What if it is 1982 all over again?

[giofranchi]

 

We all know the image in attachment. So, what if Jeremy Grantham is right, what if Hugh Hendry is right, what if John Mauldin is right, what if John Hussman is right, what if many other “macro-guys” are right, and in 2017, or 2018, or 2019 will be 1982 all over again? And a new secular bull market will be finally launched?

My parents are truly great! They gave me the best education possible, they were always loving, and they always cared for me. But, there is just one regret I keep holding against them (I know, too bad of me!), that is: Why on earth didn’t you invest in Berkshire Hathaway in 1982??!! Ok, they had never heard of Ben Graham or Phil Fisher, so I guess they can be forgiven!

 

But, on this board you are all very bright and knowledgeable money managers, and you know everything about value investing. Nonetheless, I keep reading sentences like the following: “I sold my shares in FFH, because I found greater values elsewhere.” So I ask you: Why on earth won’t you be invested in Fairfax Financial in 2017?

Bear with me a moment, and allow me the chance to explain.

Let’s assume that in 2017 FFH will be trading around book value, like it is trading today. Most probably, if a new secular bull market is just a few days away, in 2017 the S&P500 Shiller P/E will be no higher than 12. Today it is 22,26. So, I guess in 2017 “greater values elsewhere” will be much more common than they are today. It follows you won’t invest in FFH.

Not to invest in FFH at book value implies the following two hypothesis:

1) You have to do better than the markets, even though at the beginning of a secular bull all markets will rally, and it won’t be that easy to keep up with them… anyway, I agree that value strategies perform much better at the beginning of a secular bull than at the end, so let’s check hypothesis number one.

2) To shun FFH at book value, you must be confident to achieve a return on your money higher than the return Mr. Watsa will achieve on FFH shareholders equity. Even though Mr. Watsa is demonstrably one of the few money managers who consistently and appreciably have beaten the markets. Even though Mr. Watsa works with the float that magnifies his returns.

Are you so sure that we can check also hypothesis number two?

My answer follows:

 

Aaron Marcu remembers the phone ringing one August evening in 2003. It was Ackman – on vacation in Italy – wanting to chat with Marcu about an article he’d come across in a bankruptcy law journal that he thought might relate to MBIA’s involvement in the credit-default-swap market.

“Bill, it’s 9 p.m. here,” Marcu told him. “It must be 3 o’clock in the morning where you are.”

“This is incredible stuff,” Ackman said. “I can’t put it down.”

Here’s a person, Marcu says, who seems to have gotten quite a few things in life right. “He’s tall, good looking, rich. He has a great family, lives in an incredible apartment,” Marcu says. “So what is he doing reading a bankruptcy treatise at 3 a.m. in the morning when he’s on vacation in Tuscany?”

- The Confidence Game

 

So, to all the Ackmans out there I say: Ok, not a single doubt in my mind that you will be extremely successful! But, you must stay up until 3 a.m., reading a bankruptcy treatise, on a vacation in… well, wherever you go on vacation! (I will be in Tuscany in two weeks!! Really!! Ahahahahahah!!)

 

Everybody else should heed the always insightful Mr. Buffett: “It’s not necessary to do extraordinary things to get extraordinary results.” I reckon an investment in FFH at book value the simple (“but not easy”) thing that will get you extraordinary results.

 

You may object: 2017??? What about the five years in between?! Well, if all those “macro-guys” are right, in the next five years ‘Bad things are going to happen’ (See the FT article on Hugh Hendry, July 17, 2012). We are still living through a secular bear market. And in a secular bear market asset allocation is much more important than stock picking:

 

“The wise investor will disregard the day-by-day fluctuations of the stock market or real estate market and base his buying and selling on these long periods of rise and fall. Above all, and I repeat it again and again—he must have liquid capital in time of depression to buy the bargains and then he must sell before the next crash. It is difficult if not impossible to do this but the conservative longtime investor who follows the general rule of buying stocks when they are selling far below their intrinsic value and nobody wants them, and of selling his stocks when people are bidding frantically for them at prices far above their intrinsic value—such an investor will pretty nearly hit the bull’s-eye.”

- The Great Depression, A Diary

 

I cannot think of a better description for Mr. Watsa.

During the next five years, there is the clear and distinct possibility that the protections Mr. Watsa had put in place will be much more valuable than all those supposed “greater values elsewhere”.

 

giofranchi

 

SP_500_1995-2011_and_Projected_Overshoot_2011-2021.bmp

[ERICOPOLY]

So, what if Jeremy Grantham is right, what if Hugh Hendry is right, what if John Mauldin is right, what if John Hussman is right, what if many other “macro-guys” are right, and in 2017, or 2018, or 2019 will be 1982 all over again? And a new secular bull market will be finally launched?

 

 

By 2019 I expect BAC to have earned $7 a share even if their earnings never improve from here.  However I expect the earnings per share to more than double by 2019.

 

So I hope they are able to find values again.  I have found what I need, I don't care if they are right or wrong.  I wish them success as well.  Hope their ship comes in.  In fact, I expect BAC to be much higher in 2019 when their ship comes in, and then I can sell and plow the proceeds back into other cheap stocks that will be everywhere to be found.

 

 

 

 

 

 

 

[ubuy2wron]

Mr. Milano ( no disrespect Milan is one of my favorite cities and you are contributing greatly here imo.) The central tenant of Mr Graham is margin of saftey. At times FFH has traded with a large discount to BV and a large margin of saftey if you assumed that the hedgies could not kill it. I am a huge fan of Prem and I am in awe of his investment acumen and have frquently road his coat tails as far as his investment ideas are concerned I just became a shareholder in Level 3 for example. I also believe that we are rapidly approaching a 1982 moment in the markets (prolly we have to see one more recession in N.A first is my bet however) If you put a gun to my head and said you have to buy on stock today and hold it for a decade I am pretty sure FFH would be on my list of potential purchases. All I need is a lower price on FFH to get me to pull the trigger  at the current time. I would like him to succeed on his Rim purchase because it will increase the premium people will be willing to pay for FFH in the future somewhat like the Buffett premium which used to exist for BRK and because I am guessing so many of the hedgies who were short FFH a few years back are all over the Rim short. 

[racemize]

shalab, I'm not certain what you are getting at with the stats on Berkshire relative to FFH--could you elaborate?

[twacowfca]

The ideal conservative investment is ( superficially ) one that will increase intrinsic value and market value more than the general stock market for many years and hold almost all of its market value in a market decline.  By this standard, BRK is now a better conservative investment than just about anything else.  In a stock market crash, BRK, with the Buffett put, should hold most of it's value, giving optionality to continue holding BRK or to rotate out of it to extraordinary bargains that might become available.

 

FFH should hold or increase its value in a bear market while its hedges are in place, but underperform in a flat or bullish market.

 

All things considered, BRK appears to be more attractive than FFH.

[west]

My feeling on whether to invest in Fairfax or not has to do with whether you're investing in a taxed account or a non-taxed account.

 

For example, let's say Fairfax will grow by 13% every year, on average, for the next 21 years.  You can invest in Fairfax and hold it for 21 years or, alternatively, invest in your own, personally selected securities and, say, get 20% on average every year, but you have to sell your positions every three years.

 

In a non-taxed account, this is a no brainer.  You go with the 20% return selections.

 

However, in a taxed account, it may make sense to just buy Fairfax and hold!  If your long term capital taxes, between state and federal, are 25%, your total returns would be:

 

1.13 ^ 21 years * (100% - 25%) - 100% = 877% total after tax returns for Fairfax, assuming it returns 13% on average and you buy and hold for 21 years.

 

OR

 

1.20 ^ 3 years * (100% - 25%) - 100% = 30% after tax returns for the 20% return selections after 3 years.

 

For 7 periods (read: seven 3 year periods is a total of 21 years, or the total Fairfax holding duration in this example) this results in:

 

1.20 ^ 3 years * (100% - 25%) * 7 periods - 100% = 807% total after tax returns for the 20% selections.

 

So you actually get better returns over the long run if you just stick with Fairfax, returning 13% a year, than if you pick your own stocks returning 20% a year, but you have to sell every three years.  At least in a taxed account.

 

The question I can't answer though, is will Fairfax actually be able to sustain 13% returns, on average, for the next 21+ years.  I'm guessing they will, but I'd be lying if I said I knew for sure.

 

What do you guys think?

[ERICOPOLY]

Buffett put?  The stock is up more than 70% since the 2009 lows.  I didn't know the IV was growing that quickly!

 

In other words, the market can still knock it down from here.

[jeffmori7]

Eric, there was not planned buyback in 2009. Now that there is one, it is less likely that the Berkshire stock will go under book. So this 70% run is more like a recovery from an undervalued stock than a growth in IV. But now on, we should see a less volatile stock on the downise, unless IV varies that much.

[ERICOPOLY]

So this 70% run is more like a recovery from an undervalued stock than a growth in IV.

 

My thoughts exactly -- it's been in large part a matter of recovery from a state of undervaluation. 

 

I put little faith in the buyback plan preventing a return to undervaluation.  Many companies have buyback plans -- are they safe havens too?

[ERICOPOLY]

I might mention that Fairfax had hedges galore and a buyback plan during the 2008 period.  Stock was dropping even as AIG cds hedges (and all CDS hedges) were soaring.  Market just sells whatever is liquid.  It all burns.

[matjone]

"By 2019 I expect BAC to have earned $7 a share even if their earnings never improve from here.  However I expect the earnings per share to more than double by 2019."

 

If you don't mind clearing something up - when you say you expect eps to more than double by 2019, did you mean to say that you thought total earnings would double?  Going to 7 would already be a double, no?

 

When I first read it I thought maybe you meant that buybacks alone would increase eps from 2 (I believe that was Berkowitz' number) to 7, and that the overall earnings would double, which would mean eps would go from 2 to 14.

[tombgrt]

Lol he means more than double from today's level of earnings. So about $1 now should turn into $2+ EPS by 2019. Wouldn't focus too much on Berkowitz's numbers in today's market.

 

And I agree with twacowfca; BRK > FFH at this point in time, although it was much clearer in the 1,15xBV range. I don't see BRK going under the lows of last summer anymore, even if the market drops 35% from here. If it does, you'd probably have a very safe 3/4-bagger by 2020.

[twacowfca]

So this 70% run is more like a recovery from an undervalued stock than a growth in IV.

 

My thoughts exactly -- it's been in large part a matter of recovery from a state of undervaluation. 

 

I put little faith in the buyback plan preventing a return to undervaluation.  Many companies have buyback plans -- are they safe havens too?

 

This buyback plan is unique.  A pledge by the world's most respected investor to buy BRK "aggressively" whenever it drops below an objective price, 110% of BV.  That's not all.  BRK is lightly traded, perhaps about 10% to 15% of the proportional daily weighted volume/market cap of BAC, for example, plus a lot of cash on the BS to make good on that pledge.  Plus the self interest of the Gates Foundation to continue to make good on the pledge when Warren is no longer at the helm to ensure that they won't have to make their mandated, regular sales of BRK at a price that greatly undervalues the stock.

[ERICOPOLY]

"By 2019 I expect BAC to have earned $7 a share even if their earnings never improve from here.  However I expect the earnings per share to more than double by 2019."

 

If you don't mind clearing something up - when you say you expect eps to more than double by 2019, did you mean to say that you thought total earnings would double?  Going to 7 would already be a double, no?

 

When I first read it I thought maybe you meant that buybacks alone would increase eps from 2 (I believe that was Berkowitz' number) to 7, and that the overall earnings would double, which would mean eps would go from 2 to 14.

 

To clarify:

 

I expect EPS to move to at least $2 over that timeframe before taking into account share reduction.

 

So the idea is that P/E will be no higher than 3.5x if the price hasn't changed.  Right, so that is lower than the market has ever been, I believe... including 1982.

 

But then I'm actually expecting it to happen in 3 years, so by 2015 I'm expecting to be holding a stock trading at 3.5x earnings per share if price still is stuck at $7.  Others aren't quite so enthusiastic, but I figure if the company hits their 9% Basel III ratio at the end of this year and are then able to return AT LEAST 50 cents per share (dividends and buybacks combined), then by seven years from now I'll only have $3.50 remaining on the table per share, or far less than that (because I expect return of much more than 50 cents per share as earnings climb).

 

Right, so $3.50 left per share -- maybe I now own 150% as many shares if I kept on reinvesting at $7. 

 

So I'm not scared of 1982 in 2019.  Maybe it will hurt a bit if 1982 valuations happen later this year, or next year, but the odds of that are not certain.

 

Keep in mind that BAC is nearly already at 1982 valuation.  I mean it's hardly anywhere near these 22x Shiller PE10 ratio that's been casually tossed around.

 

Sure, the Schiller P/E ratio scare is all about earnings profit margins reverting to normal.  However, if BAC profit returns to normal then the stock goes sky high from here  :D  So look, mean reversion is basically the last thing I fear.

 

 

 

 

 

 

 

[ERICOPOLY]

When I first read it I thought maybe you meant that buybacks alone would increase eps from 2 (I believe that was Berkowitz' number)

 

I think Berkowitz has been saying $2-$3. 

 

The funny thing is that even Mike Mayo was saying $2 per share last year.  Oh how quickly they run after the stock drops (Mayo, not Berkowitz).

 

I frankly have a low opinion of him, but here it is anyway:

 

http://www.cnbc.com/id/41891291/Sell_Citigroup_Buy_Bank_of_America_Mayo

 

"Bank of America — No. 1 — is you don't even need revenue growth for this company to earn to earn $2 dollars a share," he said,  "No. 2, half of Bank of America is the old Merrill Lynch with a little bit more capital markets that's a very nice business fix.  And No. 3, no question that expectations are low on Bank of America management team, but I think they can exceed what is already pretty low expectations," Mayo added.

[ERICOPOLY]

So this 70% run is more like a recovery from an undervalued stock than a growth in IV.

 

My thoughts exactly -- it's been in large part a matter of recovery from a state of undervaluation. 

 

I put little faith in the buyback plan preventing a return to undervaluation.  Many companies have buyback plans -- are they safe havens too?

 

This buyback plan is unique.  A pledge by the world's most respected investor to buy BRK "aggressively" whenever it drops below an objective price, 110% of BV.  That's not all.  BRK is lightly traded, perhaps about 10% to 15% of the proportional daily weighted volume/market cap of BAC, for example, plus a lot of cash on the BS to make good on that pledge.  Plus the self interest of the Gates Foundation to continue to make good on the pledge when Warren is no longer at the helm to ensure that they won't have to make their mandated, regular sales of BRK at a price that greatly undervalues the stock.

 

Light trading has long been a hallmark of BRK, including 2008 and 2009-- still the price fell.  As the whorehouse burned, even BRK came running out .  They can purchase only up to 25% of average daily volume though (I think that's right).  Unless they do a tender offer, which he might.  So the effective volume is 75% of what is already considered "light volume".  It's weird though, in past years he said he would never try to support the stock -- nothing wrong with a person trying something new, if that's indeed what he intends to do.

 

ORH was a lightly traded stock too.  I remember when FFH sold more of their ORH stake and people thought it would be good for the stock as it would make it more liquid.  I thought huh?  Anyways, it didn't help the stock.  But I think right there in the ORH annual report they stated something to the effect that more liquid would improve the stock performance.

 

Anyway, less liquid improves it too?  I don't know.  I tend to believe that supply/demand sets prices, but I'm so naive I guess because I argued that point back when ORH shares float was increased and nobody agreed with me -- liquidity being more important because it would attract more serious investors, I think they argued.  Or maybe ORH was unique because even so, it was still just a minority stake. 

 

 

[bargainman]

Perhaps I'm not remembering right, but I distinctly remember him saying that he will *not* backstop/support the stock.  Just cause he'll purchase aggressively doesn't mean he'll hold the fort if people sell enmass.  After all he might have other better deals to chase with that money if the bottom really falls out...

[berkshiremystery]

When I first read it I thought maybe you meant that buybacks alone would increase eps from 2 (I believe that was Berkowitz' number)

 

I think Berkowitz has been saying $2-$3. 

 

 

 

In 2009 Paulson had also some $3 EPS estimate in his head.

http://touch.valuewalk.com/valuewalk/#!/entry/a-flaw-in-paulsons-calculation,501638c17af68a84dc48b87a

 

I would rather say that such an number is near term unrealistic, but in my opinion a $2 EPS number should be easier achievable around/after 2015 or in the following years thereafter. But it also depends on where the share price trades,... if it stays lower for some extended time frame they might be able to reach some higher EPS ratio through share repurchases.  A $2 EPS number on a $7.5 stock price would be an awesome 26.67% earnings yield. Anyway, I myself feel with a lower estimate of around $2 EPS much more comfortable,... it is better to be roughly right than precisely wrong.

 

[giofranchi]

Mr Giofranchi referred to buying BRK in 1982 - FRFHF today is not the same as BRK in 1982. FRFHF is a different type of operation - FRFHF is more of a macro play and Graham type operation.

 

Also BRK had lower float in 1997 than FRFHF does today. The float went up after GenRe acquisition.

 

 

Shalab,

I did not mean to say that BRK and FFH are the same kind of business. Instead, what I meant is the following:

1) when you find a manager with a proven track record,

2) when you understand what he does and agree with his investment philosophy,

3) when he works with permanent capital (not subject to investors’ redemption),

4) when he is still young enough to go on compounding for the next 20 years,

5) when he doesn’t have to work with too much capital yet, that inevitably dampens returns,

6) when he can use “insurance leverage” (which is quite different from “leverage”), and you cannot,

7) when you can partner with him at book value,

Etc. etc. etc.

Well, it is generally a good idea to invest in his or her company, whether it is BRK or FFH.

 

When you say that BRK had lower float in 1997 than FFH does today, I guess you mean that FFH is more leveraged, and therefore riskier. Of course, I agree. But let’s examine how an insurance company increases shareholders’ equity:

 

T/S = (I/A)(1+R/S) + (U/P)(P/S)

 

Define:

T = Total after-tax return

I = Investment gain (or loss)

U = Underwriting profit (or loss)

P = Premium income

A = Total Assets

R = Reserves & Other Liabilities

S = Shareholders’ Equity

T/S = Total Return on Equity

 

(1+R/S) will always be positive, and, as long as an insurance company continues to write insurance, P/S will be positive too. So, for T/S to become negative (that’s to say, for shareholders’ capital to decrease), I/A and/or U/P must be negative. Furthermore, I/A is much more important than U/P, because the insurance leverage factor (1+R/S) will always be greater than 1, whereas P/S might be lower than 1 (actually, at the end of 2011 P/S for FFH was less than 1, see Net Premiums Written vs. Statutory Surplus in attachment). And I hope you agree with me if I say that, as far as I/A is concerned, I am fully confident with the Hamblin Watsa Investment Performance (see attachment).

 

This is not to minimize the importance of U/P! Which is extremely important: as long as U/P stays positive, P/S can increase. Furthermore, if underwriting results are good, FFH could “indulge” in a more aggressive investment policy (more RIM like investments… ok, just joking!!!!). And this is why I wrote in another post that, given his track record at Odyssey Re, I really like Mr. Barnard to oversee all FFH insurance operations. If FFH as a whole becomes a profitable underwriter, I believe that this company will be much more valuable than many now think possible.

 

Finally, compared to other insurance and reinsurance companies, FFH does not seem to be too much leveraged: Premium/Surplus is less than 100%, while Investments/Surplus, if from investments we subtract $8 billion in cash, is more or less 220% (see the attachment "Insurance Leverage").

Net_Premiums_Written_vs._Statutory_Surplus.pdf

Hamblin_Watsa_Investment_Performance.pdf

Insurance_Leverage.pdf

[giofranchi]

I called (1 + R/S) the insurance leverage factor. That might be misleading. I think it is much better to define (1 + R/S) as the “investment leverage factor”. While P/S could be defined as the “underwriting leverage factor”. In fact, being R = A – S, it follows that:

(I/A)(1+R/S) = I/A + (I/A)(R/S) = I/A + (I/A)[(A –S)/S] = I/A + (I/A)(A/S – 1) = I/A + I/S – I/A = I/S, which is return on equity from investments.

Of course, (U/P)(P/S) = U/S, which is return on equity from underwriting.

 

I know this is 101 insurance analysis, but may some “Newbie” can find it useful… at least, I hope so!

 

Lastly, from Investments should be eventually subtracted $7 billion in subsidiary cash, the $1 billion at the holding company doesn’t count. That leaves us with an Investments/Surplus of almost 240%.

 

[rmitz]

Perhaps I'm not remembering right, but I distinctly remember him saying that he will *not* backstop/support the stock.  Just cause he'll purchase aggressively doesn't mean he'll hold the fort if people sell enmass.  After all he might have other better deals to chase with that money if the bottom really falls out...

 

You are correct.  But I also agree there is some value to that public statement--he does have some incentive to keep the price not absurdly low for his donation, and he will now use his gusher of a capital stream to buy opportunistically over time.  I wouldn't expect there to ever be much of a purchase, but it will be a factor over time.

 

Anything can happen on a particular day.

[giofranchi]

So you actually get better returns over the long run if you just stick with Fairfax, returning 13% a year, than if you pick your own stocks returning 20% a year, but you have to sell every three years.  At least in a taxed account.

 

What do you guys think?

 

West,

you are certainly right. But, as I wrote at the beginning of this topic, I have nothing to say to people who can achieve a 20% CAGR for 21 years… There is not a single doubt in my mind that they are future billionaires! They do not have even to promote their skills! Money will surely find them!

The brother in law of my brother in law (ok, that sounds a little bit confusing…) is Mr. Carlo Pesenti, CEO and controlling shareholder of the Italcementi Group. If I could assure him that I will achieve a 20% CAGR for 21 years (and if he believes me!!!!), he will sell all the cement he possesses, will shut down his multinational company, and will give me the proceeds to invest!

 

giofranchi

 

[giofranchi]

And I agree with twacowfca; BRK > FFH at this point in time

 

I do not agree.

 

1) Mr. Watsa is 20 years younger than Mr. Buffett: FFH > BRK,

2) Mr. Watsa has to work with much less capital than Mr. Buffett: FFH > BRK,

3) Mr. Watsa is fully hedged: don’t get me wrong, it is not that “value investing” doesn’t work, value investing is the only way of investing, but, in a secular bear market, when valuations are high, and there is a mountain of debt in the system ($70 trillion of G10 debt is the collateral for $700 trillion in derivatives… 1200% of global GDP… mind numbing!), it is “INVESTING” that does not work! FFH > BRK,

4) FFH relies on insurance much more than BRK: and I like insurance in a bear market, people always need protection, in good and in bad times, what saved the day at BRK in 2008 were the insurance operations: “Most of the Berkshire businesses whose results are significantly affected by the economy earned below their potential last year, and that will be true in 2009 as well. Our retailers were hit particularly hard, as were our operations tied to residential construction. In aggregate, however, our manufacturing, service and retail businesses earned substantial sums and most of them – particularly the larger ones – continue to strengthen their competitive positions. Moreover, we are fortunate that Berkshire’s two most important businesses – our insurance and utility groups – produce earnings that are not correlated to those of the general economy. Both businesses delivered outstanding results in 2008 and have excellent prospects.” Warren Buffett. And I like what Mr. Watsa said in the most recent Q2 2012 Earnings Call: “As I said in the first quarter call, we are growing again. The large catastrophe losses in 2011, very low interest rates and the reduced reserve redundancies means that there is no place to hide in the industry. Combined ratios have to drop well below 100% for the industry to make a single-digit return on equity with these low interest rates.” FFH > BRK,

5) FFH trades at 1,2 x book value, while FFH trades at 1,05 x book value: FFH > BRK,

6) BRK is less leveraged, and therefore less risky than BRK: BRK > FFH.

 

Where does this leave us? FFH 5, BRK 1.

 

Of course, you might object it is too simple a thesis. Quoting Sam Zell: “I philosophically believe

that if you can't delineate your idea in one or two sentences, it's not worth doing. I'm the Chairman of everything and the CEO of nothing, which means that the people who work for me come to see me with ideas all day long. My criterion is if they can't concisely explain their idea, then I throw them out of my office and tell them to come back when they can. Simplicity is critical.”

 

giofranchi

 

 

[giofranchi]

these 22x Shiller PE10 ratio that's been casually tossed around.

 

Sure, the Schiller P/E ratio scare is all about earnings profit margins reverting to normal.  However, if BAC profit returns to normal then the stock goes sky high from here  :D  So look, mean reversion is basically the last thing I fear.

 

ERICOPOLY,

I wasn’t talking about BAC. I simply won’t invest in mega-cap financial companies that I do not understand. No matter what their shares’ price is. If you understand BAC, the way certainly Mr. Berkowitz does, you will make a lot of money, along with Berkowitz and others. Glad for you!

 

Instead, I was talking about market valuations. And, whether you use the Shiller P/E, or the Market Value / GDP ratio, or the Q Ratio, or the GMO 7-years Asset Class Return Forecast, or the Regression to S&P Composite Index Growth Trend, or you pay attention to the very accurate work done by John Hussman, one thing seems clear to me: market valuations are not consistent with a secular bear market bottom. At least, I have still to find someone with an analysis rigorous enough, to convince me of the opposite. Please, mind I didn’t say ‘market valuations are high’, that might be more debateable. Instead, I just said ‘market valuations are not consistent with a secular bear market bottom’. That is true, even if we use the S&P500 TTM P/E: right now it is 15,93, while at secular bear market bottom it has always been below 10. Please, check the image in attachment (which, of course, you already know!).

Last week the TTM P/E of the Russell2000 was 31! Ok, I get that they are small-cap and growth stocks, but do you really think that people would be willing to pay 31 times earnings (for any kind of asset), if we really were at the bottom of a secular bear market?

I have serious doubts.

 

giofranchi

[txitxo]

  Speaking about valuations, 1982 was 2011 in Europe (have a look http://mrmarket.eu/). The Shiller P/E hit 11, the same level  it had in 1982 (of course it went well below 10 in 1975).

 

I have looked really hard at how to use value-informed statistics for investing (as a scientist, that's my circle of competence). Valuations are very limited tools. They obviously identify extremes, if the Shiller P/E hits 30, run for the exits, and if it gets close to 5 you should pawn all your possessions to buy stocks. However, anything in the middle is useless as a short term predictor. You can have a 40% drop from P/E=11, although you will do well in the long term if you buy at that level. 

 

  The best tool I've found for timing  (where "timing" is ~1 year) is what I call the "expensive crap" indicator. You look for companies which have really bad financial indicators, lots of debt, fuzzy accounting, etc. but which are relative expensive in a statistical sense. That of course will not tell you much about any single company, but when you look at the aggregate, at their fraction in the market, it is a very accurate signal of overall "optimism". And we all know what happens when too many people are paying too much for objectively crappy companies just based on their "stories".

 

  That indicator is now flashing crimson red for the US market, may be due to QE3 expectations. Every time that happened since 1990 the returns were extremely poor during the next year. That's why I also have a large chunk of my portfolio in FFH and keep adding to it. 

 

  The Euro-core countries, on the other hand, look like a safe place to invest right now. Lots of pessimism already baked into the prices.