It's Just Getting Stupid!
As Cantor's Peter Cecchini notes today
"when things are this senseless, a reversion to sensibility will occur again at some point."
His view is to be long vol and as the disconnect between the economic cycle and stocks continues to grow, we present three mind-numbing charts of the exuberant hopefulness that is now priced in (oh yeah, aside from AAPL actually selling some iPhones in pre-order). Whether it is earnings hockey-sticks, global growth ramps, or fiscal cliff resolutions, it seems the market can only see the silver-lining. We temper that extreme bullish view with the fact that all the monetary policy good news has to be out now - for Ben hath made it so with QEternity.
These three factors - weak economic growth, powerful monetary policy and elevated public policy uncertainty - remain the critical drivers of performance and with weakening data, the market is all the more dependent on central bank life support - and following the rally through the Fed signalling period to 1460, much of the monetary policy related rally seems to be priced in, with the market already discounting considerable data improvement. With already high oil, gasoline and food prices, the Fed’s balance sheet expansion risks driving down the dollar, boosting commodities and dampening consumption and thus growth.
As this chart comparing P/E multiples to the ISM New Orders index, we need to see some serious unicorn-conjuring for these valuations to be sustained...
One tool often utilized to assess the attractiveness of equities relative to other assets is the equity risk premium (ERP), also known as the Fed model or the difference between the forward earnings yield and the yield on the 10 year U.S. Treasury. We have argued, based in part on the prior period of extreme financial repression in the U.S. following WWII, that a sustained contraction in the ERP and expansion of the PE multiple was unlikely until the Fed began the policy normalization process. Integrating inflation and a ratio of stock to bond market volatility paints a far less compelling picture for equity market valuation. We are at least 3 years from any normalization of Fed policy (according to them) and thus...
the following chart (or real rates vs P/E multiples) suggests current valuations are unsustainable at best, or down-right crash-worthy as you simply can't fight the cash-flow forever...
The reach for yield and safety has led investors to push into mega caps - defensive ingredients including lower betas, lower earnings volatility, and lower P/E multiples as well as higher dividend yields. This has pushed the relative median P/E of the mega caps notably above smaller (and higher beta) stocks - as the somewhat odd beta-defying rally of the last few weeks took hold...
Our point here is that 1) the spread between LTM and NTM PE is gaping (something that we saw in the run-up to the peak in 2008), and 2) that the mega-caps which dominate the indices (which everyone watches including Ben) are 'over-valued' rightly or wrongly relative to less-defensive stocks... leaving plenty of room for rotational risk-off as well as reality disconnects
On balance, Barclays are less bullish than they were at this time in either of the last 2 years. Investors seem to mis-remember history; monetary policy was not the only driver of the rallies following QE2 and Operation Twist. In the signalling period prior to QE2’s launch, and in the immediate aftermath of its commencement, both the economic and public policy outlooks were improving.
[They] remain relatively cautious given a weaker economic outlook and no clear trend in the polls to provide confidence that the U.S. can avoid the potential massive tax hike scheduled for January 1, 2013
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