The S&P 500 has fallen 7.37 percent so far this year. What to make of it…
Naturally, some people find falling stock prices to be unpleasant. Others find them distressing. Another way to look at falling stock prices, however, is like a high-fiber diet. The effect is necessary to a healthy functioning system.
The simple fact is that stock prices, fueled by speculative liquidity, have long since outrun the real economy. The disconnect between the two has been widely observable. The economy’s lagged, incomes have stagnated, yet stocks have soared.
Thus the present, ever so slight reduction in liquidity, and the subsequent lowering of stock prices, is having a cleansing influence. For it will serve to eliminate marginal businesses, and trim the fat from larger businesses.
Consequently, business owners, managers, and workers of marginal undertakings will have to redirect their efforts into something new…something that’s of greater value. For example, Walmart recently announced it would be closing 269 stores and laying off 16,000 workers. Obviously, we don’t wish any harm to hard working Walmart employees. But we’re also confident many of these 16,000 people will now find a new, more meaningful, and more prosperous purpose in life.
Though it can be painful at times, eliminating and minimizing wasteful activities is how the world becomes more affluent. On the other hand, propping up negligible endeavors with cheap credit ultimately subtracts wealth from the world.
Mean Reversion
How much more stocks will fall, no one really knows for sure. Perhaps they’ve already fallen as far as they will. But we wouldn’t bet our life savings on it.
This is merely conjecture, of course. But we do recognize that even with the 7.37 percent drop year-to-date, the S&P 500’s Cyclically Adjusted Price Earning (CAPE) Ratio is 23.97. We also recognize that the CAPE Ratio’s mean, going back to 1881, is 16.65.
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