Is The Bottom Almost Here?

[vinod1]

3 hours ago, Kupotea said:

I don’t think you need a recession for stocks to perform poorly again this year. Lets assume the economy keeps chugging along which by all indications it has to date, where do long term treasury yields go? What’s a fair risk premium for equities if the 10 year yields 4-5%? Look at how copper is reacting with China reopening. Do oil prices stay subdued with low inventories and a global economy moving forward at full strength? How do you convince an entire cohort of retirees to come back to the workforce?
 

There are compelling arguments that the economy remains strong. There are also indicators that we get a recession sometime in H2. I have yet to see a convincing argument that long term rates should be inverted without a corresponding hit to earnings.

 

I think treasury 10 year yield of 4%ish range is quite consistent with 20ish PE on the market.

 

Historically stocks had a 6.5% risk premium. But the vast majority when this premium was earned was when no one can actually earn that much. Just not possible during this time. 

 

In 1880s or 1900s or 1920s or 40s you would have no way to assemble a portfolio of diversified stocks at low cost. You would have to take a train to a city to a brokerage house, then have your broker buy stocks that he is familiar with at large brokerage costs, bid spread costs, etc. Then store the stock certificates safely. There is limited financial information. Limited investor protections. All these end up costing investors in returns.

 

One could have gone through investor trusts. They had what 5% loads and 1 to 1.5% annual fees. And they would have underperformed the market.

 

Say they underperformed the market by 1%, then you lose about 2% in fees annually over the lifetime of the investment. An equity risk premium of 6.5% would end up being 3.5% for the investor.

 

Now you can get diversified exposure at near zero cost. An equity risk premium that should be demanded by investors is probably in the 3 to 4% range.

 

Vinod

[vinod1]

Think of this another way.

 

People invest in Berkshire at 1.3x BV licking their hands and most would argue fair value is about 1.5x BV or a bit more.

 

These same people assume BRK would beat the market at most by 1% or 2%. Buffet and Munger likewise say the same.

 

So one is willing to buy BRK at 1.5x BV for something that is going to return maybe just maybe return 1 or 2% more?

 

What does that say about the market valuation?

 

[vinod1]

Many people here would say you just need to hold good businesses over the long term.

 

Very few companies exist more than 100 years. Less than 20% of the S&P 500 companies survived 60 years.

 

I cannot think of a better business than the total stock market. Compared to it, Berkshire has the moat/riskiness of a lemonade stand. I do hold Berkshire. Just pointing out the riskiness compared tot he market which is virtually indestructible.  Backed by the 7th fleet and nuclear arsenal.

 

So what should one pay for such an extraordinarily resilient business? I do not see why a PE of 20 is too high.

 

 

[Gregmal]

Ill never forget how early in my career, maybe 2011 or so, how many jerk offs smugly went on TV and pontificated about 14x for the SPY being “a little too rich” for their taste, seeing as how much “uncertainty” was in the economy and broader markets. How the long term averages were 15x ish, so there just wasn’t a favorable risk/reward, or so they said. I don’t recall their names but I would hope none of them currently have jobs. Those people are the worst. Not just wrong; everyone is allowed to be wrong, but doing so in such an arrogant and condescending way. And turning out to be idiots.

[vinod1]

In 2011/12 when S&P 500 reached 1000 or so there were worries that it got too expensive and many reduced allocation. Profit margins too high, PE too high, yada yada. I was sure profit margins would go back to their historical range of 6 or 7%. I wrote it down in my investment journal. I also noted that if profit margins again came back to 10% that I would change my mind as that would mean something else is going on.

 

I am one of them.

 

I got bailed out of that madness because bank stocks got cheap and I was able to invest my portfolio into BAC and other financials.

 

Then profit margins came back up, I was already invested, so it did not hurt me as much as it would have.

 

Now I see people falling for the same type of thinking. S&P 4000 must be expensive, etc.

 

[vinod1]

2 minutes ago, Gregmal said:

Ill never forget how early in my career, maybe 2011 or so, how many jerk offs smugly went on TV and pontificated about 14x for the SPY being “a little too rich” for their taste, seeing as how much “uncertainty” was in the economy and broader markets. How the long term averages were 15x ish, so there just wasn’t a favorable risk/reward, or so they said. I don’t recall their names but I would hope none of them currently have jobs. Those people are the worst. Not just wrong; everyone is allowed to be wrong, but doing so in such an arrogant and condescending way. And turning out to be idiots.

 

Hussman is the worst. Not sure how he is managing money with a straight face telling investors that he is protecting their money while showing negative returns over 10 and 15 years!

[vinod1]

Many pension funds, insurance companies, endowments have a 7% return target or need to fund their expenses.

 

If treasuries are going to get 5%, high grade corporates and other investment grade bonds are going to be yielding 6% to 7%. 

 

Many of these institutional investors would be all over these bonds in that case. So I think treasury yield of 5% is sort of the upper limit and most likely would remain in the 3% to 4.5% range. 

 

Put an equity risk premium of 3.5% to 4%, a PE of 20 would look pretty attractive.

 

S&P 500 earnings of $180 should be a conservative estimate. So a value of 3600 to 4000 should be quite reasonable. 

[vinod1]

If the argument is S&P 500 is going down "X" percent this year because of "Y" reasons, you are just pissing over everything Buffett, Munger and Graham taught.

[changegonnacome]

2 minutes ago, vinod1 said:

3% to 4.5% range. 

 

Put an equity risk premium of 3.5% to 4%, a PE of 20 would look pretty attractive.

 

3% Risk free rate + 3.5% ERP............is a PE of 15 no?

[vinod1]

2 hours ago, changegonnacome said:

 

3% Risk free rate + 3.5% ERP............is a PE of 15 no?

 

No. Earnings yield is not your return. In a crude and approximate way you can say the earnings yield is your real return. So total return is earnings yield + inflation, again in an approximate way.

[Dinar]

2 hours ago, changegonnacome said:

 

3% Risk free rate + 3.5% ERP............is a PE of 15 no?

No, because you are assuming zero growth, or growth that is worth zero.  (when returns on marginal capital = cost of capital), you are correct.  When there is growth and return on marginal capital exceeds cost of capital then that justifies a higher p/e.  Technically, we should not even be looking at earnings, but at free cash flow.  

[vinod1]

13 hours ago, Dinar said:

No, because you are assuming zero growth, or growth that is worth zero.  (when returns on marginal capital = cost of capital), you are correct.  When there is growth and return on marginal capital exceeds cost of capital then that justifies a higher p/e.  Technically, we should not even be looking at earnings, but at free cash flow.  

 

+1

 

Damodaran has a spreadsheet you can play with. Assuming $200 earnings in 2023 and 75% total payout (which is about average of last few years) to get free cash flow of $150 and using your 3% risk free rate and 3.5% ERP, IV of S&P would be 4800ish.

 

His model is internally consistent unlike many others from wall street. For example, long term earnings growth is limited to the risk free rate. So in above the valuation is based on S&P 500 earnings growing at 3% rate over the long term. 

 

 

Edited January 15, 2023 by vinod1

[Gregmal]

Anyone else wondering how long until the usual suspects abandon the newly popular "recession" thesis and jump straight to the debt ceiling drama as their reasons for systematic bearishness and high cash balances?

[changegonnacome]

Agree with Mark’s - optimism around falling inflation , the severity or otherwise of a recession and an impending Fed pivot pervade the market at ~3900 - 4000

 

I also agree with Mark’s about being bottoms up…..I have a top down view…..but a bottoms up methodology & approach….I remain pretty much a fully invested bear  

Edited January 18, 2023 by changegonnacome

[UK]

7 hours ago, Gregmal said:

Anyone else wondering how long until the usual suspects abandon the newly popular "recession" thesis and jump straight to the debt ceiling drama as their reasons for systematic bearishness and high cash balances?

 

https://www.bloomberg.com/news/articles/2023-01-18/summers-now-more-optimistic-on-us-outlook-than-three-months-ago?leadSource=uverify wall

[Ulti]

https://www.cnn.com/2023/01/13/opinions/us-economy-recession-achuthan-banerji/index.html

[changegonnacome]

 

As I've said before - TINA dominated flows into equities up until very recently.....multiples expanded in response...........could it be that record bond issuances YTD and by extension purchases is demonstrating that TINA is over?.......and equities are facing competition for flows for the first time in over a decade?.......as allocators think about deploying that marginal dollar into competing financial instruments they are being presented with options with acceptable returns that aren't stocks for the first time in a long time.

 

Retail investors/savers likewise - as CD's & high yield savings accounts paying 4% start to look like not such a bad place to be on a risk/reward basis vs SPY/QQQ that took you to the woodshed in 22.

 

In a QT world with shrinking money supply such that marginal liquidity is contracting.......record flows into bonds like this have consequences......the marginal dollar game has become zero sum.......the liquidity/money supply pie is shrinking, not expanding as the Fed rolls off the balance sheet......and so for bonds to 'win' flow, equites have to 'lose'.

 

I myself have a confession to make - I bought a 3M T-Bill yesterday with an annualized YTM of 4.4% with some cash laying around. Never bought a sovereign bond before. It felt weird. Pray for me.

[TwoCitiesCapital]

43 minutes ago, changegonnacome said:

 

As I've said before - TINA dominated flows into equities up until very recently.....multiples expanded in response...........could it be that record bond issuances YTD and by extension purchases is demonstrating that TINA is over?.......and equities are facing competition for flows for the first time in over a decade?.......as allocators think about deploying that marginal dollar into competing financial instruments they are being presented with options with acceptable returns that aren't stocks for the first time in a long time.

 

Retail investors/savers likewise - as CD's & high yield savings accounts paying 4% start to look like not such a bad place to be on a risk/reward basis vs SPY/QQQ that took you to the woodshed in 22.

 

In a QT world with shrinking money supply such that marginal liquidity is contracting.......record flows into bonds like this have consequences......the marginal dollar game has become zero sum.......the liquidity/money supply pie is shrinking, not expanding as the Fed rolls off the balance sheet......and so for bonds to 'win' flow, equites have to 'lose'.

 

I myself have a confession to make - I bought a 3M T-Bill yesterday with an annualized YTM of 4.4% with some cash laying around. Never bought a sovereign bond before. It felt weird. Pray for me.

 

+1

 

You can get agency mortgages yielding 6+%. Why take equity risk if you can get equity-like returns in government insured bonds? 

 

Blackrock is suggesting investors consider flipping the 60/40 concept to be 60% fixed income.

 

There are individual stocks that I like and will buy. There are individual sectors that may do well. But equities, on average, are likely to have another terrible run because they're still expensive relative to what the real economy is suggesting is coming. 18-20x forward earnings isn't attractive to me and receding tides will lower most boats regardless of fundamentals. 

 

As long as that remains the case, I like the guarantee of short- and intermediate bonds and cash.  

 

 

[mattee2264]

For me it is still a question of valuation.

 

Bulls can talk about 4000 SPY being reasonably valued by using generous forward earnings estimates that seem to rest on the idea that any recession will be mild or short lived and earnings will soon surpass the 2021 peak of just under $200 a share. But 2021 earnings got a pretty massive assist from monetary and fiscal stimulus, cheap debt, pent-up demand and other favourable factors that are unlikely to recur going forwards.

 

The TINA argument for high valuations is a lot weaker now you can get 4% on bonds. The inflation argument for favouring equities despite expensive valuations is declining as inflation is coming down. Any economic recovery is not going to get much of an assist from fiscal or monetary policy. So I do not think you can count on earnings catching up to bring valuations down to more reasonable levels. 

 

2022 earnings are going to come in below $200. 2023 earnings at best will probably be flat and more likely will fall somewhat. So even if you think earnings can get back to $200 by 2024 you are paying 20x two year forward earnings which is a very rich multiple. 

 

Incidentally at the end of 2021 bulls were still talking about how 2022 earnings estimates were $250 and therefore 4800 was only 19x earnings. 

 

Edited January 19, 2023 by mattee2264

[TwoCitiesCapital]

24 minutes ago, mattee2264 said:

For me it is still a question of valuation.

 

Bulls can talk about 4000 SPY being reasonably valued by using generous forward earnings estimates that seem to rest on the idea that any recession will be mild or short lived and earnings will soon surpass the 2021 peak of just under $200 a share. But 2021 earnings got a pretty massive assist from monetary and fiscal stimulus, cheap debt, pent-up demand and other favourable factors that are unlikely to recur going forwards.

 

The TINA argument for high valuations is a lot weaker now you can get 4% on bonds. The inflation argument for favouring equities despite expensive valuations is declining as inflation is coming down. Any economic recovery is not going to get much of an assist from fiscal or monetary policy. So I do not think you can count on earnings catching up to bring valuations down to more reasonable levels. 

 

2022 earnings are going to come in below $200. 2023 earnings at best will probably be flat and more likely will fall somewhat. So even if you think earnings can get back to $200 by 2024 you are paying 20x two year forward earnings which is a very rich multiple. 

 

Incidentally at the end of 2021 bulls were still talking about how 2022 earnings estimates were $250 and therefore 4800 was only 19x earnings. 

 

 

While this argument was made, it NEVER held water. Inflation is precisely why equities fell 20%. Equities never do well in periods of elevated inflation. They may do better than bonds pending how quickly and how prolonged the inflation is, but real returns are almost always negative. 

 

The receding of inflation WOULD be bullish for stocks if not for the earnings/economy being the next shoe to drop. 

 

I haven't done work on the bottom up earnings myself to come up with aggregate earnings, but I think the hot to earnings will be significant given inflation in the supply/labor chain (and the inability to pass along all of those costs), higher USD crushing foreign earnings, and rolling any debts at higher rates (though this will be minimal for the next 2-3 years). 

 

Morgan Stanley's base case is $190 with a bear case of $180. I think that under-estimates it and there one of the more bearish ones on the street. Revenue growth for the last 20 years averaged something like 3.5%. In 2021 it was closer to 12%. That's all stimulus. I think you'll see A LOT of that come back out now that money supply is contracting and we're not stimulating. If revenues fall by 5-10%, doesn't operational leverage suggest the hit to earnings will be quite a bit more than 5-10%?

 

 

Edited January 19, 2023 by TwoCitiesCapital

[changegonnacome]

1 hour ago, TwoCitiesCapital said:

18-20x forward earnings isn't attractive to me and receding tides will lower most boats regardless of fundamentals. 

 

Yep and those forward earnings estimates are looking very very suspect

[Spekulatius]

The Fidelity government MM fund currently yields 3.91%. I do nothing and that's where my cash goes to automatically in my Fidelity accounts:

[valueseek]

On 1/14/2023 at 2:36 PM, vinod1 said:

 

I think treasury 10 year yield of 4%ish range is quite consistent with 20ish PE on the market.

 

Historically stocks had a 6.5% risk premium. But the vast majority when this premium was earned was when no one can actually earn that much. Just not possible during this time. 

 

In 1880s or 1900s or 1920s or 40s you would have no way to assemble a portfolio of diversified stocks at low cost. You would have to take a train to a city to a brokerage house, then have your broker buy stocks that he is familiar with at large brokerage costs, bid spread costs, etc. Then store the stock certificates safely. There is limited financial information. Limited investor protections. All these end up costing investors in returns.

 

One could have gone through investor trusts. They had what 5% loads and 1 to 1.5% annual fees. And they would have underperformed the market.

 

Say they underperformed the market by 1%, then you lose about 2% in fees annually over the lifetime of the investment. An equity risk premium of 6.5% would end up being 3.5% for the investor.

 

Now you can get diversified exposure at near zero cost. An equity risk premium that should be demanded by investors is probably in the 3 to 4% range.

 

Vinod

This makes sense but somehow I have not come across this argument being put other places. Whatever I am aware of most people peg ERP above 5%. Is there any research or document or articles you have seen this or is more your thinking/analysis? Thanks.

[dealraker]

To me it is always the same: There's fear times and in this setting the name of the game is bottom picking.  If you do not obsess over the precise timing and duration of "the recession" and the "bottom" then you are simply NOT part of the game being played.  Getting it right, just once, is a lifetime of achievement and publicity.   Elain Garzarelli predicted the market was 35% overvalued in 1987 and instantly stocks fell 20%; she gained stardom; the market ended the year even higher than before her prediction but...

 

...she was paraded around by CNBC and others for a decade afterwards as the great forecaster....(you know....the one who got "one" out 100 calls correct).  

 

In generall the lowest bottom picker gets a good deal of attention, sometimes incredibly so.

 

In the upside times?  Hell, it is just names or sector.  Get that right?  Shit baby, it is endless stardom like you would never believe.  Abby Joseph Cohen and technology?  Oh my lord the woman was god, not for a couple years like Cathie, but for a damn decade!  But actually she was terribly wrong for most of that period as per the "reset" that came.

 

Not picking on women, but those two did shine...at least to me.  Then of course there's also Harry Dent, the Harvard grad who can't get a single damn thing right on names, sectors, or bottoms---- but still got decades of elaborate praise and followers.  He wrote best selling books that didn't have one single correct sentence.

 

And then there's us long term investors who never tend to be in the right sectors on the upside and never even try to guess the bottoms.  Ain't it awful?

 

 

 

 

 

Edited January 19, 2023 by dealraker

[changegonnacome]

@dealraker Agree monkeys pick their bottoms (in the british sense)!!! People shouldn't 

 

I'm a fully invested bear - my bearishness is expressed via 5-10% portfolio weighting allocated to bear-ish positioning usually a little levered via put options, some short OTM calls.........if I'm right it provides profitable hedges and some alpha to smooth out the 90% of the portfolio exposed to the beta flow......the hope is for superior stock picking on the long side too that can outdo the beta but sometimes the beta is just too strong .....if I'm wrong and history says the broad market goes up 70% of the time so the odds are your gonna be wrong.....well 5-10% of portfolio doesn't work out so well but 90% does......2022 was the first year I've run things with downside hedges versus 2020/2021 slightly levered long with some margin/calls.......2023 to me feels like another year to be hoping for the best (90% long) but planning for the worst (~10% in negative levered hedges)......I also like now more than ever kind of market neural stuff.....workouts, merger arb etc. Twitter deal last year was a god send on that....maybe Activision is the one this year.

 

My bear hunting is to try and figure out when to remove the 10% negative allocation and go back to my 2020/21 posture which is slightly margined long!