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Interesting little blip in today's WSJ.....

 

http://www.wsj.com/articles/moneybeat-deals-are-getting-dear-1429493348

 

16.5

The average Ebitda multiple firms are paying to acquire U.S. companies this year, the highest on record.

 

Not only is U.S. deal making surging, so are valuations for U.S. companies.

 

Buyers are paying 16.5 times earnings before interest, taxes, depreciation and amortization, or Ebitda, for companies. That is the highest level since 1995 when Dealogic began tracking the data, according to Dealogic, and easily exceeds the previous high mark of 13.3 times Ebitda recorded last year.

 

Rising U.S. valuations also have lifted the average valuation globally to its highest level on record. The average enterprise value to Ebitda multiple stands at 12.4 world-wide. Enterprise value represents a company’s stock market capitalization minus a company’s cash, plus its outstanding debt.

 

The increase in valuations comes as deal activity is surging. So far this year, buyers of U.S. companies have announced $448 billion worth of acquisitions. World-wide, $1.08 trillion worth of deals have been signed. Both are at their highest levels since 2007.

 

Yet buyers are paying just 25.2% above where the sellers’ shares were trading the week before the deals were announced. That stands as the third-lowest level for a year on record, according to Dealogic.

 

With U.S. stocks hovering near record highs, but having lost some of their momentum, and the Fed looking to raise rates for the first time in nine years, the modest premium suggests sellers aren’t holding out for an even richer payoff.

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with all these earnings multiple analysis, don't you have to account for interest rates? 16.5 at 5% interest rates is very different from 16.5 when rates are below 2%

 

also, regarding raising rates, i don't understand why they would rise signficantly.  Most the the yield curve is very low, and the fed hasn't been buying for a bit.  Is it possible that the market rate for money is very low because we are in a long term secular deleverging?  businesses not borrowing, but instead paying back debt

 

i took a quick look at the spread between the 10 t-bill rate and the 10 year E/Y (ie 1/shiller PE).  This number is graphed below since 1880s.  looks like its not really all that overvalued given interest rates.  Sorry the x-axis is ascending in the wrong direction (2015 on left side)

 

http://imgur.com/nRD7lIv

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also, regarding raising rates, i don't understand why they would rise signficantly.  Most the the yield curve is very low, and the fed hasn't been buying for a bit.  Is it possible that the market rate for money is very low because we are in a long term secular deleverging?  businesses not borrowing, but instead paying back debt

 

 

I think people have bought into the "Fed is going to raise rate => rates are going to rise" idea so much that, its very possible that the 10Y actually collapses sub 1% after the first rate hike. Just look at the German 10Y Bunds (7bps), Japan 10Y (30bps).....the UST 10Y at 188bps looks artificially high! Fed doesn't control the 10Y, only the overnight rate.

 

I am in the camp that long term rates aren't going anywhere but down in near future absent a stupid US govt crisis.

 

Now, compare the SP500 index dividend yield against this rate backdrop. I don't understand how people are so confident about a general market overvaluation. Dividend yields have been rarely below 10Y rates and we are in an environment with one of the lowest dividend payout ratios...

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I remember how obvious it was in 2009 that higher inflation was an imminent unavoidable hangover from all the Fed juice. It was painfully obvious. Everyone smart you could look to said so, too.

 

No one knows what will happen. It's true that all else equal if rates stay low for a very long period the market is not clearly overvalued, and certainly not relative to other asset prices. Unfortunately all else is never equal. Further, if you knew what rates were going to do you could make a ton of money on that information without having to bother with the stock market.

 

Edit: to clarify, this means justifying 16.5x ebitda because of rates is questionable to me

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Interesting little blip in today's WSJ.....

 

http://www.wsj.com/articles/moneybeat-deals-are-getting-dear-1429493348

 

16.5

The average Ebitda multiple firms are paying to acquire U.S. companies this year, the highest on record.

 

Not only is U.S. deal making surging, so are valuations for U.S. companies.

 

Buyers are paying 16.5 times earnings before interest, taxes, depreciation and amortization, or Ebitda, for companies. That is the highest level since 1995 when Dealogic began tracking the data, according to Dealogic, and easily exceeds the previous high mark of 13.3 times Ebitda recorded last year.

 

Rising U.S. valuations also have lifted the average valuation globally to its highest level on record. The average enterprise value to Ebitda multiple stands at 12.4 world-wide. Enterprise value represents a company’s stock market capitalization minus a company’s cash, plus its outstanding debt.

 

The increase in valuations comes as deal activity is surging. So far this year, buyers of U.S. companies have announced $448 billion worth of acquisitions. World-wide, $1.08 trillion worth of deals have been signed. Both are at their highest levels since 2007.

 

Yet buyers are paying just 25.2% above where the sellers’ shares were trading the week before the deals were announced. That stands as the third-lowest level for a year on record, according to Dealogic.

 

With U.S. stocks hovering near record highs, but having lost some of their momentum, and the Fed looking to raise rates for the first time in nine years, the modest premium suggests sellers aren't holding out for an even richer payoff.

 

I think the lower premiums has more to do with the bull market than sellers accepting less. When your stock moves 400% in 5 years there's less incentive to hold out for higher premiums. From the seller point of view, the stock market is undervalued if rates stay at these levels for another 5 years or overvalued if rates move to 5% in 5 years.

 

Equities are not as directly priced by interest rates moves as fixed income products but the dependency is still quite high with expectations. The relative valuation of the overall stock market is pretty dependent on long-term interest rates (and the expectations of them). I think that the US is going through a tremendous deleveraging period in what was nominal terms and certainly still real terms. Savings rate just reached above 5% for the first time in a long while. Investment is extremely low. I tend to agree that I don't know how interest rates can really go too high because I think deflation is the real risk at this point. Not only because demand (investment) is so low but also due to fairly high productivity. I just bought a computer for $300 that was priced at ~$600 just 4 years ago! There is incredible pockets of deflation (much to the benefit of consumers).

 

The current S&P P/E is ~20 (5%), CAPE is ~25 (4%), and 10/30y UST is 1.90% and 2.56%. Doesn't really seem overpriced to me unless 30s are going to 4%, fast. Rates are down since QE ended so that's either a lot of new supply or a severe drop in demand. I don't see it when UST already seems relatively undervalued given the level and recent moves of USD.

 

Because of recent runup, if anything happened with the US govn't then the USD drops and rates are extremely low relative to European rates. Counter-intuitively, rates might actually drop if there were some kind of government/budget funding crisis. The large appreciation in USD against the world has created a tremendous buffer in interest rates (or significant near-term value based on expectations of crisis in non-western regions).

 

http://www.multpl.com/

http://www.multpl.com/shiller-pe/

http://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield

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I think the argument that stocks are not expensive because the yields on treasuries are low is a bit dangerous. Low yields on treasuries imply that we are close to deflation and this means that growth rates in the future will be a lot lower than we are used to. If the bond markets in the world are pricing the bonds correctly we are going the japanese way in the world economy and i am not sure if this is a good sign for equity markets. The question is only when the stock market will realize this.

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My challenge is that while I think the market as a whole is overpriced, I think most of the stocks I own are pretty fairly valued (but if the market goes down, they'll go down along with everything else). So need to decide whether to hold stocks through a possible correction, or sell some to free up some cash.

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also, regarding raising rates, i don't understand why they would rise signficantly.  Most the the yield curve is very low, and the fed hasn't been buying for a bit.  Is it possible that the market rate for money is very low because we are in a long term secular deleverging?  businesses not borrowing, but instead paying back debt

 

 

I think people have bought into the "Fed is going to raise rate => rates are going to rise" idea so much that, its very possible that the 10Y actually collapses sub 1% after the first rate hike. Just look at the German 10Y Bunds (7bps), Japan 10Y (30bps).....the UST 10Y at 188bps looks artificially high! Fed doesn't control the 10Y, only the overnight rate.

 

I am in the camp that long term rates aren't going anywhere but down in near future absent a stupid US govt crisis.

 

Now, compare the SP500 index dividend yield against this rate backdrop. I don't understand how people are so confident about a general market overvaluation. Dividend yields have been rarely below 10Y rates and we are in an environment with one of the lowest dividend payout ratios...

 

I tend to agree here. The two paths that could take place would be for the long end of the curve to rise (growth picks up meaningfully) or the long end of the curve falls (low growth). The latter looks more likely right now.

 

The action in the bond market is perturbing. I share Munger's feelings on interest rates from the DJCO annual meeting: "Anybody who is intelligent who is not confused doesn't understand the situation very well."

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also, regarding raising rates, i don't understand why they would rise signficantly.  Most the the yield curve is very low, and the fed hasn't been buying for a bit.  Is it possible that the market rate for money is very low because we are in a long term secular deleverging?  businesses not borrowing, but instead paying back debt

 

 

I think people have bought into the "Fed is going to raise rate => rates are going to rise" idea so much that, its very possible that the 10Y actually collapses sub 1% after the first rate hike. Just look at the German 10Y Bunds (7bps), Japan 10Y (30bps).....the UST 10Y at 188bps looks artificially high! Fed doesn't control the 10Y, only the overnight rate.

 

I am in the camp that long term rates aren't going anywhere but down in near future absent a stupid US govt crisis.

 

Now, compare the SP500 index dividend yield against this rate backdrop. I don't understand how people are so confident about a general market overvaluation. Dividend yields have been rarely below 10Y rates and we are in an environment with one of the lowest dividend payout ratios...

 

 

So basically what you are saying is 'We are Japan'.

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My challenge is that while I think the market as a whole is overpriced, I think most of the stocks I own are pretty fairly valued (but if the market goes down, they'll go down along with everything else). So need to decide whether to hold stocks through a possible correction, or sell some to free up some cash.

 

I think this is far more dangerous and difficult to do than withstanding the correction/slump when it comes. Personally timing isn't my forte (at least when it comes to selling) and I have had difficulty selling bad/average businesses when they reach close to my estimate of intrinsic value (things start to look very rosy even in a bad business when this happens usually and i typically make the mistake of staying in longer than i should have).

 

Many well known investors have been raising cash selling stuff awaiting the correction and have consequently missed out on a lot of return. Its one thing to hold cash because you cant find opportunities meeting your expectations and another thing to sell because you expect the market to correct at some point.

 

Regarding equity markets not realizing what the bond markets have figured out, is it possible that due to the deleveraging in the developed world, we get a revenue growth slowdown/recession, but because of globalization/technology/general productivity improvements businesses reduce costs much more and still show good earnings growth?

 

I believe this is what we have been experiencing over the last 3 years, at least after the post crisis snap back. Ray Dalio calls it beautiful deleveraging. I can kind of see how earnings growth of such quality might not be a long term sustainable thing, but it can go on longer and maybe we get to the end of deleveraging at that point and start seeing revenue/gdp growth again.

 

Bottom line, no one knows. its too difficult to figure out.

 

I just know, I can still find one or two businesses to my liking every now and then and that i can't time my buys or sells optimally. Personally, I am trying to get into businesses which I wouldn't want to sell even in a 50% correction....average businesses are out of my opportunity set for now. No matter the valuation gap, if I can't hold onto the businesses, then i figure, I am never going to earn that spread.

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So basically what you are saying is 'We are Japan'.

 

I don't know. We could be in a similar situation to them. I don't think we are genetically that different from them. Japanese are smart people, and if they couldn't figure out how to get out of this rut in 2 decades, we must at least accept that it is a tough problem to solve.

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To quote Munger on the difference between the Chinese and the Japanese:

 

The Chinese are gamblers; the Japanese are not.

 

I suspect that Americans are gamblers as well. The Japanese have played the role of Mark Twain's cat to a tee ("having sat on a hot stove, he never sat on a hot stove again, but he also never sat on a cold one").

 

We're probably a little different than that.

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No one knows what will happen. It's true that all else equal if rates stay low for a very long period the market is not clearly overvalued, and certainly not relative to other asset prices. Unfortunately all else is never equal. Further, if you knew what rates were going to do you could make a ton of money on that information without having to bother with the stock market.

 

tend to agree that no one can be all the certain on the direction of rates.  Though i do think that going through a major deleverging will tend to suppress rates for a very long time as Dalio has discussed.  from 1934 to the mid 1950s, during the last major deleverging in the United states, total credit to gdp went form 235% to 125%.  the yield on the 10 year treasury during the ENTIRE period was below 3%.   

 

right now we are at 330% (down from 360% in 2009).  I can't guarantee that we will continue to delver and reduce that 330% number, but if you could guarantee me that we continue to delever, then i think i could almost certainly guarantee low interest rates during that period of deleverging. 

 

So the main question is, do we continue to drop that 330% number? and if so, where does it bottom out and how long does that take?  give me that answer and i can make a pretty good estimate of interest rates, and therefore stock returns as well over the next few decades or so

 

edit:  a bit more actual #'s during the 1934-1955 period which may have some relevance for today --> http://i.imgur.com/vTJ7zU3.png

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To quote Munger on the difference between the Chinese and the Japanese:

 

The Chinese are gamblers; the Japanese are not.

 

I suspect that Americans are gamblers as well. The Japanese have played the role of Mark Twain's cat to a tee ("having sat on a hot stove, he never sat on a hot stove again, but he also never sat on a cold one").

 

We're probably a little different than that.

 

I think its more of an age/wealth thing rather than a cultural attribute. (though there are some cultural differences). Chinese society is on average younger and poorer than Japanese society. As they get older and richer, they might want to preserve and protect wealth rather than risk and build. Chinese future might resemble Japanese past. And American future need not resemble the American past .

 

I have experienced this cultural change in course of a couple of generations in the indian society i grew up in. My parents and grand parents generation was all for stable incomes, job security, savings and investing in govt bonds/cd's and gold (maybe cash real estate if you were relatively adventurous). We resembled the Japanese in our personal finance behavior until say early 1990s.

 

The current generation though is skewed towards risk, growth,consumption and debt. Stable incomes are not good enough for us and a lot of my smarter friends want to do a startup or some other such career move which would have been deemed very risky just a couple of decades ago. They buy stuff like we do in the US and are happy to do so with debt. They are yet to move as a society from investing in gold and real estate to equities big time, but I am sure that trend is pointing in the right direction as well.

 

In the US, the difference in attitude pre-2008 and post 2008 is quite remarkable. My friends and relatives here couldn't leverage enough pre-2008, but now even the well to do ones don't want debt, don't want equities and are quite happy with CD's earning 1% at most. Job security is now priced well above taking even moderate career risk if it can be avoided.

 

Point is societies and cultures change over time. Sometimes its fast and sometimes its slow.

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The action in the bond market is perturbing. I share Munger's feelings on interest rates from the DJCO annual meeting: "Anybody who is intelligent who is not confused doesn't understand the situation very well."

 

I haven't heard this and I like it. We are definitely in for some interesting times over the next decade.

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with all these earnings multiple analysis, don't you have to account for interest rates? 16.5 at 5% interest rates is very different from 16.5 when rates are below 2%

 

also, regarding raising rates, i don't understand why they would rise signficantly.  Most the the yield curve is very low, and the fed hasn't been buying for a bit.  Is it possible that the market rate for money is very low because we are in a long term secular deleverging?  businesses not borrowing, but instead paying back debt

 

i took a quick look at the spread between the 10 t-bill rate and the 10 year E/Y (ie 1/shiller PE).  This number is graphed below since 1880s.  looks like its not really all that overvalued given interest rates.  Sorry the x-axis is ascending in the wrong direction (2015 on left side)

 

http://imgur.com/nRD7lIv

 

They've done studies that were similar to this. Instead of analyzing interest rates, they analyzed inflation rates. American companies did best when inflation was around 2-3% (I don't know if there's anything magic about that number or the economy simply likes it because it's a stable benchmark that the Fed has mandated). They did markedly worse as inflation rates extended in either direction from this number. Now, in a situation where all else is equal, if inflation rates were falling so would interest rates and yet...stocks did relatively poorly when inflation was less than below 2-3% despite the interest rates that would have generally trended lower as well. This is likely due to the increased risk premium being necessary to invest in businesses whose underlying assets/products/etc. decline in value with every passing day. 

 

Also, knowing that the market could sustain higher multiples at lower levels of interest rates is largely irrelevant. It was helpful to know 5 years ago. We need to know what's going to happen going forward and not what mattered in the past. Rates can continue to fall, but that doesn't mean the market can sustain an infinitely high multiple. At some point, multiples are too high regardless of rates simply because consumers aren't benefiting enough to defer consumption or to accept the risk of investing in the deflationary environment.

 

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Also, knowing that the market could sustain higher multiples at lower levels of interest rates is largely irrelevant. It was helpful to know 5 years ago. We need to know what's going to happen going forward and not what mattered in the past. Rates can continue to fall, but that doesn't mean the market can sustain an infinitely high multiple. At some point, multiples are too high regardless of rates simply because consumers aren't benefiting enough to defer consumption or to accept the risk of investing in the deflationary environment.

 

Right.  Definitely agree with that.  Interest rates at 5% on the 10 year assume a market P/E of around 100/5 = 20 (maybe a little lower p/e for the higher risk in stocks), 3% rates = P/E of around 100/3=33, etc etc.  But as you pointed out,  as you get interest rates very low, the relationship breaks down.  interest rates of 0.5% imply a P/E of 100/.5=200 which is obviously not going to happen.  I''m guessing we are about there now with the ten year yielding 1.9%.

 

that said, with rates at 1.9%, i don't think a shiller pe around 30 is all that crazy.  If it remained at 1.9% for the next 20 years, then i'm perfectly fine riding the market and its 6%/yr or so growth from earnings increasing.  I can definitely see a plausible scenario where the Shiller P/E stays above 25 the whole time....that is if interest rates remain in the 1-3% range during that period.  Shiller P/E of 50+ is less likely but who knows

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