Weekends are awesome for catching up on reading. I have done some reading, run some charts, and caught up generally on mkt stuff.
I have come to a realization. Since starting this thread, my sense of things has gotten better. I am being more empirical. I have always been a bit empirical but with the ability to fall for a good story. After all, my job on Wall Street was to do due diligence which was both quantitative and qualitative, finding the data to back things up, but also figuring out the story to tell. This was most true for equities and junk bonds but also for M&A. The narrative was important. In my private investing, I generally eschewed the AMZNs of the world with sky high PEs but not always. I generally found lots of value traps and dying growth stories. I fell for the story but was trained in both.
I now realize that I may have fallen for a very simple false narrative (and I have been generally bullish since mid to late February). We all may have. The narrative goes as follows:
- (or should I say bullets as bullets are not really narrative)
- World growth is OVER
- The world is drowning under too much debt
- Japan is dead (20 years+ this one has been out there)
- Europe is drowning under socialist economic policies - growth is finished
- The US Fed has ruined the economy and is not letting businesses fail; the powerful control the govt.
- Earnings are at records/record margins and are mean reverting. Sell!
Some folks add in other pieces like world population growth (now expected to hit zero by 2100 btw), technology killing the middle class or the fact that baby boomers now taking money out of stocks:
- Is this the reason the investor surveys are so blahhhh?
- Are funds flows always negative now as a result?
- Or are funds flows missing ETFs or is something else going on?
- Also is this the reason behind such large cash balances at asset mgrs?
- Aside - I noticed some pretty big funds evaporated over night recently - is that the reason behind the big cash balances?
- All a bit Harry Dent-like, he who has never ever been right on anything but is still selling books and services.
On to a potential alternative narrative (think Elliott Wave here - always lots of alternate counts and narratives).
We have been through a global depression called the Great Recession. It lasted 15 years effectively starting with the boom into Y2K and being masked by a few bubbles into 2007 and into 2015. This period roughly matches the period from 1929-1945 except there the War boosted things.
But starting from end of some bubbles here in 2016, upside in mkts will be more muted than in the past. Also the slower growth potential of the economy will brake things.
But things are not as bleak as we have been led to believe. Availability bias has folks in the markets calling another 2000-2002/2007-2009. It also has everyone calling for slower growth/collapse of China/emerging mkt. death/oil never coming back. What if none of this is true? What if increasing commodity prices bring back the emerging mkts and stop dollar strength? What if nominal growth in US reverts back to 5% (not 6% of old) because of exports/solid demand?
Ahhh, you say, but look at stock mkt. Massive bubble. Record high PEs on record high profit margins. I even saw someone argue that CAPE, which had just recently stopped show record highs and said mkt was fairly valued on last 25 years, was wrong because it incorporated the record high margins. Hey wait, wasn't the point of CAPE to average this stuff away? People do this - argue opposite of past just because it doesn't fit a narrative.
Well, I just realized I got sucked into the valuation narrative. I made a once every 2-4 weeks visit to the Yardeni Earnings site listed in the description of this thread. I got caught saying , "Damn! Valuations do suck! No room to go up." I then realized I was looking at a graph of PEs from 2009. Of course valuations have come up from the Crash of 1998/99. Not only did earnings crash then, but so did forward valuation metrics which is what caused the greater than 50% fall.
Is the era of ever higher PEs probably coming to an end? MAYBE/MAYBE NOT. Before calling me crazy, go look at the top graph on Page 13 (site is yardeni.com for those who need it again). BEFORE we entered this depressionary 2000s, valuation multiples were a full 50% higher. Now that was an era with HIGHER interest rates BUT higher growth. But folks (including me) saying there cannot be much upside ARE WRONG! There has been and recently. If we get it, that may kill forward returns - heck, most argue we are looking at max 0-2% returns over next 5-10 years (Kass, Hussman, Zero Hedge, 2-3 other guys slipping my mind at moment).
OK but do we need ever higher PEs? NO. Earnings were collapsed by at least 10-15% by lower oil and the strong dollar. A bounce back over 1-2 years with trend growth could enhance earnings by a quarter over the next few years, creating 25% stock market growth. Any enhanced PEs allows the mkt to either front run this or enhance it. Remember, US government spending is increasing. A Democrat will be elected, meaning it will not slow, even with a Republican House (and Dem Senate). M1 is very expansionary. China is stimulating and shifting its economy at same time. Japan will soon be stimulating. (I do think Japan and Europe have little room left but…..). If you get positive spirits going, the malaise of the last decade and a half lifts and you get positive feedback loops with reasonable interest rates, meaning bad businesses could even fail.
Naaahhhhh, you say. Earnings suck. They have been declining forever. Feedback is all negative. Government is on businesses back. I point you to page 10. No one will tell you this, as negative news sells better, but the estimates are now reverting to normal historical decline curves from the hyper drop of last year or so. Heck on the smaller cap stocks (everything non-500), you even see inflection points AND turn Ups on estimated Q1 earnings. AND Q2. AND Q3. AND Q4.
Oh, btw, this brings me to a point I forgot about. Go back to Page 13 again. Look at the 2009-2017 chart again - Figure 17. You notice S&P 500 near the top of its range. But the other indices have fully 5-10% more growth to the tops of their ranges in PEs (not prices). Now go to Figure 14 on page 12. SPX has been dead for years in revenues, using buybacks AND record profit margins to grow earnings per share. Midcaps have been growing nicely except for this latest earnings recession. Smallcaps never even slowed.
This narrative graphically (pun intended) shows the effects of the bear market which ended in February. These stocks went down on order of 30-50%, not the 15% or so of the S&P 500. You see this in the broader indices like Value Line, Russell, New York, etc. It also explains why small caps may be historically oversold, even still. Think small cap industrials and energy. Biotechs. Techs. Go check out the small fry. MOST have not moved much in this rally. Ok, maybe they matched big caps RECENTLY. Most did not bottom until the big caps were already up 5-7% from the lows. So matching since then, means underperforming by 10-20% since beginning of just this year. Think how folks pay up for any big cap with growth (TFANG). What if this shifts to small fry? Look out.
OK guys. Enough of this alternative narrative. I am not sure how much of it I actually believe. BUT it is a real possibility. Add to it the fact that even the bears are now recognizing that the chart patterns they are using to predict 1500 also can project to 2400/2500 on SPX (http://www.zerohedge.com/news/2016-04-16/big-move-coming). Of course they use this article to point out the negatives. As a rule, as mentioned here before, I do NOT go to ZH. I have a trading chat room where everyone is very bearish and using their view of bad fundies to talk down market, and every negative ZH article is linked there.
To do that this year means expanding FORWARD PEs by 0-10%. "What?" you ask. Earnings are not growing and you just shifted the market higher by a minimum of 15%. I answer: look at Q4 estimates (up 9 to 15% depending on index with 9% for the SPX we are discussing). So over the next 6 months, shifting the forward earnings ahead 1/2 year and lapping the lows in this earnings recession could easily pick up 5-10% growth. SO PEs probably need very modest growth, but the bulk of the work will come from growth.
Jon |
