For many active U.S. focused value managers the past decade has been a tough one leading Goldman Sachs Ben Snider to proclaim Value Investing Dead. Just the fact that one can raise that possibility is one of many indicators that currently point to an exuberant U.S. market. I will highlight a number of different indicators pointing to an overvalued S&P 500.
Value is Dead
That value struggles is reflected in the iShares Russell 1000 Value vs the Russell 1000. The value index is lagging its core equivalent by half. If you compound the available risk free rate as exemplified by 10 year treasuries over that time period the return at is quite close to that of the iShares Russell 1000 Value. My very rough calculations got me to ~25%. Of course the Russell comes with a lot more risk.
Goldman Sachs ultimately concludes the value style is not dead but we are in the later stages of a bull market where the value factor lags. Value often lags when a bull market is well underway and everyone is getting involved.
This time value’s underperformance is exacerbated or at least prolonged due to the shift from active investing to passive investing. Since 08’ passive investing has taken off like a rocketship and without a bear market people have not yet experienced its drawbacks. Drawbacks include steeper drawdowns as compared to actively invested mutual funds. Potentially accompanied by reactionary outflows depressing the ETF universe just as inflows are currently floating all boats. More on ETFs later.
The CAPE
I've thrown in one traditional market value indicator. I'm not going to spend a lot of time on it as most readers will be familiar with it. Historically peaks in the CAPE ratio orShiller PE Ratio has been a reliable indicator of lower future returns.
The current CAPE ratio equals the level seen just before Black Tuesday, and it is almost double that of Black Monday. Only the 1999 tech bubble sported a higher CAPE ratio. Today, startups are staying private longer and some of the 99' like investments may have been made outside of public markets.
Mutual Fund Inflows
Historically inflows into equity mutual funds have been inversely correlated with world equity returns.
Source: Ici Factbook
I’ll venture out there and speculate, this time around, we should start paying more attention to the inflows into index mutual funds instead.
Source: ICI Factbook
Year after year of record inflows. This is another indicator pointing towards lower future returns of the index universe.
Consumer Delinquency Rates
Consumer delinquency rates are at record low levels. When all is well, the economy is churning, the FED has been dovish for a long time and the bull market is running undisciplined lenders start to take share from disciplined lenders. Also known as Gresham’s law where bad money drives out good money. When I search for credit through Moneybanker SoFi pops up offering the lowest rates
Across many categories; ie poor credit, good credit versus loan amounts. Interestingly, SoFi isn’t a traditional lender but a privately funded startup. On its site it says (emphasis mine):
We look behind just credit scores and debt-to-income ratios to consider factors like estimated cashflow, career and education. So while other leaders charge higher rates to account for the possibility that borrowers won't pay back their loans, our unique underwriting process helps ensure our members have a high likelihood of making their payments.
For good measure: I do put credence in big data and tech companies being able to assess creditworthiness in novel ways. I also think they are going to have screw ups. The algos that survive a couple of real recessions I’m will be awesome. Many fintechs may not survive the first real recession they will see.
Insider Buying
Insider buying at the company level is indicative of future returns. Especially when insiders are buying shares. Insiders are historically net sellers. They receive part of their compensation in shares or options and they sell some of those. Gurufocus tracks the aggregate insider buy/sell ratios and it’s currently only 0.3. Historically the average has been 0.4. That means insiders are bearish and they have been so since the third quarter of 2016.
Summary
Disciplined value investing is pretty much dead after ten years of underperformance. As a fun aside: check the P/B ratio of Greenlight Re managed by David Einhorn or Dan Loeb’s Third Point Offshore Investors Price to NAV. The current thinking seems to be passive investing beats having your money invested tax efficiently by some of the most brilliant investors of their generation. Not to mention any dollar invested immediately turns into a $1.10 or something thereabout. So, investors are getting really serious pumping money into the market through ETFs.
The CAPE ratio of the S&P 500, where much of the ETF inflows are going, is indicating a market that’s valued near previous record highs. Credit is loose and provided by “bad money” reminiscent of 2007. For good measure it seems unlikely it will cause a financial crisis this time, mainly just losses for venture capitalist and private investors. Finally, insider buying has been significantly below average levels for several quarters. This is a great time to fade the S&P 500 and seek returns elsewhere.
Disclosure: Author is long GLRE
Article by Bram de Haas
