On Valuations and the inability to see

Updated on

“The Federal Reserve is not currently forecasting a recession.”
– Ben Bernanke (2008)

I mentioned last week there would be no OMR this week.  Well, against my wife Susan’s best advice (to take the week off), following is a short post I hope you find helpful in your work with your clients (or for you personally if you are not an adviser).

Thank you again for taking the time to read my weekly e-letter.  It means a lot to me.  My friends at investment consultancy 720 Global penned a short and candid piece titled, “Deception.”  I think it is well done.  It’s about extremely high valuations and the inability to see:

Janet Yellen and Equity Market Valuations:

At the December 14, 2016 FOMC press conference, Federal Reserve Chairwoman Janet Yellen responded to a reporter’s question about equity valuations and the possibility that equities are in a bubble by stating the following: “I believe it’s fair to say that they (valuations) remain within normal ranges.”  She further justified her statement, by comparing equity valuations to historically low interest rates.

On May 5, 2015, Janet Yellen stated the following: “I would highlight that equity-market valuations at this point generally are quite high,” Ms. Yellen said.  “Not so high when you compare returns on equity to returns on safe assets like bonds, which are also very low, but there are potential dangers there.”

In both instances, she hedged her comments on equity valuations by comparing them with the interest rate environment.  In May of 2015, Yellen said equity-market valuations “are quite high” and today she claims they are “within normal ranges”?  The data shown in the table below clearly argues otherwise.


Interestingly, not only are equity valuations currently higher than in May of 2015 but so too are interest rates.

Further concerning, how does one define “normal”?  Does a price-to-earnings ratio that has only been experienced twice in over hundred years represent normal?  Do interest rates near historical lows with the unemployment rate approaching 40-year lows represent normal?  Is there anything normal about a zero-interest rate monetary policy and quadrupling of the Fed’s balance sheet?  Does the Federal Reserve, more so than the collective wisdom of millions of market participants, now think that it not only knows where interest rates should be but also what equity valuations are “normal”?

One should expect that the person in the seat of Chair of the Federal Reserve would have the decency to present facts in an honest, consistent and coherent manner.  It is not only her job but her duty and obligation.

Amen.  720 Global also shared an interesting chart showing just how much house a person can afford at various interest rates assuming a $3,000 per month mortgage payment.  You’ll find that chart below.  They then concluded their piece with the following:

The point in highlighting these examples is to remind you that people’s opinions, especially those with a vested interest in a certain outcome, may not always be trustworthy. We simply urge you to examine the facts and data before blindly relying on others.

We leave you with historical insight from a few so-called experts:

– “There is no cause to worry. The high tide of prosperity will continue.” Andrew Mellon (1929)

– “Stock prices are likely to moderate in the coming year but that doesn’t mean the party is coming to an end.” Phil Dow (1999)

– “The Federal Reserve is not currently forecasting a recession.” Ben Bernanke (2008)

720 Global is an investment consultancy, specializing in macroeconomic research, valuations, asset allocation, and risk management.  Click here for the full piece.

Likely tax cuts and the potential repatriation of $2 trillion in overseas corporate cash is bullish for equities.  Excitement is in the air.  There remains some distance between here and there.  What is clear is the equity market trend remains positive.  However, like in 2008, something just does not smell right to me.

Periods of overvaluation can go on for some time but to be blind to a CAPE of 28.26 and a trailing 12-month P/E of 25.21 will prove to be dangerous to your wealth.  The point is to keep our lights on.  Mindful of risk.  Vow in 2017 to follow the trend and have a “stop-loss” exit plan.  And keep a close eye on rising inflation and rising interest rates.  They could be the heavy snowflakes that cause the next slide.

We’ll take a broader look at year-end valuations next week.

Wishing you and your family a happy, healthy and prosperous New Year!

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Included in this week’s On My Radar:

  • An Interesting (and Quick) Note on Housing – 720 Global
  • Trade Signals – Happy New Year! Sentiment Extreme, Equity Trend Bullish, Fixed Income Bearish, HY Bullish and Gold Bearish

Housing – More from 720 Global

On December 15, 2016, CNBC reported the following: “The National Association of Home Builders/Wells Fargo Housing Market Index (HMI) rose to 70, the highest level since July 2005. Fifty is the line between positive and negative sentiment. The index has not jumped by this much in one month in 20 years.

The graph below shows how much house one can afford at various interest rates assuming a $3,000 mortgage payment.


Over the past two months, U.S. mortgage rates increased almost a full percent from 3.50% to 4.375%. Given such an increase, a prospective homeowner determined to limit their mortgage payment to $3,000 a month would need to seek a 10% reduction in the price of a house. In the current interest rate environment, this equates to drop from $668,000 to $601,000 in order to achieve a $3,000 a month mortgage payment. One would expect that homebuilders temper their optimism, given that a key determinant of housing demand and ultimately their companies’ bottom lines is facing a sturdy headwind.

720 Global is an investment consultancy, specializing in macroeconomic research, valuations, asset allocation, and risk management. Their objective is to provide professional investment managers with unique and relevant information that can be incorporated into their investment process to enhance performance and marketing.

Trade Signals – Happy New Year! Sentiment Extreme, Equity Trend Bullish, Fixed Income Bearish, HY Bullish and Gold Bearish

S&P 500 Index — 2,262 (12-28-16)

Posted each Wednesday, Trade Signals looks at several of my favorite stock, investor sentiment and bond market indicators.  It is my weekly risk management dashboard, designed to keep me better in sync with the major technical trends.  I hope you find the information helpful in your work.


Equity Markets:  The overall trend remains bullish as measured by the CMG NDR Large Cap Momentum Index (a trend-based indicator), the 13/34-Week Moving Average Trend and Volume Demand (more buyers than sellers).  Don’t Fight the Fed or the Tape (Trend) is neutral.  The weight of evidence for the equity market remains bullish.

Investor Sentiment:  Investor sentiment is an indicator designed to highlight short-term swings in investor psychology.  It combines a number of individual indicators in order to represent the psychology of a broad array of investors.  The objective is to identify trading extremes that may be used for trading or hedging purposes.

Periods of extreme investor optimism are generally short-term bearish for equities and periods of extreme investor pessimism are generally short-term bullish for equities.  If the overall equity market trend is bullish then adding to positions is best when investor pessimism is high.  Periods of extreme optimism may suggest a time to add to hedges or trim exposure.

Today, investor sentiment is excessively bullish.

Fixed Income:  Our fixed income trend indicators have done a great job at avoiding the large declines that have hit the bond market.  Rates moved even higher and bond values lower over the last week. The Zweig Bond Model (ZBM) moved to a sell signal on October 12, 2016 and remains in a sell today.  It has sidestepped the majority of the sell-off in high grade bonds.

Zweig Bond Model – We favor holding “BIL” over longer-dated fixed income ETFs, such as BND or TLT.  The short-term trend for high quality fixed income remains bearish.

The CMG Managed High Yield Bond Program remains in a buy signal.  The trends in HY funds and ETFs is bullish.  We are positioned long in high yield bond funds and ETFs.  Additionally, the December to March period tends to be a bullish period for HY bonds and ETFs.

CMG Tactical Fixed Income Index.  Currently positioned: 50% in JNK (SPDR Barclays High Yield Bond ETF) and 50% in CWB (SPDR®Bloomberg Barclays Convertible Securities ETF).  Both fixed income asset categories have been trending higher.  You can track the CMG Tactical Fixed Income Index here. The Index is up 12.37% YTD.

Click here for the most recent Trade Signals blog.

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