Feeling Like It's 1999

[JEast]

Historical point - in early '99 things were expensive but not crazy expensive.  It was not until the next 16-20 months passed until things got crazy.

 

As I knew our board members would point out, there is always something to do (in pocket areas).  I would also agree with Buffett (as all value investors should) that if rates stay at present levels then this discussion is a moot point.  But Buffett kind of hints at my point -- are we bond investors or are we equity investors?  Presently I guess he recommends that we be both, and that makes it hard with a potential binary outcome.

 

 

[merkhet]

I found the answer to my own question about correlations and pockets of value.

 

http://basehitinvesting.com/michael-burry-focus-on-bargains-and-not-stock-market-valuations/

[CorpRaider]

I found the answer to my own question about correlations and pockets of value.

 

http://basehitinvesting.com/michael-burry-focus-on-bargains-and-not-stock-market-valuations/

 

Throw in Buffett (Munger), Icahn and Greenblatt as other famous investors who find little no value in having a view of the market's direction (at least that is what they say; Buffett and Icahn seem to flirt with a little timing).  But its fun to discuss I suppose.  Doesn't feel like 1999 to me.  More like early 90's pre LTCM maybe 1994 (?) or a more pedestrian moderately richly valued market.  Maybe like the time right before the junk bonds imploded and Michael Milken went down.  I was just a kid then so I don't remember a lot of detail, just general impressions.  Now, I'm not investing in Uber or high yield bond etfs.

[Viking]

If US interest rates are key then inflation expectations will be a good thing to monitor. Oil falling from $110 to $60 is very disinflationary as input costs fall. The U.S. dollar increasing 20% is also disinflationary as import costs fall. The U.S. is going to have very weak headline inflation numbers for another 6 months or so. However, as these two events calendarize then we should start to see an uptick in inflation.

 

Another key will be if the U.S. labour market continues to tighten further. Labour costs have been increasing the past 4 years but the increase Has been small.

 

Later this year or early next year we could see a scenario where the inflation rate starts to tick up. Should inflation expectations surprise to the upside we could see a bloodbath in the bond market. This fear will also hit the stock market and things would likely get ugly there as well. To me the bond market is the real risk right now. If things get ugly, cash will be king and those with cash will likely get another buying opportunity of a lifetime... Interesting how these 'buying opportunities of a lifetime' seem to be happening about every 8-10 years!

 

To follow what is going on in the U.S. economy, with a focus on the housing market, I read the calculatedrisk blog, which is first class in its analysis.

[boilermaker75]

Not till I see commercials like these,

 

 

[BTShine]

Not till I see commercials like these,

 

 

 

Great find.  Those commercials are classics.

[stahleyp]

I'd be careful on being too confident about about euphoria and market crashes. There wasn't market euphoria in much of the market in 2007. Perhaps in emerging markets and real estate but not in the general market. People were concerned that high oil costs would derail the economy. Even without all the euphoria, 2008 was still worse than the dot com meltdown (for the overall market).

[DavidVY]

Not quite... there are still whole sectors that are reasonably priced

- Insurance, Financials, and Financial Services

- Old tech- Microsoft, google, qualcomm and cisco. All selling at reasonable multiples w/tons of cash on hand.

- Food processors- Hello Avian bird flu! Poultry processors look reasonably priced

- O+G/ Mining- Tons of stuff here (shares selling at 5x FCF).

- Spin-off situations

- Misunderstood companies (Zynga springs to mind)

 

I see froth in Facebook, Tesla, utilities, cell-towers etc, but def no forward-looking accounting schemes like the telcos or dot-coms.

 

Just my 2c.

[mikazo]

Almost $100 Million of VIX Options Traded Hands in a Split Second Today

 

http://bloom.bg/1zTuBV4

[rpadebet]

No offense to anyone,but as long as we have threads like this discussing euphoria, there won't be a market bubble. Honestly, I don't think we are going to hear shoe shine boys calling the top this time, it will most likely be the "value" investor who finally gets tired of waiting, sees the opportunity cost of sitting out, throws in the towel and decides to buy with both hands ( ignoring high valuation and reasoning he/she is investing for the long haul). Then we will have a top.

[jschembs]

Not till I see commercials like these,

 

 

 

Great find.  Those commercials are classics.

 

Great commercials indeed. We do have the Jacob Wohls of the world in this cycle, which may be more pernicious. Main Street could still feel burned from 00 and 08, but if their money has now gone to Mr. Wohl and wirehouse brokers investing in ETFs, is that much different? Obviously my Wohl reference is tongue in cheek, but I do worry about increased ETF activity and the unintended consequences of hot money.

 

A couple of points. First, that we're even comparing this to 99/00 as "it's not as bad as it was then" should give folks pause. Second, I remember 07 as well, and the issue there was moreso related to leverage than initial valuations once shit hit the fan. Buyouts using either internally generated funds or via debt left those companies with little margin for error - and we're certainly seeing the same depletion of cash from balance sheets to fund buybacks today.

[crastogi]

Casual observations, but in the sandbox that I play in – it is starting to fell like it is 1999 again.  However, for you folks that had capital invested in the market during '99-'00 they were probably filled with great wonders and excitement.  I on the other hand was filled with “you got to be kidding me” as for example I still recall that Juniper Networks went to 100x times sales (sales not earnings) at one point.  We are surely not at that stage, but anecdotally the rhythm/rhyme of today’s market has that undertone.  Some random observations:

<blockquote>1. Ivy League graduates instead of wanting to go to Wall Street or consulting jobs are instead now more interested in starting their own business or entering VC. 

2. The FED making market comments that they appear a little frothy.  The last time that happened (e.g. irrational exuberance), the markets went on a tear.

3. Attended a VC conference a few months ago and there was actually some very good functional and operating tech (vs. two years ago of paper tech).  However, no one wanted capital as they were holding out.  Reminds me of holding out on the last dollar before the 2007 housing boom and broadcast shows like “Flip This House.”

4. Speaking of TV shows, does programs like “Shark Tank” at this pint hint at the possibility that VC has – jumped the shark (pun intended).

5. Much like the Business Week headline theme, is it time to sell the headline?

6. At my recent Toronto visit, and reason I like the many events during FFH week is that all the value investors attending are very open and we talk individual stocks.  Unlike all my past years (9 years), not very many hardcore value folks had any stocks to talk about this year.

7. Headlines are starting to pop up that value investing has lost its luster.  One recent headline indicated that Mark Mobius is a washed up value investor and sure more articles are in the works as the 5 and 10 numbers are starting to turn over.</blockquote>

I am sure astute board members could find (and will) more anecdotal and cautionary tales.  Sure, there is always something to do, and I am, but if any of this true, then we hardcore value investors probably have another 18 months or more of value pain.

 

Cheers

JEast

 

I started buying individual stocks in '99, 2000.  My impression - at that time there was wide dispersion in the market and plenty of value stocks to go around.  Now it seems almost everything is pricey. 

[Guest Schwab711]

Maybe this is more 1936 than 1999 since it's currently not irrational exuberance. Small recovery, high margins and confidence, and a housing/jobs recovery that was "enough" but not strong. I think the Fed has done quite a bit to dampen the recoil (short and long-term) but a recession would seem more likely now than anytime in the last few years.

 

Some have alluded to pockets of value at current levels. Of course! Law of Large Numbers pretty much guarantees as much. If we researched it, I imagine we would see that the current % of stocks considered absolutely "cheap" regardless of quality are at historic lows (higher co-variance). How long can this be supported? What % of total investments are currently equities for US citizens (I know this is imperfect)? People no longer seem to follow the bond/stock split. I'd even bet that the majority of board members have $0 in bonds currently!

 

I also think some timing, both in individual securities and the market as a whole is necessary. Following Buffett too closely seems dangerous since his advice is impersonal and likely incomplete. He also pulled out of the markets (more or less) near a top for over a year.

[james22]

Moreover, our impression is that equity valuations are actually only mildly less extreme “when you compare the returns on equities to the returns on safe assets like bonds.” The reason is two-fold.

 

First, the “returns on equities” here are typically taken to be earnings yields, which as we’ve frequently noted, are affected by cyclical variations in profit margins that make them notoriously poor indicators of long-term prospective returns (see Two Point Three Sigmas Above the Norm and Margins, Multiples and the Iron Law of Valuation).

 

Second, if one cares to actually examine reliable measures of prospective equity returns, bond yields don’t have a tight relationship with those prospective equity returns at all – as the chart below should demonstrate.

 

The belief that equity valuations are “not so high when you compare the returns on equities to the returns on safe assets like bonds” is a common one, but is based on overgeneralizing a very limited period of history. Specifically, the “Fed Model” – the notion that equity earnings yields and 10-year Treasury yields should move in tandem – is an artifact restricted to the period between 1982 and 1997, when both equity and bond yields fell in virtually one-for-one lock-step – bond yields because of disinflation, and equity yields because of what was actually a move from extreme secular undervaluation to extreme secular overvaluation.

 

The Fed Model grossly misinterprets this data as if it were a fair value relationship between stock yields and bond yields. The model had its origins in the chart below, which appeared in Alan Greenspan’s July 1997 Humphrey Hawkins testimony to Congress.

 

Warning: The apparent one-to-one relationship between interest rates and equity yields embodied in the Fed Model is entirely the artifact of this single period in history. If one excludes the 1982-1997 period, the historical correlation between 10-year Treasury yields and 10-year prospective (and actual realized) equity returns is actually slightly negative over the past century, and is only weakly positive in post-war data.

 

I realize that some observers will get upset about that statement, but it's just an empirical fact. The current 10-year Treasury yield says less than investors imagine about the valuation or likely 10-year returns of U.S. equities.

 

I do believe that yields and prospective returns on stocks and bonds are likely to be correlated in strong inflation-disinflation cycles, but prospective equity returns have a far larger and more variable speculative component than investors seem to appreciate.

 

http://www.hussmanfunds.com/wmc/wmc150511.htm

[Uccmal]

Not till I see commercials like these,

 

 

 

Great find.  Those commercials are classics.

 

Great commercials indeed. We do have the Jacob Wohls of the world in this cycle, which may be more pernicious. Main Street could still feel burned from 00 and 08, but if their money has now gone to Mr. Wohl and wirehouse brokers investing in ETFs, is that much different? Obviously my Wohl reference is tongue in cheek, but I do worry about increased ETF activity and the unintended consequences of hot money.

 

A couple of points. First, that we're even comparing this to 99/00 as "it's not as bad as it was then" should give folks pause. Second, I remember 07 as well, and the issue there was moreso related to leverage than initial valuations once shit hit the fan. Buyouts using either internally generated funds or via debt left those companies with little margin for error - and we're certainly seeing the same depletion of cash from balance sheets to fund buybacks today.

 

The ETF activity is going to be a stress point at some point for sure.  We know from experience that when the market tanks and people look at their ETFs, many are going to bail, exaggerating the effect.  At least with mutual funds there are stop gaps in place, with an advisor, and redemption fees in the way of liquidation.  With ETFs, many of those schooled in buy and hold are going to panic, and out they go with the push of a button. 

[ScottHall]

You all think too much.

[mvalue]

I'd be careful on being too confident about about euphoria and market crashes. There wasn't market euphoria in much of the market in 2007. Perhaps in emerging markets and real estate but not in the general market. People were concerned that high oil costs would derail the economy. Even without all the euphoria, 2008 was still worse than the dot com meltdown (for the overall market).

 

Absolutely - not sure where people get the idea that everyone has to be out of their minds bullish for a downturn. I will never forget Bill Miller and Leon Cooperman near mocking the worriers in 07. On the other end, plenty of smart people knew the late 90s were nutty and said so.

[Jurgis]

You all think too much.

 

Thank you Master! /bow

[wawallace]

It's easy to see pockets of overvaluation when there is wide dispersion among asset classes and within asset classes. When you get to this point, and nothing is "absolutely" cheap and you have to get out your "relative" valuation ruler, it gets much harder to judge.

 

Banks look cheap, but they are by-and-large being converted into public utilities. Jamie Dimon said this himself. In addition, cost of regulation is increasing and they may be bumping into the ceiling on buybacks, especially if the regulatory restrictions keeps getting cranked tighter. Didn't JPM's annual report say something about 800 attorneys on staff, just to implement Dodd-Frank?

 

Insurers look cheap as well; however, (especially in Europe) a lot of them are upside down on assets in relation to guaranteed minimums on contracts, see Germany; we haven't had a hurricane in like 10 years; and as long as inflation is subdued underwriting losses will remain relatively predictable.

 

Food companies look cheap because commodity prices have adjusted downward 20%, but if this deflationary cycle continues, they will have to reduce prices as well based on demand.

 

Profit margins are at 11%. Isn't mean something like 8%? Sure there is the argument that technology has propelled us to a new higher plateau of margins...but Irving Fischer would remind you to be cautious about this prognostication. In addition, buy backs will stop at exactly the wrong moment, which is coming down the pike because the fixed income guys are starting to cry about the increase in risk caused by declining equity cushions... it will eventually be worked into covenants.

 

Meanwhile, the lens through which all assets are priced, interest rates, are rising. 30 year is over 3% from 2.5%. And revenues are down over a strengthening dollar. Higher interest rate = higher dollar = lower revenues for our companies that now get 30% of sales from overseas.

 

Declining revenues, declining margins, compressing multiples (due to increasing long rates)...

[oddballstocks]

It's easy to see pockets of overvaluation when there is wide dispersion among asset classes and within asset classes. When you get to this point, and nothing is "absolutely" cheap and you have to get out your "relative" valuation ruler, it gets much harder to judge.

 

Banks look cheap, but they are by-and-large being converted into public utilities. Jamie Dimon said this himself. In addition, cost of regulation is increasing and they may be bumping into the ceiling on buybacks, especially if the regulatory restrictions keeps getting cranked tighter. Didn't JPM's annual report say something about 800 attorneys on staff, just to implement Dodd-Frank?

 

Insurers look cheap as well; however, (especially in Europe) a lot of them are upside down on assets in relation to guaranteed minimums on contracts, see Germany; we haven't had a hurricane in like 10 years; and as long as inflation is subdued underwriting losses will remain relatively predictable.

 

Food companies look cheap because commodity prices have adjusted downward 20%, but if this deflationary cycle continues, they will have to reduce prices as well based on demand.

 

Profit margins are at 11%. Isn't mean something like 8%? Sure there is the argument that technology has propelled us to a new higher plateau of margins...but Irving Fischer would remind you to be cautious about this prognostication. In addition, buy backs will stop at exactly the wrong moment, which is coming down the pike because the fixed income guys are starting to cry about the increase in risk caused by declining equity cushions... it will eventually be worked into covenants.

 

Meanwhile, the lens through which all assets are priced, interest rates, are rising. 30 year is over 3% from 2.5%. And revenues are down over a strengthening dollar. Higher interest rate = higher dollar = lower revenues for our companies that now get 30% of sales from overseas.

 

Declining revenues, declining margins, compressing multiples (due to increasing long rates)...

 

Agree, but would mention that if you step down and look at banks besides the giant one the view is much different.  Dodd-Frank isn't strangling regional or smaller banks.  There is considerable growth going on beneath the biggest names. 

 

I know of a $35m bank (yes terribly tiny) that told me there is no additional regulatory burden beyond what they've had over the past 10-15 years.  Had a guy at a $350m bank griping regulation was killing them because customers have to sign a lot of new paperwork.  Then he admitted they plunked down $20-30k on some software that automates the signing and it solved the problem.

 

We have a regulatory system in banking that is built to push the evils of large bank problems from the last crisis.  Thus large banks will suffer, we see this.  Smaller banks aren't being crushed, and they're taking advantage of the large bank misfortune.

 

 

[wawallace]

Agree, but would mention that if you step down and look at banks besides the giant one the view is much different.  Dodd-Frank isn't strangling regional or smaller banks.  There is considerable growth going on beneath the biggest names. 

 

I know of a $35m bank (yes terribly tiny) that told me there is no additional regulatory burden beyond what they've had over the past 10-15 years.  Had a guy at a $350m bank griping regulation was killing them because customers have to sign a lot of new paperwork.  Then he admitted they plunked down $20-30k on some software that automates the signing and it solved the problem.

 

We have a regulatory system in banking that is built to push the evils of large bank problems from the last crisis.  Thus large banks will suffer, we see this.  Smaller banks aren't being crushed, and they're taking advantage of the large bank misfortune.

 

I am still finding investable companies at the micro cap scale, including banks, so I agree with you... I guess that's the problem with speaking in generalizations. My fear is that the weight of 85% of the investable universe correcting to higher ""risk-free rates"" will crush us all; so margin of safety, management experience and conservatism,  and adequate cash balances are huge. I read in Grant's that there are 263 Trillion in global assets. Google says only 20T of that is the US stock market, and 63T in stocks worldwide... that's a big tide to swim against.

 

Enjoy your newsletter, btw!

[Uccmal]

I dont think insurers are cheap in this scenario, unless they have done a great job hedging against higher rates.  Look for alot of mark to market losses this quarter unless bond prices reverse. 

[ScottHall]

Insurers suck b/c they can't earn anything on their float in this environment. Insurers suck b/c they're gonna take mark-to-market losses on their portfolios as interest rates rise.

 

I don't even know man. Does anyone seriously care about any of this? Some insurers are baller and most are mediocre or suck. Is it really that complicated if you're holding for 10+ years?

[CorpRaider]

I dont think insurers are cheap in this scenario, unless they have done a great job hedging against higher rates.  Look for alot of mark to market losses this quarter unless bond prices reverse.

 

Agree, also a bunch of guys are probably writing a lot of junk over the last year or three.

[Uccmal]

Insurers suck b/c they can't earn anything on their float in this environment. Insurers suck b/c they're gonna take mark-to-market losses on their portfolios as interest rates rise.

 

I don't even know man. Does anyone seriously care about any of this? Some insurers are baller and most are mediocre or suck. Is it really that complicated if you're holding for 10+ years?

 

Huh?