IS THE MARKET CHEAP?
25 July 2009 by TPC
31 Comments
I’ve compiled a few different measures of valuation for your consideration. Regular readers know that I am not much a “value” investor. Value, in my opinion is in the eye of the beholder. Is Apple cheaper at a high PE than GE at a low valuation? Perhaps yes, perhaps no. Most valuation metrics are based on the guesses of the analyst community – something that I believe is entirely unreliable. Nonetheless, here are a few measures to help you put things in perspective:
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you got two components to stock prices
E
and
the multiplier
E is what it is, it’s a fact (although can be fudged, that is another discussion)
the multiplier is a reflection of Investor Sentiment, etc
so, when E falls (ie recession, great recession, depression, great depression….hey this brings up another topic…hence my AHAD….the 30’s were the great depression, when was the ‘regular’ depression??)
Anyway, pay attention here, when E falls, Price falls if sentiment stays the same, if sentiment falls, then the composite fall is much greater, and if E falls and sentiment improves (higher PE ratio), then Price improves….
what we had lately was increasing/favorable sentiment outweighing the decline in earnings…..
look around….are people ‘less worried’? are they accepting the economic decline in stride?
have you heard the following in the spring
“i will wait it out”
“i guess i will ride it to zero”
“this is money i dont need until i retire, and that is a long way to go”
“well, cant sell now, ill wait”
“i just dont look anymore”
so in the times of despair, many held tight….(i call them ostriches)
then this stupid green shoots ‘theory’….people started feeling better, why? cause they wanted to…they want to believe….so sentiment improved…..they had no choice…as well as total systematic failure being taken off the table
E stays the same, PE ratio (sentiment improves) and presto….rally, sustained rally…..
i myself was not giving enough credit to the ostriches in believing that things are better….i guess not only did they stop reading their brokerage and 401k statements, they stopped reading the paper, and stopped watching TV
CNBS had a 2 hour Dow 9,000 party….hilarious….9,000 is a time to party? 5,000 pts off the high is good news? schmucks…as buggs bunny would say,”imbesills, what a maroon”
a couple for what they are worth comments……..
1. apparently ostriches have longer lives than bears, crap
2. i saw the heated debate on whether TPC was short at 870, or went long, or was hedged and/or what was implied in his blog….the answer is of course there are many sides of to every story when not all the information is available, that is PTC does not elaborate in detail all his trades, time horizon, hedging, diversification strategy, exact time of trades, etc….this would take too much time, is no one else’s business and then would open up even more cans of worms….so all we have is our opinions and inferences from what is written.
My OPINION – TPC has shown to be shrewd, level headed, and a moderate risk taker (as i have not seen evidence of excess leverage)….also, although he is bearish in nature, he swing trades both long and short….(which i need to do, being a perma bear is a weakness of mine)
that being said, i took what was written as PTC short about 2 weeks ago and not long, hence PTC being on the wrong side of this massive earnings rally….
3. suggestion – maybe you can add a portion to your site with grid indication time horizon and net postion as short of long, and level of intensity of your trade
example –
Short term: strong + bias is 80%+ long, 20% cash
Short term: + bias is (between the one above and below)
Short term: neutral/+ is 20% exposure long, 80% cash
then add for medium term and long term
then define the “term” periods, say, 1 week for short, 1 month for medium, 6 months+ for long….
4. for video or audio links/posts, i cant access at work, forbidden, so,what about adding a little bit of your summary of what is said/heard
5. i work for a major global financial institution (with no gov’t ownership/backing etc….) and let me tell you this, DO NOT BE FOOLED times are bad, very bad
You guys obviously don’t read the entire posts. I was far from being short heading into earnings…. http://pragcap.com/how-are-we-doing-2 – in fact, I was EMPHATIC about being long into earnings….I have no idea where this confusion stems from.
E,
Please elaborate on your statement “DO NOT BE FOOLED times are bad, very bad.” Just how bad? What do you expect to happen going forward?
TPC,
My take on the above charts is that the market is about fairly valued for normal times and is undervalued relative to the euphoric 1990/2000 levels, but is now seriously stretching it to the upside in the current economic environment.
The market cap to GDP barely hit the level of the pre-nineties average in March. The March lows were not all that low from a historical perspective.
Price to trend earnings were much lower in all other major bear markets except 2001-2003. The current price to trend earnings is about where it was in the mid-nineties just as an economic boom and massive increase in leverage was starting. How much further up can it go during a deleveraging cycle?
I fail to understand why investor sentiment is so high just because lowball earnings estimate were beat. Many of the estimates came in below Q1 2009 actual earnings. The better than expected operating earnings are still running 25% below trend earnings and about 50% below the latest peak earnings. GAAP earnings are running 40% or so below trend earnings. Nevertheless, the price to trend earnings is right on the historical average which includes the nineties mega-bubble.
i posted…..”i took what was written as PTC short about 2 weeks ago and not long, hence PTC being on the wrong side of this massive earnings rally….”
you are missing my point, it was inferred by me…..as obviously many others to be something different…i gave suggestions for clarity…..
and i am not being maliscious or attacking….i am just writing what i interpreted….
and ROB, i cant write about the specifics…..but….
there is fear of a big double dip
and lending…well…..stuff i cant write about
E,
I don’t think you’re being malicious. I just don’t think you’ve been reading the site every day. There is no confusion as to my current position. I don’t see how anyone who has been reading the site regularly can misconstrue my current thinking. I was bullish heading into earnings. I covered my short specifically because I knew the cost cuts would lead to “better than expected earnings”. I got out of my shorts at 880 which was part lucky and part good call.
See here: http://pragcap.com/trade-of-the-day-moving-to-neutral
You can see that I went bullish just days later heading into earnings.
When questioned about my position I said I had a “definite long bias” –
http://pragcap.com/whats-on-tap-16
There is no confusion here.
Sales do not appear to be growing at all. Q2 sales appear to be flat to Q1 and down at least 10% over last year. Rail shipments and UPS do not point to a major increase in Q3.
I would be interested to see a updated historical price to sales ratio chart for the market (and one that goes back to the 1920’s). William Hester wrote an article at Hussman Funds in December 2007 on P/S ratios and their usefulness in earnings recessions.
http://hussmanfunds.com/rsi/psratio.htm
Since the 1950s (up until the tech bubble and aftermath) a P/S ratio of about 1.0 marked the peak P/S ratio except in the inflationary 1970s nd 1980s when it was much lower. The trough P/S ratio was about 0.7 (excluding the tech bubble and aftermath). In part, outsized earnings in the financial sector kept the P/S higher in the late 1990s and 2000s. Are those outsized earnings for financials now back to stay after this exceptionally good quarter?
The March lows fell to about the historical average trough P/S, which would make sense if this ends up taking the typical normal recession / recovery path.
I find it interesting that following other major bear market lows (except 1982 when the P/E hit low single digits), there has always been a significant sucessful retest of the lows. Even in 1932 when market almost doubled off the final low, it retested and retraced about 75% of the rebound off the low. 1973-1974 and 2001-2003 all saw significant sucessful retests of the low. This time appears to be different. Up, up and away.
E,
Let me ask you about something I see a lot hear in inland California. I know many people who have stopped paying their mortgage 6 months to a year ago and no foreclosure action has been taken. Some have bought another home at half the price of their current mortgage (home prices have fallen by about 50% since the peak) and simply stopped paying on their old mortgage once the new mortgage closed. Others are have stopped paying and are simply living in the house for free (no action taken by their lender for months). They are just waiting it out. Better living for free until kicked out than moving out and paying rent. Many more are trying to make a short sale. They have also stopped paying since the bank will not consider a short sale if they keep paying their mortgage. Many homes simply sit empty and are not for sale.
How much of this is known and included in existing reserves? Are the lenders simply overwhelmed or are they kicking the can down the road?
How about some generalized specifics on “very bad”? You have peaked my interest.
TPC,
I think you have to realize that most readers probably don’t read your site every day. And they certainly don’t read the comments. If you were an infrequent visitor to the site it would be easy to lose track of your market calls. Especially the ones in the last two weeks. Also, you’re likely to build a lot of haters as you navigate this market correctly but dont let it get you down.
Make no mistake though – those of us who follow the site regularly know you absolutely nailed this earnings rally. Great call and keep up the great work.
TPC,
Maybe you could create a Market Bias tab on your website that shows short term market view.
Rob,
bottom line, banks are reluctant to lend in the US mkt. Why? Cause it would be expansion of the balance sheet. Ain’t happening in general. Only in very specific segments such as energy, power generation, etc.
Real estate is dead
gaming and lodgin dead
capital markets dead
all else, loan margins thru the roof
bankers have no leverage, fear of losing jobs left and right
bonuses canceled
now you depressed me on my day off
TPC (author) said:
According to Rosenberg it started then. Personally, I see 850 before rebounding then anoter failure in early 2010, but I’ll play it by ear….
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please wait…
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as a regular reader i know where to look
TPC wrote on July 3
“We should see real underlying weakness in earnings (despite better than expected numbers) and continued cautious guidance.”
E – That contradicts your earlier statement that pragcap was bearish throughout the entire recent run up. He obviously thought the earnings were going to be better than expected and a rally.
I find it hard to believe that any “regular reader” could think that I have been bearish over the last two weeks. My move to neutral and then “definitely” bullish into earnings was pretty straight forward. Perhaps you were reading a different blog E.
With the caveat that technical analysis is not my strong suit, please consider the following:
The wedge pattern shares most of its characteristics with the symmetrical triangle and the flag. The wedge forms much like the triangle and signifies a sharp expected breakout in the direction of the prevailing trend. Much like the flag, however, the wedge itself forms at an inclination opposite to the direction of the trend before breaking out in the direction of the prevailing trend.
Assuming that the prevailing trend is down(i.e. bear market), then do you see what I see?
http://stockcharts.com/def/servlet/Favorites.CServlet?obj=ID3186525&cmd=shows159029483&disp=P
Once you click on the hyperlink above, please go in the upper right corner of the chart and click on:
$$ G SPX – 60 min – 6 Months
You can then see an ascending wedge touching its upper limits.
You can then see a clear ascending wedge @ upper limits.
TPC,
I’m a new reader of your website and I look forward to reading it every night when I get home from work. Thanks for all of the great information that you post here.
1. i do like the site
2. i do read regularly
3. if i was confused by your stance, and so were others it was not that clear
4. i dont know why if i express my opinion that others call me a non regular reader or someone missing it
i dont think i am alone on this
sorry for expressing what i felt and some suggestions for clarity
later
E,
I have no problem with you expressing your opinion so long as that opinion isn’t founded on nothing. My analysis is fact based and thorough. My hope is that the comments are also. You are essentially questioning the credibility of the site and my calls without backing it up with any factual evidence. You claim I was bearish yet you point to a quote that in no way implies I was short or bearish over the last two weeks. I pointed to multiple quotes showing that I was in fact long over the last two weeks. And no, there are not a lot of people who are confused. It seems to be you and one or two other guys. And the other one called the site a perma bear site which essentially discredits anything he says.
Sorry to bust your chops, but I just don’t see how anyone can misconstrue my comments heading into earnings. I banged the “better than expected” rally for weeks.
If you can find some place in the last two weeks where I directly said to get short I’ll issue a mea culpa, but you won’t find it because it was never said. I know because I am talking my book….
TPC
I am a frequent reader. Can you please create a tab or a thread that expresses your “current” outlook or position. A few sentences describing your position would be a great help to the novice(readers).
Sometimes your position gets lost in the numerous postings, which ofcourse may “appropriately” change as things unwind in the market. Maintaining a seperate outlook thread (with history) would be awesome. What do other readers say? It also helps us distinguish your outlook and other’s views that you may post. For example, when you cover other blogs and post content or link to them, it would be better to know whether your subscribe to those views – inspite of the fact they make great reading material.
I would second the recommendations that santo kuma made.
At the risk of wading into this fray I will say that even though I am a daily reader I was not aware of your actual call to be long coming of the 880 level. I was under the impression that you were in a neutral stance there even though you saw potential for positive reaction to earnings beats (i.e. bullish). You have to admit that you’re actual statement that you were long was in a comment, not a post.
If you’re going to make these market calls and emphasize them as you have, then you really should make them more clear and easy to find rather than buried in the comments, etc. That’s all. Realize that the reason we ask for that is that you’ve proven to be very prescient and we value your guidance. Take it as a compliment.
No big deal. We all have to make our own decisions. Thanks
guess i am not alone
How was the replacement value calculated in the Tobin’ Q? Are they a proxy of Assets on the Bal Sheets when capacity utilization is at 70%? Can anyone have a true proxy of replacement values of the corporate america’s assets? Is it not all estimates?
EV = Mar Cap + Debt – Cash eq. At this juncture, can one really calculate the value MV of debt?
Again marketcap/gdp around .7 -> looks cheaper.
I believe that growth in GDP going to be way lower going forward. This is the real economy.
growth in Market Cap is a reflection of sentiment. If one observes the recent euphoria’s, I am feeling that growth in Market Cap is going to be higher. (Even 9k to 10k on Dow is like a 11% growth). This ratio compares sentiment with true economy. Keeping in perspective that economy could contract in the near future, I have a feeling that current ratio is expensive even at .7
Cmoing to PE trend earnings, I dont beleive in any of the earnings that are being reported on a fundamental basis. If one adjusts all the reported earnings for one timers, and the perception of accounting manipulation that is involved, the earnings may be lower and the PE may be higher.
I would like to know the sensitivities of these ratios to each of the parameters.
TPC, what does trend earnings mean?
If the “buy and hold” strategy is erroneous in this market, then traditional metrics are also of limited importance. The key in this market is short term directional correctness. To paraphrase Archimedes “give me the market direction and I can show you how to move the world”.
re: TPC MARKET CALL
I find the amount of time & energy focused on this discussion quite ridiculous.
1. Short-term calls (< 1 month) in this environment are pure speculation. Things change and move so quickly that using blog postings to convey sentiment will likely come across as conflicted (as I believe is the case with TPC over the past several weeks)
2. Anyone with half a brain will hedge their commentary in favor of positive interpretation (that includes Cramer & Nostradamus & yes, even TPC)
3. I agree with E that the only way to eliminate confusion by readers is to have a constant (daily) short/inter/long sentiment measure posted which is updated per your sentiment shift. A historical log would also be appropriate. If you’re not interested in doing this, then refer to comment#2.
4. For all the back-and-forth, I have no idea of TPC’s current outlook/duration/targets. Are we going to +1060 on the S&P500? Next month or next year?
TPC,
I’m a regular reader and know you’ve nailed the recent rally on better than expected earnings.
If people are unclear it’s likely because they don’t read the comments and/or get confused by the bearish take on economic data (and neglect that economic data and market direction do not have to constantly travel in lockstep).
Of course we’d all like you to have a special section devoted to your short-term market outlook. Bolded, highlighted, in hot pink at the top right of the page — because you’ve been quite right thus far (as a previous commentor mentioned), and (I feel it comes across through your site) there is a REASON in your reasoning process.
But do whatever you want to do. Post outlooks in the comments, don’t post them at all when you don’t have a good feel. You’re doing this for free on your time, so I’m not going to look a gift horse in the mouth. If I don’t want to miss anything, it’s on me to read the comments, or whatever/wherever else.
Keep up the great work.
One thought on comparisons that I have seen made to the 1981-1982 recession and bear market and V-shaped recovery (both economy and stock market). I saw a story on Bloomberg that compared the 1982 rebound in the stock market to the current stock market rebound. V-shaped with no retests of the lows.
There are two major differences between 1982 and the present.
1. 1982 bottomed at a much lower valuation. (In part due to the inflationary environment, but that doesn’t seem to account for the entire difference in trough valuation since interest rates and inflation were expected to fall.) Falling interest rates led to a expansion in the PE multiple. (Today, interest rates would seem to have no where to go but up which should limit multiple expansion and decrease the multiple when interest rates evenutally rise.)
2. Real GDP growth was very strong following the 1982 recession.
The peak to through decline in real GDP was about -2.8% in 1982. The blue chip concensus for the current recession is about -3.6%. But following the 1982 recession, 4 quarter real GDP growth was almost +8%. Lending was strong and interest rates were starting to fall from very high levels. Real GDP was higher than the previous peak within 4 quarters.
http://2.bp.blogspot.com/_pMscxxELHEg/Sms3utpubAI/AAAAAAAAF5g/OWAOe4tRNXQ/s1600-h/Altig.jpg
This time around the blue chip concensus is that 4 quarter growth following the recession trough will be somewhere from 1 to 3% with the concensus at about 2%. Real GDP will likely take more than a year to just reach the previous peak again. If there is a relapse it will take longer.
The projected growth following the current recession sounds much more like 2001-2002 than 1982.
Without a boom in lending and falling interest rates it is hard to imagine strong growth following the current recession. (Interest rates are as low as they can go and credit is still tightning rather than increasing.)
In 2001, the peak to trough decline in GDP was only about -0.4%. Not much of a recession, but the 4 quarter growth following the trough was only about 2%. For most people it didn’t feel like the recession had ended. Unemployment while remaining relatively low, continued to rise. (The so-called jobless recovery). The Fed was lowering interest rates. Interest rates had not already hit bottom prior to the end of the recession as they did this time. The housing market was starting to really boom. Cash out refinancing was increasing as ARM mortgage rates fell together with the Fed funds rate. The effects of cheap financing and equity extraction seemed to cancel out the effect of moderately rising unemployment. Retail sales were flat but never really fell much. Asia had their big crisis in 1998 and by 2002 was really booming. The Federal budget was balanced before the recession so Bush could cut taxes to help stimulate demand.
I remember the rebound year of 2002 as being worse than the recession year of 2001. Actually, until 9/11 the year 2001 was a pretty good year. I don’t remember the recession as such, just the NASDAQ falling. Yet the recession ended a few months after 9/11.
Now the fiscal deficit is huge. Tax cuts seem out of the question. Targeted tax increases are the order of the day. The increase in public debt will ultimately be a drag on the economy, the decrease in private leverage will also be a drag on the economy. (Part of the magic of the 1990s boom was a decreasing public debt burden and increase in private leverage). Interest rates can hardly be cut further. Credit is tightning. We seem to be in a liquidity trap. (Well not so trapped, it seems it has found its way into commodity speculation and the worlds stock markets). Residential and commerical real estate prices are falling and a large percent of homeowners in the boom areas in the West and Florida are underwater on their mortgages, in some cases by very large amounts. Equity extraction is no longer a preferred (or in many cases possible) option to make up for lost income. U6 Unemployment is at 16.5% and rising. It is increasingly common that employed people are being furloughed for several days each month to cut cost and avoid layoffs. (I have seen estimates the reduction in paid hours due to furloughs would be the equivalent of another 2% to 3% added to the unemployment rate if the hours were reduced via job cuts instead of furloughs). This recession is largely worldwide. It is hard to imagine the US exporting itself out of the recession. The reduction of imports will help increase reported GDP, but will not feel like growth. The necessary increase in private savings has barely begun. The increase reported in May has been attributed to the
With the current situation, a 1982 type recovery with strong GDP growth is very hard to imagine.
All very well said Rob. Anybody comparing the present to ‘82 is just a fool or has a reason to be lying to us. It’s hard to imagine anybody in the investment community being that ignorant of the macro picture or history, but I suppose it is so. History is full of them. And some are just trying to pick our pocket, luring naive investors back into the market to give them the greater fools they need.
I’ve given up on trying to figure out who has what motives. But I won’t be fooled into thinking that I should ignore this massive weight of evidence that says we’ve got a long slog ahead of us before the global economy, and certainly ours, is ready for healthy, strong and sustainable growth with an accompanying secular bull.
Hey all,
It seems to me that the VW incident was a microcosm of what is going on in this market. As a whole, we cannot be short for any substantial time because the government/banking industry won’t allow it. McDonalds had a bad quarter and the stock went down. Why? Because few were short. Few believed that McDonalds would have a lousy quarter. Then there was UPS. Many knew they had a lousy quarter and that their forecast would be dismal. Many got short and wham…the stock goes up. It seems all too clear that this is what is happening. Anyone else have an opinion on this?
Happy going long,
RMP
Robs last comment and RMP are right on those that control us want to make money so they’ll let it go go up until it’s not as easy to make and they’ll let the air out till they start in again it works every time.
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