One guy says earnings are robust. Another says people are falling asleep at the wheel like in 2005.
Who can condense each sides argument in the most concise way? Each sides pivotal assumptions?
is it time to buy gold??? lol jk
Well, after 2005 the S&P still added over 15% in 2006 and 5% in 2007. Timing.
How is the fear index at an all time high? Measured by what? VIX? If so, VIX is pretty freaking low.
I’m just throwing these numbers out without much context, but let’s compare today to 2007. SPX closed at 1448.31 five years ago today. Based on today’s close of 1517.93, that is less than 1% index growth per year. This is very low compared to the average of such periods in history.
Rephrase the question as “did the economic crisis cut off 5% per annum of earnings growth for 5 years?” A lot of people might even say that is an aggressive estimate.
Re: VIX. True, people regard it as a “fear index”. However, we should be aware that it reflects other things, other than fear. People want options for many reasons. For instance, if there was a huge run up from January to November, many investment companies might buy puts to lock in their annual gain. That would drive up options prices.
I don’t get it.
some random comments:
bear:
I think Ohai’s argument assumes 2007 had somewhat fair prices, which may not be true.
Compared to the world, US seems to be getting stronger at bad things (debt, political gridlock) and weaker at good things ( size of world gdp, education). US is still awesome, but the 20th century pretty much precified all the awesomeness.
Eventually rates will possibly go up and discount those cash flows hard. If they don’t, maybe that will happen because the economy is still bad.
I feel weird when the markets get too happy.
bull:
companies are much more profitable and lean than before
much more deleveraged as well
they still have exposure to the entire world, so US internal issues don’t show the whole picture
exceptionalism, creativity, yadda yadda
even though the market went up a lot, word on the street dooesn’t feel “bubbly”. You don’t see many professionals getting excited about the S&P.
neutral:
valuations seem historically just OK. You may look at cyclically adjusted P/Es, P/CFs or whatever, and the market does not seem that much expensive, but it’s definitely not cheap. I guess that’s slightly bullish since stocks are usually good for the long term and what not.
Stocks perform well in deleveraging. Sorry, can’t come up with a bear case.
One Word:
Sequestration. I think this is real this time. Repubs don’t want to get shafted since they went along with Dems tax plan. Dems don’t want to cut entitlements and Repubs don’t want to raise taxes further.
I’m anticipating a drop in March and I’m hoping to take advantage of it. Hopefully high yield bond prices will also fall; one can only dream.
FYI…I bought before the Bush Tax cuts expired because I knew there was no way the Dems/Repubs could face their electorates after letting middle class taxes increase. They had to make a deal then; But now they don’t because most Americans think Washington spends too much.
Can you please elaborate on this?
What do you guys think will be the next catalyst? Dow went from 1000 to 14000 in 18 years due to consumer leveraging and the internet. What will have to happen for the market to double, triple, quadruple from here?
Another super thing that has happened is that China, Brazil and other parts of the world have gotten much richer. This is extremely good for US company earnings. Companies like Apple, GM, Intel, Nike, are looking to these countries to provide a large percentage of their future customer base. The global market has changed significantly over the past 10 years, or maybe even the past 5 years. More and more, SPX prices reflect global economic growth, not just US economic growth. And global economic growth has been pretty ok, despite the clown show in the US and Europe.
Agree that 2007 was probably not fairly valued. However, what I was trying to say is that, in general, stock market increase over time is to be expected. Let’s say we adjust the 2007 SPX number down by 10%; today’s SPX close would still only imply 2.5% price growth per year over the past 6 years. This is lower than the historical average. Now, let’s say we want to target a “reasonable” metric of 7.5% growth per year once we include dividends. That’s about 5% index price growth per year, implying 2007 was about 22% over valued.
Also, this is using the February 8 2007 close of 1448, not the all time high of 1553 in July, which was 7.5% higher than the level I’ve been using for 2007. So, assuming SPX is near the current level in July 2013, “normal” SPX growth would imply that the index was some 30% overvalued at the highs in 2007.
I’m not saying that 2013 is safe from any stock market pull back. However, the idea that we are “near all time highs” is not so scary to me when I look at what the historical data implies. We should be mindful of political risks, etc., but the index level itself is not scary.
We’ll, they’re richer and will buy more stuff, but they’re not going to be able to sustain the profit margins that companies could get by having US consumers cash out their home equity and buy useless crap. So luxury goods will do well on an earnings perspective, and materials will do well from a revenue perspective. And the (possible) long term drop in local interest rates will likely provide a tailwind, but it’s not going to be like pre-2008.
US GDP is higher than it was in 2008, so it isn’t necessarily ridiculous that market indexes would be just as high as 2008. To the extent that the index reflects growth (which it does), one can ask if lower growth prospects are enough that the index should be lower, in spite of GDP being higher. Maybe yes, maybe no, but there is no reason why an all time high should be anything more than a psychological marker for market participants.
Very good points above, and I do agree with Ohai that valuations are hardly scary. I also think bchad is spot on about the psychological marker Given that, I think it’s hard to think of the US market as cheap as a whole ( banks are probably still cheap - at least way better than their pre-crysis conditions). On an expensive-to-cheap scale of world markets, US is probably top or 2nd quartile, depending on assumptions and favorite valuation tools. If we agree that US/Europe are not that hot for the medium/long term, I think overweighting “better” markets is better than getting a 50-50 world exposure from the S&P500 companies. Bringing a lot of money from overseas, S&P is possibly the “safe” US play, as Stoxx 50 may be for the Eurozone. Still, there are a bunch of frontier markets that seem more appealing, not only from valuations, but also from the easier path towards growth by leapfrogging technology developments and infrastructure.
Here are some charts based on various SPX historical data:
Observations:
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SPX earnings have a surprisingly robust upward trend. You can essentially draw a straight line through the log chart.
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SPX dividends have been declining since like, forever. Does this just mean that the market is getting more liquid, so people can easily sell stock instead of relying on dividend? Or some other explanation? Notice that stock market performance does not have a reliable long term relationship with dividends. Not convinced that required return would change a lot through time either. So much for DDM.
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Interest rates are too low. Real interest rates -0.57%. Fuuuuu…
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SPX P/E is around the historical average. However, based on the chart, low P/E does not seem to really imply good future performance. Look at 2002 and 2009-2010. Both of these show incredibly high P/E, because the economy sucked right before. However, in both cases, the stock market rallied signicantly right afterwards. Might be possible to derive other relationships after adjusting for “extraordinary” conditions like this though.
In a paper by BWater called “Asset Class Returns in Deleveraging”, they describe the various asset returns in both “beautiful” deleveragings - what we have now and “ugly” deleveragings, which we don’t. Stocks perform well, Bonds perform as well as stocks on a risk adjusted basis. Gold and Oil do really well.
My guess, there will be a pullback, but overall, don’t see much of a bear case except “Stock market is going up, let’s all be contrarians!”.
Ok, one can argue that this deleveraging is special, so that stocks go up despite deleveraging, but the statement that “stocks perform well in deleveraging” sounds like a proposition of general principle, and a bit batty, since it implies that earnings or valuations rise even as revenues become constrained by deleveraging. Are you sure that’s what you meant?
I haven’t read the BWater paper and haven’t heard the argument in a while, but I think Dalio was a bit surprised that the deleveraging was working out as well as it had (it would not be “beautiful” if this were just the way deleveragings always worked), and it seems to be largely about how central bank policy seems to be navigating safely between inflation and new recession.
He has a pretty clear definition of “beautiful” deleveragings. One in which deleveraging is accompanied by monetary easing which pushes short term interest rates below GDP growth rates.
I think the whole thing is going to sink like the Titanic.
Palantir, bwater research is pretty awesome and the case for beautiful deleveraging makes a lot of economic sense, but there is not much data to say that those few examples will happen every time or most of the time. And even those guys mention how hard-to-predict stuff may mess things up for a while ( wars, Grexit?)
I’m not really disagreeing with you. I just think that some scenarios may be tough for the index. Great article snyway.
For anybody interested, I think it’s nice to first read “How the economic machine works” on the bridgewater website, which lays down the overall idea on how Dalio looks at economic trends, and then go to the article Palantir mentioned.
According to Dalio, basically, every 50 years or so, economies get to a point when there’s too much credit. Once credit dries up, QE is wise to replenish that void with money. This will not be inflationary if done right ( new money is just replenishing the lost credit, thus avoiding deflation) . If everything goes well growth is bigger than ST rates and the debt/income ratio starts going down - deleveraging does not screw income.
Of course there may be a point when monetary easing goes too far ( inflation) , but they seem to think of it as unlikely. Bwater seems very pro currency devaluation, but that probably doesn’t work as well when US, China, Jpn, Switzerland and the ECB all seem to want a weaker currency. Jpn seems to be trying to follow Dalio’s book - it will be huge if they can reignite the economy there.