Stock Market Whiplash

Stock Market Whiplash

Entering 2020, the greatest potential economic threat that kept most economists up at night was that stock market values were becoming unsustainably high and there may be a bubble in the making. But then the pandemic hit, and global markets had shed an astounding $7 trillion of value by April 2020. Moves by Central Banks across the world (including the US Treasury purchasing $3 trillion in bonds) stabilized the market quickly. By August 2020, markets had regained that $7 trillion. And then they began to soar. By the time they peaked in November 2021, global markets were up 45.0% from where they stood before the crisis.

This rate of growth simply was not going to be sustainable in the long-run and was increasingly leading to company valuations that were completely disconnected from reality.

The Shiller Price to Earnings (P/E) Ratio measures the price of a stock, divided by the average of ten years earnings, adjusted for inflation. It is a measurement for judging whether the prices investors are paying for stocks make sense based upon their underlying fundamentals. When investors pay too much for an asset, bubbles are created. Eventually those bubbles burst and that is how recessions usually occur.

The average reading of the Shiller P/E ratio since 1990 is 26.6. The all-time high for this metric came in December 1999 when it hit 44.2—within six months, the tech collapse occurred. Spikes in the Shiller PE ratio preceded the Black Tuesday collapse of 1929 that led to the Great Depression, as well as the Black Monday crash of 1987.

The second highest reading ever recorded by the Shiller P/E index was in January 2022 when it hit 36.9. There is a substantial upside to the stock market’s downward reset last year as market pricing had become disconnected from underlying fundamentals. The continuation of that trend would have likely driven a significant stock market crash that would have created much more economic damage than what occurred. The current P/E ratio of 28.7 is close to historic norms that enable sustainable growth. In other words, there is no longer a potential stock market bubble waiting to burst and, given the right economic conditions, the market is set to soar again.

Corporate Profit Surge

US Unemployment Rate Back to 50-Year Low

Corporate Profit Surge

Despite the growing economic concerns and turmoil of 2022, it turned out to be a banner year for corporate profits. The FRB tracks quarterly corporate profits, after taxes. As of the close of Q3 2022, annual corporate profits were up 45.6% annually.

This may seem hard to fathom in an inflationary environment, but the hard truth is that large corporations are much more able to shield themselves from those costs than small businesses due to their size, buying power and dominance in the market. Though by year-end 2022 we were seeing a steady drumbeat of corporate layoffs (mostly media and tech), this means that most companies are sitting on healthy balance sheets—which bodes well for their ability to ride out whatever economic scenario unfolds in 2023.

California Unemployment Back to Record Lows

National Unemployment

According to the US Bureau of Labor Statistics (BLS), the national unemployment rate stood at just 3.5% as of December 2022 (the latest data available as this report went to press). This is back to the pre-pandemic rate that was posted in February 2020, just prior to lockdowns. At that time, the unemployment rate was the lowest it had been since 1967.

Statewide Unemployment

This same trend has played out for unemployment throughout the State of California. As of December 2022, it stood at 4.1% (slightly elevated over the national level), but had returned to pre-pandemic record lows, despite ongoing economic concerns.