cash flow yield, are only a guide to when the selling is done. There is a psychological element as well, when investors “give up.” Such a thing has happened, for instance, with fiber companies or home builders after previous busts. Will investors who have been trained and rewarded to always buy tech continue to do so? SK Hynix is down 63% from its June high, but these stocks often overreact on the downside.

   

In sum, we are trying to find a price level where stocks and bonds can clear the capital market. We do not appear to be there yet, though we are closer, suggesting, in the US, higher bond yields and lower stock prices.

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