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5 Things To Ponder This Weekend: Valuations, Triggers & Inequality
Submitted by Lance Roberts of STA Wealth Management,
I woke up this morning to this headline on ZeroHedge:
CNN Politics: BREAKING: China Dumps All Bonds, Declares South China Sea Zone Closed
My first thought was "Oh! S***" here we go. My nightmare scenario has become a reality. I quickly flipped over to my markets page to find stock futures deep in the red by....wait a minute...less than 1%? That can't be right? If the nightmare scenario was upon us then markets should be crashing.
Sure enough by the time I got back over to ZeroHedge the page had been updated to show:
"Luckily this time it was merely a hack, as can be seen by the 'article's' subsequent deletion from the live page and CNN's mea culpa:
CNN SAYS SOME OF ITS SOCIAL MEDIAL ACCOUNTS WERE COMPROMISED
CNN SAYS COMPROMISED ACCOUNTS INCLUDE TWITTER PAGE, FACEBOOK"
While this was not the ideal way to start my morning it did get me to thinking about valuations, profits and what could cause a real correction in the markets. That is the premise behind today's "Things To Ponder" for your weekend homework.
1) Valuation Update: Stocks Are Expensive by Doug Short
If you don't read Doug's site daily you are really missing something as part of your daily research. I always dedicate some of my time to review his valuation studies (here, here and here) in particular but most importantly, for me, is the combined study of 4 different valuation measures.
"Here is a summary of the four market valuation indicators I update during the first days of the month. The four indicators are:
? The Crestmont Research P/E Ratio
? The cyclical P/E ratio using the trailing 10-year earnings as the divisor
? The Q Ratio, which is the total price of the market divided by its replacement cost
? The relationship of the S&P Composite price to a regression trendline"
"The next chart gives a simplified summary of valuations by plotting the average of the four arithmetic series (the first chart above). I've also included a log-scale area chart of the real (inflation-adjusted) S&P Composite along with recessions."
Doug correctly notes that valuation levels are not useful as short-term signals of market direction as "irrational exuberance" or "extended despondency" can last far longer than logic would dictate. However, with combined market valuations now at levels only seen before horrific market corrections it may be prudent to think that most of the "low hanging fruit" of this current bull cycle has already been harvested.
2) Overvaluation: The Evidence via The Economist
The Economist also picked up the theme of overvaluation recently but also made a very important point about media bias stating:
"INVESTORS get bombarded with advice over whether to buy shares. Much of this comes from interested parties; brokers or fund managers, whose salaries are dependent on getting them to buy stocks. The media chips in too, but most reporting consists of trend following; if the market goes up, journalists quote someone who can explain why the market has gone up.
The problem with this approach is that investors (and commentators) can get carried away with the crowd. Of course, everyone is bullish when the market is at an all-time high; that is why the market is high. What we need is a reliable valuation measure. Then you can sit back and say "buy when the market is cheap" and sell, or at least not buy, when it is dear."
"Another reason to trust the CAPE is that its message is replicated by a completely different (and independently-calculated) measure; the Q ratio (see chart). This compares share prices with the replacement cost of companies' net assets. In simple terms, if the Q ratio is high, then it will be cheaper to buy assets in the market than to buy the shares of companies that own those assets; if the ratio is low, then shares will be a bargain for their asset content. Over the long run, arbitrage should close the gap.
Now there are plenty of measurement issues with the Q ratio and it has to exclude the financial stocks because of their odd balance sheets. But the ratio was used by Andrew Smithers and Steven Wright in their book Valuing Wall Street, which correctly announced that US shares were overvalued just as Wall Street was peaking in 2000. The two ratios are shown in terms of the deviation from their long-term geometric average. On this basis, the two measures suggest the market is 76%-80% overvalued."
3) Climbing A Wall Of Complacency by Doug Kass
Markets are supposed to climb a "Wall of Worry." Since 2009, there have been plenty of things to worry about from the Eurozone crisis to the debt ceiling debates and threats of a U.S. default. However, that has changed as Doug Kass points out:
"• Mr. Market has climbed a wall of complacency.
•There is a strong consensus about nearly every asset class.
• Historically stock markets are often unkind to consensus and to the changing of the Fed.
• Reward vs. risk has deteriorated for the U.S. stock market
• Beware: Risk happens fast.
It has been nearly five years since the Great Recession and the ensuing generational bottom in the U.S. stock market.
The S&P 500 has risen from 666 to almost 1850. At 58 months, the current cyclical bull market advance is the second longest on record and is quickly approaching the 60-month expansion that occurred from 1982 to 1987."
4) What Will Trigger The Next Correction by Robert Seawright
Robert Seawright recently made a very interesting point about what will trigger the next correction. This is something that I have discussed many times in the past, both on the daily radio program and in the newsletter, which is that we simply will not know until after the fact. Rather it was 1929, 1972, 1987, 2000 or 2007 the trigger that caused the crash was only obvious in hindsight. At the peak of the market everything looks just fine...until it isn't.
"I considered what obvious catalysts might stem the tide of higher equities and saw none. While it was already clear to me that market obstacles need not be foreseeable in advance (think Donald Rumsfeld’s famous “unknown unknowns”), that lack was still a significant factor in my preliminary thinking. Other than the unforeseeable — which seemed limited to me somehow — it looked like clear sailing ahead, despite high market valuations and the need for some correction to clean things out. That is, it looked like clear sailing until I remembered Black Monday: October 19, 1987. Coverage by The Wall Street Journal of that day began simply and powerfully. 'The stock market crashed yesterday.'"
"In other words, the market collapse had no definitive (or even clear) trigger. The market dropped by almost a quarter for no obvious reason. And while it’s counterintuitive, that observation is wholly consistent with catastrophes of various sorts in the natural world and in society. Wildfires, fragile power grids, mismanaged telecommunication systems, global terrorist movements, migrating viruses, volatile markets and the weather are all complex systems that evolve to a state of criticality. Upon reaching the critical state, these systems then become subject to cascades, rapid down-turns in complexity from which they may recover but which will be experienced again repeatedly."
5) The Profits Bubble by Chris Brightman
One of the biggest concerns that I have currently has been the very elevated level of corporate profits. Profits have been driven by accounting magic rather than increases to the top line of revenue. Chris summed this up well:
"Profits are dangerously elevated by all reasonable measures. S&P 500 Index real earnings per share are far above their long-term historical trend. Industry profit margins are at or near all-time highs. Corporate profits, both as a percentage of GDP and relative to labor income, are at or near record levels. The dramatic rise in income inequality is a direct consequence of this spectacular reallocation of income to capital and away from labor."
"Many of today's investors uncritically assume that the conditions they have known over the course of their professional careers must be normal. The idea that we may soon experience a multi-decade period of zero or negative growth in real earnings per share, taking the level of profits down to a lower share of national income, seems preposterous. Yet economic history has seen many examples of such a turn, including the 1880–1890s, the World Wars, the 1930s, and the 1970–1980s. In fact, almost every decade except the 1990s and 2000s saw a protracted profits slump. Some declines in profitability lasted most of a decade; others, longer!"
Chart Of The Week: Income Inequality
Chris Brightman touched on the issue of income inequality in his profits study above. This past week I showed this point specifically in the following chart on profits versus wages and employment.
"Those two charts also suggest that, despite hopes of continued profit growth, the ability to increase profits from suppressing employment and wages is both finite and likely nearer its end than the beginning. In other words, what happens to corporate profit growth when there is an inability to extract profitability through cost cutting?"
The real issue is not "income inequality" but "productive inequality." The solution to solving income disparity is by focusing on measures that increase productive capacity.
While the issue of income inequality is going to be the centerpiece of the upcoming State of the Union address, it is more about diverting attention away from the Affordable Care Act than economic reality.
Political Calculations devolved the argument of income inequality quite well:
"Income inequality theory is a lot like ancient astronaut theory, in that in order to believe in it, you have to disregard a lot of evidence to the contrary."
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OT: I would like to go golfing with Jamie Dimon and when we get to the 2nd hole, beat him to death with my pitching wedge.
It felt good to get that off my chest.
Let's first put a Titleist in his mouth and see if you can chip it up to the hole and take out most of his teeth.
stock market evaluations are the least of this planet's problems
Q - why did Jamie get rid of his vibrator? A - it kept chipping his teeth and giving him a sore throat. Plus every time he loaned it to Lloyd it came back stained brown and smelling rancid.
I only play golf under protest,
but I would go with the one iron.
Maybe we should consult an expert, like the former Mrs. Tiger Woods;)
Remember Andrew Ryan, from "BioShock"? Before handing Jack the golf club, Ryan says "A man chooses, a slave obeys," and repeats this as the player beats him to death. (It should be a 9 iron).
Corporations treat their toilets better than they treat their employees.
Growth?
I'm not betting on it.
Rather than ponder on what has happened in the market today let's try and figure out what will happen on Monday, Tursday, next week, etc?
Further declines on the DOW taking global markets down... or a nice big pump up in Asia on Monday morning leading Europe and the US up? The banksters have all weekend to work out a plan after all.
Soothing words from Davos big-wigs, some FED dove-speak and backdoor liquidity injections, some MSM distractions and happy talk and we could be back above S&P 1,800.
I hope not because S&P should be at 666 but there are at least three big tops to this circus and a plethora of clowns.
The shit only goes up trend has been broken but this was a big distribution....A bounce wouldn't surprise me at all.
"The banksters have all weekend to work out a plan after all."
The banksters have had centuries to work out this plan after all.
Fixed!
What we need is a reliable valuation measure. Then you can sit back and say "buy when the market is cheap" and sell, or at least not buy, when it is dear."
WE HAD ONE, THEY WERE CALLED FUNDAMENTALS AND PRICE DISCOVERY........
For fuck sakes avoid the 'Economist', completely ate up with the dumbass-
No ponder. Additional surplus for fmj's,water, etc etc.
Sorry for the off topic rant here but I need to vent. Was thinking about going snowboarding tomorrow. I just priced a one day lift ticket... $109! Seriously not that many years ago it was far far cheaper. And they say there is no inflation! ha!
Investors after thinking all weekend about possibly giving back all last years profits are going to sell Monday morning. It's just a matter of how much. Margin debt is higher than 2008, so just deleveraging is going to be a whole lot of selling, than comes rebalancing, next is underweighing equities because it might look a little rich here, than comes the get me out and in cash now and on top of this the new momentum player is the short seller. This is as crowded a trade as I have seen in 30+ years of professional money management and it is not going to end pretty. To top it off, there is no price that I am ready to start buying, not at S&P500 1600, 1200, 800 or 666. If you can't have honest price discovery, there is no value at nearly any price above 450. Many stocks like Amazon (love it as a customer) at a 1400 P/E, has no value at any price.
It's a game of musical chairs with not a lot of chairs.
This could get ugly when the music stops.
Actually my first thought on the headline was, before opening the page:
Damn, ZH has been hacked!
The "headline" was just a little too perfect what the Chinese expectedly would do to turn up the heat.
Price discovery, profit bubble, p/e, higher margins, china, bonds, economic outlook, fundamentals, and the list is fucking endless from the number of articles trying to rationalise the blood red ink in the markets. I'm sticking with the theory that this is planned as an impetus for the debt ceiling debacle coming up on 7th February.
I posted this back in November and again a couple weeks ago:
"Have we all forgotten that the debt ceiling fiasco will rear itself in February? (I think the 7th). Back in November, before the cross party 2yr budget deal, I thought we'd see a red December, certainly January, but obviously it didn't happen. I got December's rise completely wrong. I reckon this might be the what I was expecting - a setup for the debt ceiling debate - the red storm to justify more debt 'to save the markets'. So yes, I wouldn't BTFD if I were still playing the rigged casino (I'm not)."
I reckon it'll get as low as it can safely go: Dow industrials 15k lows, maybe even touch 14.9k as we approach the first week of February, then the outcome of the "debate" (there is only one outcome: higher ceiling - more printing) will determine how quickly the Obama republic officially becomes the banana republic as all time highs are broken once again in the coming months. This script is well worn, so I don't have the foggiest idea why nobody else has picked up on it.
I've predicted every bloody year that the systemic collapse will happen soon, except this year. I don't want to jinx it this time. ;)
Has anyone asked, was the pre-release of a potential headline 'accentently' put out as a warning by say, a disgruntled laid off cnn worker?
"I would like to go golfing with Jamie Dimon and when we get to the 2nd hole, beat him to death with my pitching wedge."
That's why I'm more alive than you!
I bet $10 CNBC blames the stock crash on Justin Bieber being arrested.
i would argue not so much "inquality" but the lack of jobs growth is a real problem here. there is an "opportunity cost" to the lack of opportunity.
this makes policy making very difficult.
while it's not Wall Street's job to "work" for Washington...are we even on the same sheet of music here?
Ironically tax revenues have been coming in substantially ahead of expectations.
My personal view has been that QE was "going" to cause a big downdraft in interest rates.
The Fed stopped QE and announced...and then effected...taper instead.
There was a momentary and substantial widening of the spread.
Now it appears we have a massive compression trade.
Even if the Fed went back on taper...back to QE...i fail to see how this compression trade could be "undone" at least in the immediate (6-8 week) term.
this does not mean you get a big market correction in equities...or even a recession.
it just means traders acted "irrationally" to the announcement of taper and...to me at least...you now have to factor that into "the worst recovery in the post War era."
The dollar has already moonshot here.
Cable and the euro got slammed today though.
The yen has already broken down massively.
Canada and the AUD have now rolled over.
I'm not buying "nickels" here.
http://en.wikipedia.org/wiki/Growth_recession
What income inequality? ? Why, just this week JP Morgue announced hefty raises for their workforce while trimming Jamie's pa..........oh, wait....... (in best Roseanne Roseanadana voice) NEVER MIND.
The International and local markets are driven by two major components, "Production and Consumption" My guess is Consumption will deteriorate and production will immediately parrallel or follow in 2014.