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The Four Regimes (And 40 Years) Of Equity Valuation

Tyler Durden's picture




 

Via UBS:

All or Nothing. Stocks tend to experience very long periods (5-20 years) of either anemic or exceptional returns, which we call Investment Regimes. For instance, the market returned 1.5% a year from 1962-82, before returning over 16% on an annualized basis from 1983-00. Since the end of the TMT bubble, stock returns have been close to flat once again.

It’s About Multiples, Not Earnings. Somewhat surprisingly, returns during these periods are not driven by divergences in economic or earnings growth. In fact, real GDP averaged 3.5% from 1962-82, marginally lower than 3.7% experienced during the boom years from 1983-00. Rather, Investment Regimes are defined by secular multiple expansion or contraction.

Key to Success: Know Your Regime. If secular returns are driven by changes in valuation, then it is critical to understand this dynamic. According to our work, investors tend to focus on one key variable during each Investment Regime. However, it’s important to note that the driver in one period tends to not work — and can even be a contra indicator — in others.

Below we briefly describe how Investment Regimes behaved since the mid-1960s:

The Disco Regime (1965-80). During the 70s, inflation was the key driver of stock multiples, given that prices were not only rising sharply, but also in a volatile manner.

In the 1970s, inflation was the primary driver of stock valuations...

 

Falling inflation since the late ’70s has made CPI less important to valuations...

 

The Great Moderation (1981-99). After Chairman Volker broke inflation, the economy entered an 18-year period of solid, less volatile growth, accompanied by falling interest rates. In this environment, investors could focus on a nominal cost of capital (the Fed model) to value stocks.

During the “Great Moderation”, the “Fed Model” explained returns...

 

Since 2000, the Fed Model has broken down...


 

The Hangover Regime (2004-09). In the aftermath of the TMT bubble, risk became a much more important driver of multiples, with investors using a full cost of capital to value stocks. During this period, stock multiples were closely tethered to investment grade (Baa) yields.

From 2004-09, P/E’s anchored on investment grade (Baa) bond yields... This relationship has come unglued since ’09...


 

Hangover Part II (2010-12). Over the past two years, the key metric for valuing stocks has shifted from investment grade to non-investment grade yields. Given the fiscal situation in both the U.S. and Europe, we believe that this regime will likely persist until structural imbalances are meaningfully addressed by policymakers.

Since 2010, valuations have moved with non-investment grade (B) yields

 

So, the new regime - as we have warned again and again - is equity performance is pegged to extreme high yield credit. Thanks to Bernanke's repression and yield-seeking unintended consequences... with leverage rising, who knows what the fundamentals will signal when technicals dry up for a split-second...

Source: UBS

 

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Wed, 11/07/2012 - 13:58 | 2957055 Precious
Precious's picture

The pink state crypto-capitalists are temporarily away.  We will return to leveraging our fortunes to pick your pockets after this short intermission.

Wed, 11/07/2012 - 14:11 | 2957115 TruthInSunshine
TruthInSunshine's picture

The Chronicles Of Bernank'd Broken Markets

Wed, 11/07/2012 - 14:02 | 2957076 slaughterer
slaughterer's picture

Excellent article: thank you for posting it.  

Wed, 11/07/2012 - 14:02 | 2957080 Cognitive Dissonance
Cognitive Dissonance's picture

So, the new regime - as we have warned again and again - is equity performance is pegged to extreme high yield credit. Thanks to Bernanke's repression and yield-seeking unintended consequences... with leverage rising, who knows what the fundamentals will signal when technicals dry up for a split-second...

In the unlimited fiat world of Ben Bernanke could someone please explain to me what "fundamentals" are?

There is only one fundamental. When do I get my next fiat fix?

Wed, 11/07/2012 - 15:16 | 2957439 dark pools of soros
dark pools of soros's picture

Fabrication > Fundamentals

Wed, 11/07/2012 - 14:05 | 2957087 Orly
Orly's picture

So in 2010, P/E began to reflect lesser credit?  How low can it go before the law of unintended consequences brings down the entire equity market?

Wed, 11/07/2012 - 14:11 | 2957119 fonzannoon
fonzannoon's picture

This was the day I was waiting for to see the 43% that are not on the dole vote with their wallets and crash this freaking market. Instead It's business as usual. Well.....looks like it's just groundhog day from here on out.

Wed, 11/07/2012 - 14:28 | 2957203 edifice
edifice's picture

Where's the chart of the "Baahh" yield?

Wed, 11/07/2012 - 16:54 | 2957888 Quisat_Sadarak
Quisat_Sadarak's picture

Yeah, and where is the chart of "DRINK@%*&!"

Love Father Ted.  ;-)

 

Wed, 11/07/2012 - 14:34 | 2957231 MrBoompi
MrBoompi's picture

If you're going to compare any real number, such as the DJIA, to inflation, it would help to use real inflation data, otherwise the conclusions you come to might be "off" as well.

Anyone who believes inflation is less than 3% shouldn't be taken seriously.

 

 

 

 

Wed, 11/07/2012 - 15:18 | 2957454 dark pools of soros
dark pools of soros's picture

a bottle of Oban in PA in 2007 = $45,   same bottle now = $75

 

 

Wed, 11/07/2012 - 15:45 | 2957607 Urban Redneck
Urban Redneck's picture

an algo can't properly differentiate between correlation and causation (yet)

Wed, 11/07/2012 - 15:05 | 2957381 Essential Intel...
Essential Intelligence's picture

 It's also noteworthy to mention the three known epochs of leverage as a direct continuation of the Ancient and Medieval concoctions of leverage, staged-opposition, false-flag and staged history, whereby several forms of political leverage have come in to play : 3 Epochs of Leverage#


Wed, 11/07/2012 - 15:14 | 2957427 dark pools of soros
dark pools of soros's picture

Hemp will set us free...  grow grow grow

Thu, 11/08/2012 - 06:20 | 2959734 bvrulez
bvrulez's picture

fucking interesting, but can anybody share an interpretation?

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