Late Friday the Dallas Fed reported its inflation measure the “Trimmed Mean PCE” at 1.4%-see table below. Inflation remains fairly low. The calculation for the SP500 (SPDR S&P 500 ETF Trust (NYSEARCA:SPY)) Intrinsic Value Index uses the 12mo Trimmed Mean PCE in the denominator-higher inflation causes the SP500 (.INX) Intrinsic Value Index to fall and vice versa. The SP500 Intrinsic Value Index at $1,841 continues to indicate that the SP500 remains undervalued historically vs. the August 2013 monthly closing price of $1,633-see chart below.
Charlie Munger’s Cancer Surgery Formula
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The SP500 Intrinsic Value Index is designed to reflect the valuations at which better Value Investors such as Warren Buffett and etc. find the market attractive. An example of this was presented by Jason Zweig’s column on August 30th, 2013 which focused on Charlie Munger’s buying bank stocks during the 2008-2009 market panic. Excerpt:
Charlie Munger: Lessons From an Investing Giant
“Mr. Munger, who will turn 90 years old next Jan. 1, is a model for individual investors who wonder how they can possibly beat the professionals at their own game. The pros have more information than you, and their trading machines are faster. But you still have an edge over them—so long as you play a different game by your own, more sensible rules.
You can be patient; the pros can’t. You don’t have to be part of the herd; they do. Above all, you can be brave; they almost never are.
“What makes Mr. Munger a model for individual investors?
In the first quarter of 2009, during the most desperate days of the financial crisis, Mr. Munger took 71% of the cash at Daily Journal, a small publishing company he chairs, and poured it into the bank stocks that so many other investors were fleeing. By March 31, 2009, his bet already had gained 60%. With other purchases he made later, Mr. Munger invested $49.7 million into stocks and bonds that today are worth $128.4 million, according to financial statements Daily Journal filed on Aug. 20, 2013”
The current investing climate continues to remain relatively attractive in the context of investor responses to economic cycles. Investors typically price securities based on their perceptions of the health of our economic cycle. Even with 4 ½ yrs of excellent economic trends, many investors remain skeptical that we have exited recession. Many believe that Fed monetary policy is the sole reason for higher stock markets and that economic activity remains weak. My view is that higher personal income, retail sales, light weight vehicle sales and now improving residential housing sales indicate that our economy has recovered and continues to expand. History shows that investors failing to recognize positive economic signals in the first years of the up-cycle is typical during recovery. Once economic expansion is recognized, investors rush in and cause over-pricing the SP500 vs. SP500 Intrinsic Value Index. We have not reached that point to date and the SP500 remains under-valued vs. SP500 Intrinsic Value Index.
How high investors will drive markets this cycle is impossible to predict. Market prices are not precisely tied to business returns as many would like to think. My observations indicate that market prices are as high/as low as psychology is optimistic/pessimistic. Since 1995, my observations indicate that Hedge Funds have greatly enhanced market swings not only throughout the cycle but importantly at market tops and bottoms. In 2000 Hedge Funds pushed the SP500 to a level which was ~100% over-priced relative to the SP500 Intrinsic Value Index. In 2007 the SP500 peaked at ~55% in excess our benchmark. How far in excess the SP500 will rise vs. our benchmark in the current cycle is impossible to predict. But, what we do know is that equity markets peak at peak when light vehicle sales and employment statistics peak. The current best estimate is that it is likely to be ~5yrs before we see an economic peak.
Markets continue to be under-priced relative to the SP500 Intrinsic Value Index. Investors should take Charlie Munger’s lesson to heart and add funds to equity at this time.