"Macro" Musings

[giofranchi]

Gio pposted a bullish article? The end is nigh. ;)

 

But thanks for posting it. It puts things in perspective. :)

 

;D ;D

 

My pleasure!

 

Gio

[fenris]

"U.S. Small-Cap Rally Sends Valuation 26% Above 1990s"

 

"As prices surged and earnings increased at a slower rate than analysts anticipated, smaller companies have become more expensive than they’ve been 86 percent of the time since 1995"

 

"The Russell 2000 is trading for 49 times reported earnings, compared with a multiple of 39 in March 2000"

 

"The outperformance accelerated this year even as earnings growth trailed large-caps. Profits from Russell 2000 companies climbed 6.8 percent in the last quarter, compared with 8.6 percent in the S&P 500. While bigger companies exceeded analysts’ estimates by a combined 4.6 percent, smaller firms missed by 13 percent, data compiled by Bloomberg show."

 

http://www.bloomberg.com/news/2014-03-24/record-rally-in-u-s-small-caps-sends-valuation-26-above-1990s.html

[rkbabang]

Humans are…guided by the immediate emotional impact of gains and losses, not by the long-term prospects of wealth.

-Nobel laureate, and behavioral investing pioneer, Daniel Kahneman

 

50 REASONS WE’RE LIVING THROUGH THE GREATEST PERIOD IN WORLD HISTORY

 

 

"You need an annual income of $34,000 a year to be in the richest 1% of the world, according to World Bank economist Branko

Milanovic’s 2010 book The Haves and the Have-Nots ... To be included in the top 0.1% requires an annual income of

$70,000"

 

This puts things into perspective.  Most of the people a few years ago holding signs and wearing shirts claiming to be the "99%" in fact weren't.

 

[stahleyp]

http://buzz.money.cnn.com/2014/03/26/whoops-shares-named-oculus-spike/

 

This stuff use to happen a lot during the tech boom. I seem to remember reading a similiar article about another company a few months back.

[giofranchi]

The Euthanasia Of Pensioners In Peoria by Charles Gave

 

 

Gio

Daily+3.28.14.pdf

[giofranchi]

Page 7: The Russell 2000 is as much overvalued as it was in 2000 and in 2007.

 

 

Gio

3.28.2014_NApdf.pdf

[nwoodman]

Thanks Gio,

 

looks like regression to the mean might have started on the Russell 2000.  I reckon we might get to see some traction on the short side of our favorite long/short "fund" FFH

 

cheers

 

nwoodman

[giofranchi]

Thanks Gio,

 

looks like regression to the mean might have started on the Russell 2000.  I reckon we might get to see some traction on the short side of our favorite long/short "fund" FFH

 

cheers

 

nwoodman

 

Of course, I hope so, though I don’t know and I cannot say…

What I do know is that, after two "valuation peaks" gone extremely bad (2000 and 2007), if we ever learn something, people shouldn’t feel comfortable about being at the peak again!

I have written “valuation peaks”, because this has very little to do with macro (I am pretty agnostic about what Mr. Putin in going to do!). Instead, it is a case of prices being out of whack with values once again… And, if we ever learn something, its outcome imo is quite predictable. ;)

 

Cheers,

 

Gio

 

[randomep]

Thanks Gio,

 

looks like regression to the mean might have started on the Russell 2000.  I reckon we might get to see some traction on the short side of our favorite long/short "fund" FFH

 

cheers

 

nwoodman

 

Of course, I hope so, though I don’t know and I cannot say…

What I do know is that, after two "valuation peaks" gone extremely bad (2000 and 2007), if we ever learn something, people shouldn’t feel comfortable about being at the peak again!

I have written “valuation peaks”, because this has very little to do with macro (I am pretty agnostic about what Mr. Putin in going to do!). Instead, it is a case of prices being out of whack with values once again… And, if we ever learn something, its outcome imo is quite predictable. ;)

 

Cheers,

 

Gio

 

Noooooo, this time it is different!

 

Shiller has not written (and does not plan to) write a 3rd edition of his book Irrational Excuberance, which preceeded each of the last two bubbles.......

 

so we are all cool to keep partying......

[tombgrt]

Thanks Gio,

 

looks like regression to the mean might have started on the Russell 2000.  I reckon we might get to see some traction on the short side of our favorite long/short "fund" FFH

 

cheers

 

nwoodman

 

 

Too early to tell but the same goes for current momentum stocks à la cloud, social media, ... We could just as easily just see that part of the market correct while the overal market stays level.

[bmichaud]

Two great "macro" articles that have nothing to do with individual stock picking:

 

http://macronomy.blogspot.com/2014/03/credit-too-big-to-fall.html?m=1

 

http://macronomy.blogspot.com/2014/03/guest-post-equities-frothy-sentiment.html?m=1

[Liberty]

Good read on profit margins and the flawed way in which they are often calculated (mixing 'national' data with 'domestic' data, etc):

 

http://philosophicaleconomics.wordpress.com/2014/03/30/foreignpm/

[original mungerville]

Good read on profit margins and the flawed way in which they are often calculated (mixing 'national' data with 'domestic' data, etc):

 

http://philosophicaleconomics.wordpress.com/2014/03/30/foreignpm/

 

Yes, thank you. A very good read. With continuing government deficits, and low interest rates, maybe corporate margins could remain elevated for some time or at least not fall back too far...say by only 20% or so...

 

If this is the case, the charts in Buffett's 1999/2000 articles in Fortune magazine showing profits relative to GDP are off...which would have been great to understand about 2 years ago!!!

 

[stahleyp]

Thanks for posting. The guy at blog is super smart. I'd like to know who this guy is though. I'm currently going though Reminiscences of a Stock Operator so the alias fits in nicely. haha

 

However, I can't but help thinking "this time is different." Isn't there always someone smart telling us why it's different this time? Yeah, deficits could continue or they might not. What happens if they don't? We always try to rationalize the market.

 

I'm not saying he is wrong. I don't know.

 

If we take a look at this post,

 

http://philosophicaleconomics.wordpress.com/2014/03/16/the-u-s-stock-market-is-expensive-and-it-should-be/

 

"OK, but so what?  Most of us already agree that the stock market is expensive–again, relative to the past. "

 

We could make an argument about "the new economy" and justify high valuations back then, too.. He readily admits that valuations are high relative to the past. But that should be the case. I can't say that I agree with that. Should valuations really be higher in the past if corporations are functioning properly due to massive government intervention?

[Liberty]

I think people shouldn't take "this time is different" to mean "it's always the same" either. I think it's a warning, but the way to find out the truth is to do a lot of work and see what makes sense, not to always assume that everything will be exactly the same.

 

This time for newspapers, it's different. Same for a lot of businesses that got disrupted (you want to own a record store?). People who assumed that the GFC was a replay of the Great Depression had it wrong. etc.

 

I don't think that the author is arguing that any level of valuation (ie. dot-com bubble) would be reasonable, just that if you look at the correct figures, things right now aren't much outside of historical norms, or at least not as high as the bears claim, and that historical norms weren't always as stable and mean-reverting as some might think. That's all. Who knows what will happen from here?

 

Lots of gray zones. It's never completely different, but it's never completely the same either, which is something that people just as often forget and pay for.

[original mungerville]

What that article does is that, if correct, it means we are not quite in bubble territory yet. We are at very very high valuations, with the Fed tapering no less (which could have huge ramifications which may not be completely priced in...I don't know), but not necessarily in bubble territory.

 

This is important because, as Jeremy Grantham points on, bubbles tend to burst / implode themselves whereas very high valuations can persist, correct a little to high valuations and high valuations can go on for some time.

 

The article also may also explain why Munger said at the last Berkshire meeting that just because Warren put up a chart on profits to GDP 15 years ago, it doesn't mean that that view is of the most relevance.

 

If this article is correct, it would explain my over -bearishness for the better part of 15 years (which made me big money in the downturns of 2000, and 2008 but cost me otherwise). 15 years... I have no anchor but this is the first time I have seen this argument backed by data.

 

Having said all this, we are very high valuations regardless. And the Fed is trying to stop its grand experiment.

 

 

[giofranchi]

Sincerely, I have yet to find an attempt to justify present market valuations with some merit…

If you look at the chart about Average Investor Equity Allocation, the author compares nowadays with the early 1980s, saying that situation couldn’t be repeated because interest rates were much higher back then. Yet, that same chart shows something very similar in the early 1950s… and during that time interest rates were as low as they are today (see the attached chart)…

 

Then, the author goes on saying that, even if a 50% market crash were to come, it wouldn’t last years or decades…  ??? ???

Who cares?!? What anyone should worry about is to have cash when good quality assets are marked down, exactly because the time frame at your disposal to take advantage of that situation will always be very limited!!

 

Listen, say whatever you want, I agree with Mr. Klarman:

When the crash finally comes, very few will be prepared.

 

We are swimming against the tide… So better choose among 2 strategies:

1) To be an incredibly smart stock picker, a la Packer;

2) To invest in something whose future results won’t depend at all on what the stock market does, a la Lancashire.

Strategy n.2 is what Mr. Buffett is concentrating on since the late 1990s, preferring the purchase of whole operating businesses to the stock market, unless the stock market were hit hard (2003, 2009).

 

Original mungerville, I am buying more Lancashire today too. ;)

 

Gio

[bmichaud]

Attached are two charts for the S&P Industrial Average:

 

1. Price to Sales Ratio going back to 1955

2. Profit Margins going back to 1955

 

Even if you conclude that margins are "permanently" higher than the historical average, the profit margin series is sharply mean reverting beginning with the '90's recession. Perhaps what goes along with a "new-age" of profit margins is more cyclicality via the "new-age" of enormous leverage. Just eyeballing the chart, an 8.5% margin is approximately 40% above call it a 6% average going back to 1990.

 

Further - would investors have not concluded in 1987 that they were in a "new-age" of permanently "low" profit margins after nearly two decades of downtrending margins? Hmmmm.....me wonders if nearly two decades of uptrending margins is just as unsustainable....

 

Same goes for the price to sales ratio - obviously a chicken and egg thing here, but would investors have not concluded they were at a permanently lower valuation plateau after two decades of below-average valuation ratios?

SP_Industrial_Average_Price_to_Sales_Ratio.pdf

SP_Industrial_Average_Profit_Margins.pdf

[original mungerville]

So second to 2000 as an all time high in price-to-sales combined with an all time high in profits relative to sales (ie profit margin). When you multiply those two out, its not a good place to be in terms of valuation is it?

[original mungerville]

Maybe I have been bearish for good reason?

[original mungerville]

I think people shouldn't take "this time is different" to mean "it's always the same" either. I think it's a warning, but the way to find out the truth is to do a lot of work and see what makes sense, not to always assume that everything will be exactly the same.

 

This time for newspapers, it's different. Same for a lot of businesses that got disrupted (you want to own a record store?). People who assumed that the GFC was a replay of the Great Depression had it wrong. etc.

 

I don't think that the author is arguing that any level of valuation (ie. dot-com bubble) would be reasonable, just that if you look at the correct figures, things right now aren't much outside of historical norms, or at least not as high as the bears claim, and that historical norms weren't always as stable and mean-reverting as some might think. That's all. Who knows what will happen from here?

 

Lots of gray zones. It's never completely different, but it's never completely the same either, which is something that people just as often forget and pay for.

 

Agreed Liberty, however earnings to GDP is just one indicator. What about bmichaud's attachments on profit margins and price to sales, or would you argue that the blogger's argument refutes those as well because they also have different means depending on interest rates (and I would suspect government deficits/surpluses) during the three periods. I am not suggesting either is correct just looking for your views. I guess that could be the case as well?

[original mungerville]

Sincerely, I have yet to find an attempt to justify present market valuations with some merit…

If you look at the chart about Average Investor Equity Allocation, the author compares nowadays with the early 1980s, saying that situation couldn’t be repeated because interest rates were much higher back then. Yet, that same chart shows something very similar in the early 1950s… and during that time interest rates were as low as they are today (see the attached chart)…

 

Then, the author goes on saying that, even if a 50% market crash were to come, it wouldn’t last years or decades…  ??? ???

Who cares?!? What anyone should worry about is to have cash when good quality assets are marked down, exactly because the time frame at your disposal to take advantage of that situation will always be very limited!!

 

Listen, say whatever you want, I agree with Mr. Klarman:

When the crash finally comes, very few will be prepared.

 

Gio,

 

Yes, buy buy buy Lancashire! I think Berkshire should do well in almost any environment as well. With the former, you get no exposure to the economic/market environment but concentration risk in Brindle's underwriting. In the latter, you get some exposure to the environment but more diversified earnings streams.

 

Of course if Brindle can produce a consistent ROE in the mid to high teens, more money will be made in Lancashire at this point.

 

We are swimming against the tide… So better choose among 2 strategies:

1) To be an incredibly smart stock picker, a la Packer;

2) To invest in something whose future results won’t depend at all on what the stock market does, a la Lancashire.

Strategy n.2 is what Mr. Buffett is concentrating on since the late 1990s, preferring the purchase of whole operating businesses to the stock market, unless the stock market were hit hard (2003, 2009).

 

Original mungerville, I am buying more Lancashire today too. ;)

 

Gio

[wisdom]

In a capitalistic system - shouldn't the profit margins be mean reverting over time?

 

If I am earning 2% while others are earning 10%+ in any given business, shouldn't my capital go into that industry and reduce the margins by increasing supply?

 

This is why I believe that the long run average has been around 6% and will be so in the future as well.

 

 

[bmichaud]

Original,

 

I am bearishly bent as it is, so I am biased....but ur bearishness over the past 15 years is justified, IMO. Stocks have done virtually nothing with two 50 percent downturns, yet because we are right back to absurd valuations, it appears historical "overvaluation" is the new normal, since we've been at these levels for the majority of the past 15 years.

 

It's completely circular. High current valuations are required to justify 20 years of overvaluation, yet because of the high valuations for 20 years, stocks have returned hardly anything to speak of, thus nullifying the Bulls' point that "old" valuation metrics have failed to predict long term market returns.

 

I agree with Grantham that you could get an even larger bubble until the next recession.

 

Though...NDR is currently calling for a 2014 "reset" of the market similar to the 1987 crash. While not predicting a crash, they think a 2011 type decline will reset the market for a push to true bubble levels.

[Liberty]

Agreed Liberty, however earnings to GDP is just one indicator. What about bmichaud's attachments on profit margins and price to sales, or would you argue that the blogger's argument refutes those as well because they also have different means depending on interest rates (and I would suspect government deficits/surpluses) during the three periods. I am not suggesting either is correct just looking for your views. I guess that could be the case as well?

 

My view is really I don't know. I do share other people's views when I find them interesting or when they seem to correct widely held misconceptions, but when it comes to macro, I just watch it from the sidelines, mostly because I find it interesting. I certainly don't have a coherent general theory of macro, and I don't need to since I don't plan on owning an index -- during a period of low returns for the indexes, lots of individual businesses have nicely compounded...

 

But like Buffett says, there's always reasons to be negative. Some people have been bearish and piling up cash since 2011 or 2012. How far would the market have to fall for them to make up the lost opportunity since then? And people who are very bearish tend to stay bearish even when things get cheap because any drop seems to confirm their views (ie. people who thought that things wouldn't turn around until the market got to a P/E of 7 in 2009 and so never bought anything).

 

Personally, I now try to be mostly fully invested in high-quality long-term holdings that should be able to survive almost anything  and allocate capital for me, and just ride it all out. I've spent the past 2 years seriously upgrading the quality of the businesses I own and diversifying more. I'm not good enough to do what many here do successfully, so I don't even try anymore.