Stocks still at 'Black Monday' highs
Market among history's richest, manager says
By Thom Calandra, CBS MarketWatch
Last Update: 8:20 PM ET Oct. 19, 2001
NEW YORK (CBS.MW) - Price-earnings measures that show U.S. stocks as historically cheap are misleading and probably dangerous, says fund manager Clifford Asness at AQR Capital Management in New York City.
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Asness, a former Goldman Sachs Group managing director and quantitative analyst, is known on Wall Street for his brainy models that apply to global equity, fixed income and currency markets. "Give him an inch and he measures it," hard-nosed chief strategist Barton Biggs at Morgan Stanley said about Asness this week.
"Stock market pundits should have their mouth washed out with soap if they currently call stocks historically undervalued as many do today," says Asness, a regular contributor to financial publications, including the Journal of Portfolio Management and Financial Analysts Journal. AQR Capital Management, with a team of former Goldman Sachs executives, manages about $1.3 billion.
His analysis, which uses data going back to the 19th century, is sure to challenge buy-on-the-dip investors who have rallied the stock market this month. Asness, in his latest research, also demonstrates how Wall Street's methods for pronouncing a security as "cheap" or earnings growth as "strong" are self-serving nonsense.
In his latest, yet unpublished, paper, Asness charts price-earnings measures using one-year trailing earnings, not the illusory forward earnings that many on Wall Street use to declare a company's equity as undervalued. "Forecasted earnings are highly subjective numbers that Wall Street is famous for being overly optimistic about," he says.
P/Es, Asness says about the price-earnings ratios that are used to evaluate the price of a company's shares, "are above any time in history prior to the 1998-2000 bubble, including the peak before 1929's crash." His research puts price-earnings for the benchmark S&P 500 at 26 for the 12 months ended Sept. 30. "In other words, excluding the 1999-2000 bubble, we are currently in the 100th percentile. Counting the bubble, only 2 percent of the time since 1881 have market P/Es been higher than today's values. Cheap? I think not," he says.
Asness examines the price-earnings phenomenon several ways. In one analysis, he uses a 10-year average of so-called real earnings, or earnings adjusted for inflation. Such a chart presumably smoothes out the one-year peaks and valleys of corporate earnings. His conclusion?
"On this scale we're now a tad cheaper than before Black Monday in 1929, but I don't think that's the tag line Abby Cohen and Ed Kerschner want to use to tout stocks," he says, referring to two of the most bullish Wall Street strategists. "Can you imagine yelling, 'Buy, buy, we're slightly cheaper than right before the crash of '29.' Nope, excluding the 1998-2000 bubble, and the period right before October of 1929, we still have the most expensive stock market in recorded history."
Go out and hunt some of your own
About half of AQR Capital's assets under management are in a market-neutral hedge fund. The rest is in a mix of lower volatility hedge funds and traditional, beat-the-benchmark portfolios.
Besides the recognition Asness has received for his Goldman Sachs (GS: news, chart, profile) work on mortgage-backed securities and quantitative models for the stock and bond markets, the fund manager is known for a sense of humor that is largely absent on Wall Street.
Not long ago, at the height of the market bubble 19 months ago, he noted, "If I hear one more person refer to buying a 200 P/E stock, that is up 200 percent in the last year but is down 5 percent from its closing high two days ago, as 'bargain hunting,' I might have to start doing some hunting of my own."
These days, Asness takes a jab at Wall Street strategists, saying "a fair amount are simple shills for the bubble, who honestly should introduce themselves by saying 'Hi, I'm not a strategist, but I play one on CNBC.' ''
Asness is at his best when dissecting the arguments employed by Wall Street's bulls, mainly the banks and brokerages that are structured to sell securities to the American public in good times and bad. Among them:
The stock market usually recovers six months before an economic recovery. Asness says in true recessions, price-earnings measures are more likely to fall below 10, "not to record highs like today."
Don't fight the Fed. "If you find any strategist saying this, who also was telling you in late 1999 or early 2000 that interest rate increases don't matter to tech stocks, first laugh at them, then short something they recommend," he says.
The market is only falling because of Anthrax scares . . . "These pundits might be right about the catalyst for any specific day's movement, but the conscious effort to blame short-term nonsense and intentionally ignore reality is real."
Asness calls the October rally a "wild rush back into speculative nonsense" and criticizes both individuals and mutual fund managers for trying to pick the stock market's bottom.
"You can't have a Krispy Kreme (KKD: news, chart, profile) selling at a P/E over 100, an EBay (EBAY: news, chart, profile) still selling for a P/E of 150 and a $15 billion market cap, without realizing that investors have not learned much about investing, despite recent experience," he notes. (AQR Capital, Asness points out, is both long and short stocks of all types.)
"Sure, Krispy Kreme and EBay make actual money and run actual businesses, as opposed to the dot-coms, but so does Cisco," he says about Krispy Kreme Doughnuts, Internet auctioneer EBay and networker Cisco Systems (CSCO: news, chart, profile). "Cisco was a joke at a P/E of 140, as it was trading for in early 2000, and investors are still telling the same joke, only some of the punch lines have switched."
The portfolio manager compares the euphoria in Internet chat rooms about Krispy Kreme, a North Carolina company whose shares sell for 104 times earnings, as similar to the raves for Internet bookseller Amazon.com (AMZN: news, chart, profile) two years ago.
Asness notes that real earnings growth for Standard & Poor's 500 companies - that's earnings minus inflation -- has averaged just 1.6 percent a year for more than a century. If the U.S. economy grows 2 percent next year and inflation runs a 2 percent yearly pace, the result for investors won't be pretty. But of course, the Wall Street strategists will say no such thing.
This fund manager and author should be applauded for his research, which is available in full at www.AQRCapital.com. The likelihood, though, is that many Americans, enjoying this month's shelter from the fiscal damage they have suffered in the past 19 months, will ignore Asness and his analysis.
That's all the more pity for Wall Street and its Main Street lemmings.
Thom Calandra is Editor-in-Chief of CBS MarketWatch.
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