RBS Warns: Sell Everything

[CRHawk]

 

 

Secondly, you only think blue chips are cheap because their profits are inflated. Margins could drop 30% and still be above their historical average - what happens to your P/E when your profits fall 30%? Your P/E increases 50%. Stocks you thought you were buying for 15x earnings now trade 22x earnings. And that's if we stop ABOVE the historical average margin level.

 

 

I just checked Value Line sheets for HSY, JNJ, UL, DEO...  Margins I see are maybe a tiny bit high... maybe 10% over average by eyeball?  I don't see a huge margin problem.  Where do you see high margins?

 

 

[TwoCitiesCapital]

 

 

Secondly, you only think blue chips are cheap because their profits are inflated. Margins could drop 30% and still be above their historical average - what happens to your P/E when your profits fall 30%? Your P/E increases 50%. Stocks you thought you were buying for 15x earnings now trade 22x earnings. And that's if we stop ABOVE the historical average margin level.

 

 

I just checked Value Line sheets for HSY, JNJ, UL, DEO...  Margins I see are maybe a tiny bit high... maybe 10% over average by eyeball?  I don't see a huge margin problem.  Where do you see high margins?

 

I'm talking in aggregate. It's been all over the place for the last 2 or 3 years. Here's a screen cap I found on Google in 5 seconds. Corporate margins in the U.S. are about as high as they've ever been and they started turning down last year.

 

http://static4.businessinsider.com/image/5612a31d69bedde3458499ce-480/barclays-margin.png

 

Long-term average is around 6-7%. We were closer to 10%. Falling back to 6.5% would erase about 30-40% of the S&Ps earnings, but you'll notice that when reverts it generally goes below the average. This is why John Hussman calls it "mean inversion" instead of "mean reversion". If you get profits that fall by 30-40%, you can be almost positive you're going to get multiple contraction on top of that. If multiples fall from the current 17x to 12x, you're talking about a 55% decline in stocks to get what is still a reasonable multiple on average margins.

 

This is what I've been pointing for the past two years. We don't need a depression. We don't need a recession. We don't need a collapse of the financial system. A 50-60% decline occurs if we only go back average margins and average multiples. You're setting yourself for long-term failure in U.S. stocks in my opinion.

[KinAlberta]

Just now read the RBS piece.  I thought Hussman was prone to extremes.  :-)

 

Hussman though thinks in terms of hard numeric reality - whereas the RBS piece is very 'story' based.  The big bad wolf kind of thinking.  As such, I wouldn't put any more credence on such fearfulness than I do on my own fearfulness. We're all prone to manic depressive behaviour and it seems that RBS analysts are as well - but they have a bigger audience. 

 

I'd much rather follow Hussman's warnings and be conservative but with an eye towards opportunity than the knee-jerk panic behaviour RBS is proposing. (And note that I was 80%+ in cash going into the 2008/2009 collapse when none of the big money managers besides Jeremy Grantham, was proposing extreme safety.)  Unlike the economy in 2007 with massive overbuilding and collapsing jobs, FASB157 and billions upon in exposed derivatives some significant amount without even collateral service agreements, today, the US economy is doing quite well, banks are well capitalized, cheapening oil will really pay off for the consumer and so many other things are reasonable. What's to fear?

 

An imploding China will hit sales for some US companies but Chinese goods will become even cheaper. This could just be a repeat of the 1990s implosion in Japan which hardly affected the US.  Bottom line, there just doesn't seem to be any big reason to panic regarding a slowing or moderating US economy.

 

Now, in my home province of Alberta, Canada, things are different. Panic may be an appropriate response, though I'm buying into the local market ever so slowly. e.g.. TransAlta cut its dividend as was fully expected and the stock tanked 13% nonetheless. Interesting isn't it.

[frommi]

 

Long-term average is around 6-7%. We were closer to 10%. Falling back to 6.5% would erase about 30-40% of the S&Ps earnings, but you'll notice that when reverts it generally goes below the average. This is why John Hussman calls it "mean inversion" instead of "mean reversion". If you get profits that fall by 30-40%, you can be almost positive you're going to get multiple contraction on top of that. If multiples fall from the current 17x to 12x, you're talking about a 55% decline in stocks to get what is still a reasonable multiple on average margins.

 

This is what I've been pointing for the past two years. We don't need a depression. We don't need a recession. We don't need a collapse of the financial system. A 50-60% decline occurs if we only go back average margins and average multiples. You're setting yourself for long-term failure in U.S. stocks in my opinion.

 

Maybe that is because IT (20%) and healthcare (14%) have now a much bigger and financials a lower weight in the S&P500 than 10-20 years ago?

 

Now that the market has fallen below the august low, i have to agree that the technicals really look weak. Easily possible that we started a bear market that takes us 40% lower from here over the next 2-3 years. But don`t forget that even bear markets have rally`s. :)

[ni-co]

Are we talking about pre- or after-tax margins? If it's after-tax, what I think it is, then what I'm wondering is how much of that margin expansion is tax-driven (especially all the large tax inversions) and, therefore, long-term unsustainable.

 

That said, I'm focussing more on the balance sheets because what companies have been doing – on average – is bringing leverage up and buying back stock, thereby blowing up the EPS and making themselves look cheaper by that metric. What they are essentially doing is replacing equity with debt and, because the debt is cheaper and more tax-efficient (you can deduct the interest as an expense whereas you can't deduct dividend payments to shareholders), it seemingly looks very rational. Naturally, after having levered up the new, higher EPS are way more fragile and the whole business just became riskier. Stanley Druckenmiller and some others have been criticizing this for at least 2 years now.

[frommi]

There are so many moving parts like interest rates, inflation or USD thats its pretty impossible to figure out what S&P500 earnings will do over the course of the next few years. But you can be sure that in 10-20 years earnings will be higher than they are now.

When you know where interest rates, inflation or the USD go, why bother with equities? Just speculate directly on them with futures.

If you are not able to figure out what happens there, than probably buying cheap stocks is whats going to work over the long run.

 

Oh and i think i figured something important out for myself. If you want to outperform the market over the long run, you first have to give up on trying to outperform it.

[ni-co]

When you know where interest rates, inflation or the USD go, why bother with equities? Just speculate directly on them with futures.

 

That's exactly what I do but I don't know anything. As with Graham's framework for companies there are frameworks that work in global macro and show you where you can find hugely favorable risk/reward ratios for certain macro events. Keep in mind that pure value investors can't know things either. In the end, value investing is all about risk/reward – exactly like global macro is.

 

I certainly agree with you that you should know what you're doing. But a lot of value investors keep arguing that you can know value on the micro level but not on the macro level. I think that's false. And like value guys can point to WEB or Carl Icahn macro guys can point to Soros, Druckenmiller or Ray Dalio.

 

I'm seriously worried, though, that we entered a macro environment in 2007 where strictly applying Buffet's methods maybe won't have the same success rate they had in the 60 years before.

[Investmentacct]

Lets say downside is 50% from here. Per Buffett, if you can not expect stocks to decline 50%, should not be in market with that money. So, Buffett expects it to go down any day and adjusts accordigly.

 

I have watched too many star wars movie recently.

Quoting Yoda on few:

"Fear is the path to the Dark Side. Fear leads to anger, anger leads to hate, hate leads to suffering."

"The fear of loss is a path to the Dark Side."

Yoda: "Train yourself to let go of everything you fear to lose."

 

Read more at http://www.notable-quotes.com/s/star_wars_quotes.html#jbWebu2KgljCg2CB.99

 

When you know where interest rates, inflation or the USD go, why bother with equities? Just speculate directly on them with futures.

 

That's exactly what I do but I don't know anything. As with Graham's framework for companies there are frameworks that work in global macro and show you where you can find hugely favorable risk/reward ratios for certain macro events. Keep in mind that pure value investors can't know things either. In the end, value investing is all about risk/reward – exactly like global macro is.

 

I certainly agree with you that you should know what you're doing. But a lot of value investors keep arguing that you can know value on the micro level but not on the macro level. I think that's false. And like value guys can point to WEB or Carl Icahn macro guys can point to Soros, Druckenmiller or Ray Dalio.

 

I'm seriously worried, though, that we entered a macro environment in 2007 where strictly applying Buffet's methods maybe won't have the same success rate they had in the 60 years before.

[John Hjorth]

I guess I should also clarify that the majority of my negative sentiment is targeted to American equities which are ridiculously pricey.

 

Yeah, right: http://www.cornerofberkshireandfairfax.ca/forum/general-discussion/cheap-stocks/

 

And before you start to sing the "historically high margins" song again - I've heard it, no need, most of these companies don't have historically high margins. Also a lot of them already had declining sales last year, so no, not cycle top.

 

Have fun

Jurgis,

 

What do you consider as your investment universe, as a base of your post above?

 

Can you clarify your question? I invest in everything. :) Some preference to high ROE "Buffettology" stocks.

 

I was thinking if you had geografical preferences, perhaps based on currency considerations. Thanks for the elaboration.

[rukawa]

I sold most of my equity positions in late November. My basic reason was interest rate increases and profit margin mean reversion meant that equities would go down. People have been arguing that profits margins don't have to mean revert. I think they do and its a fundamental feature of capitalism.

 

Lets take two examples: Apple and Microsoft. Microsoft has juicy profit margins. And has for a long time. The problem is: how to reinvest all the money it generates. Apple has the same problem. Now in the beginning you find a lot of highly profitable ideas: Ipod, Iphone, Ipad for Apple. Windows, Office for Microsoft. But of course you can't keep changing the world. Eventually you run out of crazy profitable ideas. But then what do you do with the gusher of cash. Stock buybacks will work only when stock prices are low. Eventually you are forced to spend money on things with vastly lower profit margins.

 

In Apples case, Cars. In Microsoft's case, useless acquisitions like Nokia. In Buffett's case you buy a railroad.

 

In my view high profit margins in aggregate are the result of a large huge influx of labour. This happened during the British industrial revolution and is why Karl Marx thought the labor class would be immiserated. But Karl Marx was wrong. Eventually the migration of workers from rural areas to cities dropped and industrial wages started increasing.

 

We had a huge influx of labour since the 1970's due to 3 things: more women working, China's industrial revolution and finally the Baby Boomers. The labour participation rate is now declining in the US. Outsourcing to China has run its course and China's labour force is also shrinking due to the effects of the One Child Policy.

 

There was one other thing that kept profit margins high and that was increasing consumer debt. 

 

Thus corporate profits get squeezed on two sides: Price don't go up because of stingy consumers repaying debts and wages go up because there isn't enough labor and there is nothing left to outsource.

[Bog]

I love the Yoda quote :)

 

I'm actually going to copy and save this.

 

 

 

Lets say downside is 50% from here. Per Buffett, if you can not expect stocks to decline 50%, should not be in market with that money. So, Buffett expects it to go down any day and adjusts accordigly.

 

I have watched too many star wars movie recently.

Quoting Yoda on few:

"Fear is the path to the Dark Side. Fear leads to anger, anger leads to hate, hate leads to suffering."

"The fear of loss is a path to the Dark Side."

Yoda: "Train yourself to let go of everything you fear to lose."

 

Read more at http://www.notable-quotes.com/s/star_wars_quotes.html#jbWebu2KgljCg2CB.99

 

When you know where interest rates, inflation or the USD go, why bother with equities? Just speculate directly on them with futures.

 

That's exactly what I do but I don't know anything. As with Graham's framework for companies there are frameworks that work in global macro and show you where you can find hugely favorable risk/reward ratios for certain macro events. Keep in mind that pure value investors can't know things either. In the end, value investing is all about risk/reward – exactly like global macro is.

 

I certainly agree with you that you should know what you're doing. But a lot of value investors keep arguing that you can know value on the micro level but not on the macro level. I think that's false. And like value guys can point to WEB or Carl Icahn macro guys can point to Soros, Druckenmiller or Ray Dalio.

 

I'm seriously worried, though, that we entered a macro environment in 2007 where strictly applying Buffet's methods maybe won't have the same success rate they had in the 60 years before.

[ERICOPOLY]

I have a sinking feeling that we'll look back on this wishing we'd all sold everything (except our puts).

 

I have no mood to buy anything and usually I do after a pullback.

[Guest Grey512]

I have a sinking feeling that we'll look back on this wishing we'd all sold everything (except our puts).

 

I have no mood to buy anything and usually I do after a pullback.

 

I'm still long a bunch of 'good businesses' and 'secular growers'. Every now and then, I get the urge to sell a bit to lighten up the exposure (even though it's already low on a net basis). So far, my willpower is holding and I try to make myself feel better by selling an index short or something.

 

This is definitely not a very pleasant environment and the longer it continues, the closer we may be getting to capitulation, probably swiftly followed by a restarting of QE. In which case banks tank, the Dollar tanks, etc; other sectors rise. Interesting times we live in, that's for sure.. And don't forget that we're in one of the most peaceful decades! Complacency all around.

[TwoCitiesCapital]

I have a sinking feeling that we'll look back on this wishing we'd all sold everything (except our puts).

 

I have no mood to buy anything and usually I do after a pullback.

 

Welcome to the dark side Eric.

 

[Jurgis]

Just sell everything guys and go full short. I know you want to do it.

[John Hjorth]

Just sell everything guys and go full short. I know you want to do it.

 

Please don't slap me while I'll continue - week by week - going forward, in small drips, one by one - to buy what I consider quality stuff, in the aim of getting [still] a lot of cash to work.

 

Darth Wader is not my God.

[Jurgis]

Just sell everything guys and go full short. I know you want to do it.

 

Please don't slap me while I'll continue - week by week - going forward, in small drips, one by one - to buy what I consider quality stuff, in the aim of getting [still] a lot of cash to work.

 

I knew there was someone raising prices on the stuff I wanted to buy.

[John Hjorth]

Just sell everything guys and go full short. I know you want to do it.

 

Please don't slap me while I'll continue - week by week - going forward, in small drips, one by one - to buy what I consider quality stuff, in the aim of getting [still] a lot of cash to work.

I knew there was someone raising prices on the stuff I wanted to buy.

 

Jurgis,

 

I'm not even trying to be arrogant, [trying to out]smart [you], nor even trying to be patronizing here: Quite a few of your posts on here lately does not make much sense [at last to me], ref. your plan to start indexing.

 

If you suffer from burnout [ref. one of your own posts lately], personally I would take a break from this [investing][again: I'm not trying to patronize you here].

[Jurgis]

Quite a few of your posts on here lately does not make much sense [at last to me], ref. your plan to start indexing.

 

As I said somewhere, I think this might not be the best time to start indexing.

If majority of value investors have underperformed in last X years, then I get a "get out of jail free" card too, no? ;).

If a lot of people are saying "hold on, this is gonna turn to value", then perhaps I should hold on? ;)

Anyway, these arguments are semiserious only.

Right now, I don't plan to switch to indexing. However, I am seriously evaluating all possibilities and considering various approaches, so I may change my mind at any time.

 

Regarding "not making much sense" - you can add  :D  ;D  8)  :P to my posts above at least.

 

However, if some of my serious posts don't make sense you are welcome to ask what I meant. Only if you care of course.

 

Best.

[Guest Grey512]

Jurgis, how concentrated are you nowadays and what's your cash balance?

[Jurgis]

Jurgis, how concentrated are you nowadays and what's your cash balance?

 

Click on the link next to my picture. Will update for January over the weekend, but hasn't changed much.

[ni-co]

I'm surprised that nobody's discussing the virtues of European banks here.

[TwoCitiesCapital]

I'm surprised that nobody's discussing the virtues of European banks here.

 

I've been accumulating SAN/BSBR the whole way down through additional purchases and reinvested dividends.

[ni-co]

I'm surprised that nobody's discussing the virtues of European banks here.

 

I've been accumulating SAN/BSBR the whole way down through additional purchases and reinvested dividends.

 

I'm short SAN, DB and CS and think Europe is on the verge of a banking crisis.

[PatientCheetah]

merkel is losing political capital, not sure if she still has enough to get through a bank recap