Thursday, August 27, 2009

The S&P 500 According to the U.S. Treasury

Let's do a little common sense extrapolation. From the minutes of the August 4th Treasury Borrowing Advisory Committee meeting, we have this little factoid about American corporate income taxes.
Director Ramanathan discussed the components of federal revenues in the current fiscal year versus last year, noting that corporate income taxes (which generally account for about 10% of total receipts) were lower by over 50% year to date...
(source: Treasury Borrowing Advisory Committee)
Ok, so if tax revenues are down by 50% and there are no significant changes in tax rates, one can extrapolate that corporate profits are down 50% from a year ago.

A stock price is claim on long-term future cash flows from the company. Therefore, equity prices should be about half of what they were last year all things being equal.

But all things are not equal. Credit is different, money is different, business prospects are different, and perceptions of risks are different. Credit will not be as readily extended, the currencies across the globe are being diluted as fast as possible, businesses don't know when or where growth will come from, and everyone is on edge about credit defaults.

The SPY 52-week high is roughly 130 and today's trading is around 102. Valuations on stocks a year ago were at historic norms according to much of the research at Hussman Funds.

It sure seems to us that S&P 500 prices today are not at sustainable levels unless one presumes valuations last year were reasonable (i.e. the current year profits are a glitch on a much longer time frame) or currency debasement has been so deep current equity prices are normal when adjusted for real purchasing power. Neither of those seem to make sense, though, unless somehow the world is at a stage to repeat the growth of the 90s. How that might happen given the financial system's recent changes is a mystery.

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