Greenbackd

By: greenbackd David Tepper was on CNBC this morning arguing that stocks are historically cheap: said the post showed “when the equity risk premium is high historically, you get better returns after that.” He continued, “So we’re at one of the highest all-time risk premiums in history.” In making his argument Tepper referred to this article, Are Stocks Cheap? A Review of the Evidence, in which Fernando Duarte and Carlo Rosa argue that stocks are cheap because the “Fed model”—the equity risk premium measured as the difference between the forward operating earnings yield on the S&P 500 (INDEXSP:.INX) and the 10-year Treasury bond yield—is at a historic high. Here’s the chart: Here’s Duarte and Rosa in the article: Let’s now take a look at the facts. The chart shows the weighted average of the twenty-nine models for the one-month-ahead equity risk premium, with the weights selected so that this single measure explains as much of the variability across models as possible (for the geeks: it is the first principal component). The value of 5.4 percent for December 2012 is about as high as it’s ever been.The previous two peaks correspond to November 1974 and January 2009. Those were dicey times. By the end of 1974, we had just
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By: greenbackd I’m back from the Value Investing Congress in Las Vegas. There were a number of outstanding presentations, but, for mine, the best was Vitaliy Katsenelson’s epic presentation based on his Little Book of Sideways Markets. 12 years into this sideways market, valuations are still 30% above the historical average, while in 1982 they were about 30% percent below average! Also, historically, stocks spent a good amount of time at below-average valuations before sideways market turned into a secular bull market. Vitaliy shows that genuine 1930s-style bear markets are rare. Most of the time the market trades sideways or up. Since 2000, the market has traded sideways. Vitaliy expects this to continue for another decade: Read GDP growth has been consistent. There’s little relationship between earnings growth and stock returns. Real GDP growth is very similar in both sideways and bull markets… …the difference in returns is the change in valuation. Don’t chase stocks. In the absence of good stocks, hold cash. Sideways markets contain many cyclical bull and bear markets. During a sideways market, asset allocation is not as important as stock selection. See the full presentation Active Value Investing: Making Money in This Sideways Market (.pdf) Order Quantitative Value from Wiley Finance, Amazon, or Barnes
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By: greenbackd Chris Turner has a guest post at Doug Short’s Advisor Perspectives called When Warren Buffett Talks … People Listen examining Warren Buffett’s favored market valuation metric: Market Value divided by Gross National Product. (I’ve also examined market value-to-GNP several times. See Warren Buffett and John Hussman On The Stock Market, FRED on Buffett’s favored market measure: Total Market Value-to-GNP, The Physics Of Investing In Expensive Markets: How to Apply Simple Statistical Models) Here Chris looks at the metric using the CPI a deflator on both the numerator — market value — and the denominator — Gross National Product. Here Chris calculates two fair values for the S&P 500. The blue line shows the historical mean and the green line shows Buffett’s 80 percent value estimate: Chris comments: Readers can see from the chart that based on both Buffett’s rule and the historical mean, the S&P would be trading much lower from present levels. The S&P would be sub 1000 based on the historical mean and around 1150 based on the 80% Buffett rule. Read When Warren Buffett Talks … People Listen. Order Quantitative Value from Wiley Finance, Amazon, or Barnes and Noble. Click here if you’d like to read more on Quantitative Value, or connect with me on LinkedIn. 'Get ValueWalk's Daily Edition By Email
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By: greenbackd I’ve posted here regularly about the implications of mean reversion in elevated profit margins (see, for example, The Temptation To Abandon Proven Models In Speculative and Fearful Markets: Why This Time Isn’t Different, What Record Corporate Profit Margins Imply For Future Profitability and The Stock Market, Warren Buffett, Jeremy Grantham, and John Hussman on Profit, GDP and Competition). Those posts sparked some intense debate in the comments and offline about the increasing influence of foreign profits on corporate profit margins, and how this change may have permanently shifted up the mean for corporate profits as a proportion of GDP. The impact of such a structural change in the mean is twofold: First, it implies that the current cyclical extreme in the level of corporate profits as a proportion of GDP is less extreme than it appears on its face; and, second, that the ratio of corporate profits-to-GDP is less predictive as an indicator than it has been historically. This is the chart, and the following comment, that sparked the debate: Source: Hussman Weekly Comment “Taking Distortion at Face Value,” (April 8, 2013) Hussman commented in relation to the chart (in Two Myths and a Legend, March 11, 2013): In general, elevated profit margins are associated with weak profit growth over
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By: greenbackd Source: “What Goes Up Must Come Down!” James Montier (March 2012) In his recent piece The Endgame is Forced Liquidation John Hussman eloquently describes the reason why investors need to be wary of structural arguments intended to dispose of indicators with a very reliable cyclical record: On the temptation to disregard proven indicators As a side-note, it’s important for investors to be wary of “structural” arguments intended to discard indicators that have very reliable cyclical records. For example, hardly a day goes by that we don’t see an attempt to harness some long-term structural factor, such as increasing globalization of trade, to explain away the spike in profit margins over the past few years – in the hope of proving that these margins will be permanent this time. Some of these arguments are discussed in recent weekly comments. But these factors don’t explain the cyclical fluctuations in profit margins at all, and can’t be used to discard the accounting relationships and decades of evidence that corporate profits have a strong secular and tight cyclical mirror-image relationship with the combined total of government and household savings. Investors get themselves in trouble when they embrace “new economy” theories not because those new theories can be demonstrated in the data; not because existing approaches
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By GREENBACKD Corporate profit margins are presently 70 percent above the historical mean going back to 1947, as I’ve discussed earlier (see, for example, Warren Buffett, Jeremy Grantham, and John Hussman on Profit, GDP and Competition). John Hussman attributes it to the record negative low in combined household and government savings: The deficit of one sector must emerge as the surplus of another sector. Corporations benefit from deficit spending despite wages at record lows as a share of economy. John Hussman spoke recently at the 2013 Wine Country conference. Here he describes the relationship between corporate profits, and government, and household savings (starting at 22.08): Hussman’s whole talk is well worth hearing. Order Quantitative Value from Wiley Finance, Amazon, or Barnes and Noble. Click here if you’d like to read more on Quantitative Value, or connect with me on LinkedIn. h/t Meb Faber 'Get ValueWalk's Daily Edition By Email and Never Miss Our Top Stories'
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By GREENBACKD We wrote an article for the April issue of Value Investing Letter giving an overview of Quantitative Value, discussing the quantitative value model outlined in the book, and applying it to Apple Inc. (AAPL). It’s been smashed up since then, and there was also some big news yesterday — which is that AAPL is going to return $100 billion to its shareholders by the end of 2015 – so I’m highlighting it here. To put that $100 billion capital return in context, AAPL closed Tuesday with a market capitalization of $380 billion. Incredibly, its $145 billion cash pile won’t shrink because the new buyback brings its return of capital up to about the level of its current free cash flow. Weirdly, it’s now regarded as the “animal investors like least: a slow-growing tech stock.” From our earlier article: We ran our model on March 13, 2013, finding Apple Inc. (AAPL) to beone of the highest quality stocks in the bargain bin. AAPL designs, manufactures and markets a variety of mobile devices, including the iPhone, iPad, and iPod, along with Mac products, operating systems, cloud products, related software and services, and many other products. Its devices are ubiquitous, and are catnip to consumers, driving one of the most valuable
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By: greenbackd Value Line’s Median Appreciation Potential (VLMAP) 2009 Marketwatch’s Mark Hulbert has a great article Finding the best four-year market forecaster examining Value Line’s Median Appreciation Potential (VLMAP), which is the median three-to-five year gain that Value Line’s analysts estimate for the 1,700 stocks they cover. From Value Line October 2010 update: The estimate of the median price appreciation potential is found by first calculating the percentage change between the current price of each stock in our universe and the middle of its 3- to 5-year Target Price Range. These figures are then arrayed, and the median price appreciation potential is determined. We select the median of the array (the middle) as the most likely price, in order to play down the effect of outliers, that is, excessively large or small percentage price changes. The chart included below depicts the results of those projections from 1983 to 2009, using the Value Line Arithmetic Index as our measure of the market. The actual price is taken as the average of the middle year of the 3- to 5-year forecast, so that a projection made at the end of 1983 would be compared to the average price of the index in 1987. Accordingly,
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By: greenbackd Ratio of Corporate Profits-to-GDP and Returns (1947 to Present) Source: Hussman Weekly Comment “Taking Distortion at Face Value,” (April 8, 2013) Warren Buffett, 1999 rom 1951 on, the percentage settled down pretty much to a 4% to 6.5% range. … In my opinion, you have to be wildly optimistic to believe that corporate profits as a percent of GDP can, for any sustained period, hold much above 6%. One thing keeping the percentage down will be competition, which is alive and well. – Warren Buffett, Mr. Buffett on the Stock Market (November 1999) Jeremy Grantham, 2006 Profit margins are probably the most mean-reverting series in finance, and if profit margins do not mean-revert, then something has gone badly wrong with capitalism. If high profits do not attract competition, there is something wrong with the system and it is not functioning properly. – Jeremy Grantham, Barron’s (c. 2006), via Katsenelson, The Little Book of Sideways Markets. John Hussman, 2013 In general, elevated profit margins are associated with weak profit growth over the following 4-year period. The historical norm for corporate profits is about 6% of GDP. The present level is about 70% above that, and can be expected to be followed by a contraction in corporate profits over the coming
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By: greenbackd Butler|Philbrick|Gordillo and Associates have an interesting post called What the Bull Giveth, the Bear Taketh Away on the duration and magnitude of all bull and bear market periods in U.S. stocks since 1871. For the purpose of the study below, we examined the S&P 500 price series from Shiller’s publicly available database to understand the duration and magnitude of all bull and bear market periods in U.S. stocks since 1871. We defined a bear market as a drop in prices of at least 20% from any peak, and which lasted at least 3 months. Bull markets were then defined as a rise of at least 50% from the bottom of a bear market, over a period lasting at least 6 months. Chart 1 and Table 1 describe every bull market since 1871 in the S&P, including duration and magnitude information. The lesson from this analysis is uninspiring for equity bulls, as we will see. The core hurdle is that the current bull market has (through end of February) already delivered 105% of gains, against the median 124% bull market run through history (using monthly data). Of course, this means that, should this bull market deliver an average surge, investors can hope for less
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By: greenbackd Butler|Philbrick|Gordillo and Associates’ argue in Valuation Based Equity Market Forecasts – Q1 2013 Update that “there is substantial value in applying simple statistical models to discover average estimates of what the future may hold over meaningful investment horizons (10+ years), while acknowledging the wide range of possibilities that exist around these averages.” Butler|Philbrick|Gordillo use linear regression to examine several variations of the Shiller PE (and other cyclically adjusted PE ratios over periods ranging from one to 30 years), Tobin’s q ratio and Buffett’s total market capitalization-to-gross national product ratio (“TMC/GNP”). They have analyzed the power of each measure to explain inflation-adjusted stock returns including reinvested dividends over subsequent multi-year periods, setting their findings out in the following matrix: Matrix 1. Explanatory power of valuation/future returns relationships Source: Shiller (2013), DShort.com (2013), Chris Turner (2013), World Exchange Forum (2013), Federal Reserve (2013), Butler|Philbrick|Gordillo & Associates (2013). Butler|Philbrick|Gordillo comment: Matrix 1. contains a few important observations. Notably, over periods of 10-20 years, the Q ratio, very long-term smoothed PE ratios, and market capitalization / GNP ratios are equally explanatory, with R-Squared ratios around 55%.  The best estimate (perhaps tautologically given the derivation) is derived from the price residuals, which simply quantify how extended prices are above or below their long-term trend.The
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