Over the last five years, the Dow Jones Industrial Average has soared to record valuations. This is not just true in terms of real dollar amounts. It is also true in terms of the values of stocks relative to their earnings. The current Schiller P/E ratio, a measure of how much stocks are worth versus their average earnings, is currently at the near-historic high of 33.
Through all of this, the question that many are asking is if there is currently a bubble in equity valuations. One clue that such a bubble may indeed exist is the fact that the market recently underwent a 2,500-point correction over just a week’s time. Shervin Pishevar, one of Silicon Valley’s foremost financial experts, said that the sudden drop in the Dow Jones was in response to just a few-basis-points uptick in interest rates. This, he says, indicates that the market has become exquisitely sensitive to even the smallest variation in interest rates.
But Shervin Pishevar says that this leads to some deep concerns about where the market and the economy as a whole are ultimately heading. Shervin Pishevar believes that the Fed’s planned winddown of its entire balance sheet could precipitate interest rate increases of up to 3 or 4 percent. This, he says, could result in a catastrophic market correction of as much as half of its value.
Shervin Pishevar believes that the Fed will not let anything like that come to pass without completely reneging on its promise to reduce its balance sheet. For this reason, he says that a renewed round of quantitative easing is likely in the event that the market corrects by a large amount. But Pishevar warns that the next round of quantitative easing is unlikely to be as effective as the first round. That is because the Fed will be expanding its balance sheet and allowing the federal government to increase its own debt cheaply by such a wide margin that it may begin to exert serious inflationary pressures on the dollar. This could result in major inflation, including the possibility of runaway or hyperinflation.