by David Stockman, International Man:

International Man: Thanks to the shutdowns, economic activity on main street is at a standstill. Government, corporate, and personal debt is skyrocketing. Yet, the stock market is in a mania. Has the stock market become out of touch with reality, and if so, what are the consequences of that?

David Stockman: Both ends of the Acela Corridor have lost their marbles. This year, Uncle Sam borrowed $4 trillion in six months, the Fed printed $3 trillion in three months, and Wall Street drove the S&P 500 to 52X reported LTM earnings in the context of a deeper economic plunge than occurred in the worst quarter of the 1930s.

Therefore, Washington has become disconnected from any semblance of fidelity to sound money and fiscal rectitude, while Wall Street has turned into an outright casino, valuing stocks based on endless Fed liquidity injections and the delusion that momentum chasing is an investment strategy.

With respect to the rampant folly in the Imperial City, Treasury Secretary Stevie Mnuchin has always reminded us of Alfred E. Neuman of “Me Worry?” fame at Mad Magazine. Recently, he more than earned that moniker when, in the context of the current monetary and fiscal lunacy, he proclaimed that, “Now is not the time to worry about shrinking the deficit or shrinking the Fed balance sheet.”

That was the so-called Conservative Party speaking, and it is a shrill reminder that the Trumpified GOP has gone utterly AWOL when it comes to its true job in American democracy, namely, resisting the Government Party (Dems) and its affinity for feeding the Leviathan on the Potomac.

That is to say, according to even the Keynesian deficit apologists at the CBO, Uncle Sam will spend $6.6 trillion during the current fiscal year (FY 2020) while collecting only $3.3 trillion in revenue. That’s Banana Republic stuff—borrowing 50% of every dollar spent.

Yet the advisory ranks of the potentially incoming Kamala Harris regency are even worse. They are loaded with “deficits don’t matter” ideologues and MMT crackpots who noisily argue that massive monetization of the public debt is not just a virtue, but utterly imperative.

Needless to say, this bipartisan commitment to all-in stimulus is financial catnip to the Wall Street gamblers because they are actually capitalizing into today’s nosebleed stock prices, not the present drastically impaired economy on Main Street but a pro forma simulacrum of future prosperity based on the delusional presumption that massive debt and money-pumping actually create economic growth and wealth.

The fact is, industrial production in August posted at a level first achieved in March 2006, and manufacturing output weighed in at levels originally attained in December 2004. So the misbegotten lockdowns and COVID-hysteria have cost the US economy 14–16 years of industrial production growth, yet this massive setback was not caused by some mysterious Keynesian-style faltering of “demand” that can allegedly be compensated for by new Fed credits plucked from thin air.

To the contrary, the current depression is the result of the visible shutdown and quarantine orders of the state, which are likely to linger for months to come or even intensify as the fall-winter flu season arrives. Undoubtedly, the Virus Patrol will spur further outbreaks of public fear based on “bad numbers” from the CDC, which are actually an agglomeration of cases and deaths from normal influenza, pneumonia, and a myriad of life-threatening comorbidities, not pure cases of the COVID alone.

But beguiled by “stimulus” and hopium, Wall Street completely ignores the contradiction between over-the-top demand stimulus and what amounts to supply-side contraction owing to economic martial law.

So, at 3400 on the S&P 500, the current LTM price-to-earnings ratio ranges between 52.1 times the earnings CEOs and CFOs certify on penalty of jail time ($65 per share) or 27 times the Wall Street brush-stroked and curated version ($125 per share), from which all asset write-offs, restructuring charges, and other one-timers/mistakes have been finessed out.

Of course, these deleted GAAP charges reflect the consumption of real corporate resources, such as purchase price goodwill that gets written off when a merger or acquisition goes sour, or the write-down of investments in factories, warehouses, and stores that get closed. As such, they absolutely do diminish company resources and shareholder net worth over time.

But for decades now, Wall Street has so relentlessly and assiduously ripped anything that smells like a “one-timer” out of company earnings filings with the Securities and Exchange Commission (SEC) that it no longer even knows what GAAP earnings actually are.

And it pretends that these discarded debits (and credits) to income are simply lumpy things that even out in the wash over time. They do not.

If ex-items reporting was merely a neutral smoothing mechanism, reported GAAP earnings and “operating earnings” would be equal when aggregated over several years, or even a full business cycle.

Yet during the last 100 quarters, there have been essentially zero instances in which reported GAAP earnings exceeded “operating income.”

So, in aggregate terms, several trillions of corporate write-downs and losses have been swept under the rug.

During the second quarter of 2020, for example, GAAP earnings reported to the SEC totaled $145.8 billion for the S&P 500 companies, while the ex-items earnings curated by the street posted at $222.3 billion. That amounts to the deletion of nearly $77 billion of write-downs and mistakes, and it inflated the aggregate earnings number by more than 52%.

The game is all about goosing the earnings number in order to minimize the apparent price-to-earnings multiple, thereby supporting the fiction that stocks are reasonably valued and that nary a bubble is to be found, at least in the broad market represented by the S&P 500.

Still, valuing the market at 52 times trailing-12-month earnings during the present parlous moment in time—or even 27 times if you want to give the financial engineering jockeys in the C-suites a hall-pass for $77 billion of mistakes and losses this quarter alone—is nothing short of nuts.

Yet, the gamblers in the casino hardly know it.

Wall Street has already decided that current-year results don’t matter a whit: the nosebleed-level trailing P/E multiples currently being racked up are simply being shoved into the memory hole on the presumption that the sell side’s evergreen hockey sticks will come true about four quarters into the future, and if they don’t, a heavy dose of ex-items bark-stripping will gussy up actual earnings when they come in.

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