Explain This!

[Parsad]

For our more astute board members:

 

What is causing such distortions in this accurate historical ratio that could justify where it is today?  Either we are in for one hell of a correction or markets are broken.  Cheers!

 

 

[wabuffo]

I won't try to explain this chart - except to say that the "Total Assets of Fed" has little to do with equity values.  So right off the bat, inserting that line makes me question the meaningfulness of these charts.

 

I would add that if the value of equities is the DCF of future cash flows, then $1 of pre-tax earnings is much more valuable to shareholders than back in the 1990s.   That's because Federal tax rate on corporate income has fallen from 35% to 21% and the discount rate as measured by the yield on 30 year Treasuries has fallen from 6% down to 2%.   So that same $1 of pre-tax earnings is worth 3.6x more (even with no growth in pre-tax earnings).

 

Bill

Edited January 4, 2022 by wabuffo

[Parsad]

4 minutes ago, wabuffo said:

I won't try to explain this chart - except to say that the "Total Assets of Fed" has nothing to do with equity values.  So right off the bat, inserting that line makes me question the entire chart.

 

Bill

 

I would agree with you, but it is quite the coincidence that Fed assets matches the overvaluation/distortion exactly.  If asset values rose with an increase in Fed assets, an unwinding will do what?  The question is can they control the unwinding and interest rates in such a way as to make it painless or relatively painless.  I find that hard to believe.  Cheers!

[wabuffo]

Parsad - you got a lot of reading to do.  Forget the Fed - its the "little man behind the curtain".  Tries to sound important but actions do very little to the macro economy.  The real 800-lb gorilla is the US Treasury.  But of course, they are quiet and maintain a low profile while the Fed does all the talking.

 

The real thing to focus on is earnings growth, long-term risk-free yields (ie 30-year Treasury yields) and Federal corporate tax rates.   If you can predict the trend of those three things, that's all you need.  Of course, no one can predict them.

 

Bill

[muscleman]

Didn't Bruce Berkowitz say, the fed is an excellent hedge fund?

I would be curious on inflation adjusted numbers. For nominal values, this chart is not nearly as impressive as Venezuela's stock market.

[Parsad]

The other part of this is to get market cap versus GDP down to historical levels means either or both of these:

 

- A drop of up to 50% in market capitalization or an increase of GDP by at least 50%.

 

I don't see the latter happening...4% annualized over five years means an increase of 22%...over ten years and you are getting to 50%.

 

If GDP can get to $28-30M or so in five years, you would still see markets drop about 40% to get to historical levels.  Cheers! 

[treasurehunt]

7 minutes ago, Parsad said:

 

I would agree with you, but it is quite the coincidence that Fed assets matches the overvaluation/distortion exactly.  If asset values rose with an increase in Fed assets, an unwinding will do what?  The question is can they control the unwinding and interest rates in such a way as to make it painless or relatively painless.  I find that hard to believe.  Cheers!

 

Even the TMC/(GDP+Fed Assets) at 152.1% is at an all time high, so how do you conclude that "Fed assets matches the overvaluation/distortion exactly"? Doesn't the chart imply extreme overvaluation even after taking Fed assets into account?

 

Wabuffo's explanation is very sensible.

 

[Gregmal]

Macro forecasting is a waste of time. Buy shit you know and understand and when you get itchy just hedge it out. 

[Parsad]

4 minutes ago, treasurehunt said:

 

Even the TMC/(GDP+Fed Assets) at 152.1% is at an all time high, so how do you conclude that "Fed assets matches the overvaluation/distortion exactly"? Doesn't the chart imply extreme overvaluation even after taking Fed assets into account?

 

Wabuffo's explanation is very sensible.

 

 

Combination of Fed buying assets across the board and Treasury issuing large amounts of debt at record low rates.  I remember Sam Mitchell saying in 2008, "You cannot ignore the macro when the macro becomes obvious!"  I'm not one to follow macro, but this is really starting to hit me in the face.  I see increasing earning power and relatively low rates for now, but I cannot see low corporate tax rates and net profit margins remaining as desirable as they are today.  Something has to give.  Cheers!

[Parsad]

2 minutes ago, Gregmal said:

Macro forecasting is a waste of time. Buy shit you know and understand and when you get itchy just hedge it out. 

 

Without understanding macro you cannot accurately hedge things out...you're just guessing then.  Cheers!

[Gregmal]

6 minutes ago, Parsad said:

 

Without understanding macro you cannot accurately hedge things out...you're just guessing then.  Cheers!

Eh in the simplest of examples, you don’t need to understand a whole lot of anything to know that “at strike X I no longer realize downside in stock ABC”. Of course one can make this as simple or as complex as they wish, but fundamentally some of this stuff is obnoxiously simple. Certainly not 2/20 worthy difficult.

[dcollon]

What happens if the top 20% of the TMC goes down or sideways for an extended period of time? Can you make money in other areas that haven't performed well over the past 2-5 years? 

[adesigar]

I think there are multiple reasons.

 

1. Lower gravity aka interest rates

2. Lower Taxes on companies

3. Increase in overseas earnings. You cant compare to just domestic GDP.

4. Earnings moving from small unlisted businesses to bigger listed companies.

5. Fed asset purchases

 

Of the above 5 points only 1 and 5 will change 2,3,4 will still be the case

[Viking]

When looking at market cap how much of the increase the past decade is being fuelled by just a few stocks: Apple, Microsoft, Amazon, Alphabet, Meta, Netflix, Tesla. My guess is if you net out these names the increase in market cap is not that nuts.

 

I wonder how inflation ripping at +6% impacts historical (nominal) measures and trend comparisons. The level of inflation has to matter.

 

I also wonder how much technology has increased corporate margins the past decade. Higher margins should result in higher earnings and then higher stock prices. 
 

Lots of companies are cheap today… perhaps 2022 will be the year stock picking matters.

Edited January 4, 2022 by Viking

[Parsad]

4 minutes ago, Viking said:

When looking at market cap how much of the increase the past decade is being fuelled by just a few stocks: Apple, Microsoft, Amazon, Alphabet, Meta, Netflix, Tesla. My guess is if you net out these names the increase in market cap is not that nuts.

 

I wonder how inflation ripping at +6% impacts historical (nominal) measures and trend comparisons. The level of inflation has to matter.

 

I also wonder how much technology has increased corporate margins the past decade. Higher margins should result in higher earnings and then higher stock prices. 
 

Lots of companies are cheap today… perhaps 2022 will be the year stock picking matters.

 

Yes.  Does this look like 1998/1999 again?  Do we see a split in value stocks and growth stocks for the next couple of years?  Cheers!

[rkbabang]

1 hour ago, adesigar said:

I think there are multiple reasons.

 

1. Lower gravity aka interest rates

2. Lower Taxes on companies

3. Increase in overseas earnings. You cant compare to just domestic GDP.

4. Earnings moving from small unlisted businesses to bigger listed companies.

5. Fed asset purchases

 

Of the above 5 points only 1 and 5 will change 2,3,4 will still be the case

 

 

That is a great point.  All of the largest companies which make up a huge percent of the stock market all do business globally, yet you are comparing them to the GDP of just one country.  I'm not sure the comparison makes as much sense as it used to.  That isn't to say that I'm not a little worried about the macro.   I've recently bought out of the money puts on Apple, Tesla, Peloton, and American Airlines as a little insurance.

 

[no_free_lunch]

I agree with the dual market theory.  This is why I'm scared to hold indexes. I can find companies that are not overvalued but most stuff clearly is and the bubble will ultimately pop.  In the meanwhile as we don't know how long this goes on for, it's crazy not to stay invested. Shiller PE has been high since around 2014.  Think about the gains since then.

 

To give a couple counter examples, Verizon has a 5% yield and a PE of 10.  I don't know what will happen with their business but that is stock and industry risk. I don't see it as historically overvalued.

 

C at PE of 8.  Same rationale.

 

Amgen is trading so where around 14x FCF.

 

There are many more like these that get posted here.  I don't see why these companies should trade at half their valuation.  Clearly the valuation is confined to certain stocks although I will admit it is spilling over as value gains.  

 

 

Edited January 5, 2022 by no_free_lunch

[Parsad]

4 hours ago, rkbabang said:

 

 

That is a great point.  All of the largest companies which make up a huge percent of the stock market all do business globally, yet you are comparing them to the GDP of just one country.  I'm not sure the comparison makes as much sense as it used to.  That isn't to say that I'm not a little worried about the macro.   I've recently bought out of the money puts on Apple, Tesla, Peloton, and American Airlines as a little insurance.

 

 

How do we quantify for that?  It's not like the largest companies in the past didn't have huge, extensive global businesses...KO, MCD, SBUX, GE, GM, WMT, XOM, DOW, etc.  Remember, the rest of the world is also doing extensive business with the U.S., so it's kind of a wash.  If anything, you would have to add the market capitalization of other countries to the market capitalization of the U.S...and divide by the U.S. GDP combined with the GDP of the other countries...and most global markets aren't undervalued either.  Cheers!

[hasilp89]

7 hours ago, wabuffo said:

Forget the Fed - its the "little man behind the curtain". 

Tries to sound important but actions do very little to the macro economy. 

The real 800-lb gorilla is the US Treasury. 

But of course, they are quiet and maintain a low profile while the Fed does all the talking.

I have no clue what this chart is saying, but i might get the poem above tattooed on my arm. 

[Sullivcd]

Erp at around 3.25 by my count, not great but within the historical range by a good margin 

[gary17]

Total market cap is based on future earnings - so that is a function of low rates, discount etc.

GDP is a measure of current output  is it not.

so i'd say the higher the ratio just means the lower the interest rate.  

[ValueArb]

21 hours ago, wabuffo said:

I won't try to explain this chart - except to say that the "Total Assets of Fed" has little to do with equity values.  So right off the bat, inserting that line makes me question the meaningfulness of these charts.

 

I would add that if the value of equities is the DCF of future cash flows, then $1 of pre-tax earnings is much more valuable to shareholders than back in the 1990s.   That's because Federal tax rate on corporate income has fallen from 35% to 21% and the discount rate as measured by the yield on 30 year Treasuries has fallen from 6% down to 2%.   So that same $1 of pre-tax earnings is worth 3.6x more (even with no growth in pre-tax earnings).

 

Bill

 

This.