Is The Bottom Almost Here?

[vinod1]

4 hours ago, valueseek said:

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.

 

I was an indexer from 2001 to 2005 and thinking/researching ERP one of my favorite hobbies (isn't it sad?) and I picked this up somewhere in that timeframe. It might be something I read somewhere or it might be my own thinking but hardly any of my thoughts on investing are original. 

 

One of the reasons I got interested in stock picking is because of the low ERP.

 

Anyway the argument has definitely been made by Siegal and Philosophical Economics which reinforced my own conviction (no confirmation bias, of course ). But I did not see anyone make estimates of this.

 

Vinod

Edited January 19, 2023 by vinod1

[vinod1]

7 hours 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. 

 

 

S&P 500 earned $153 in 2018 and $157 in 2019. Definitely closer to peak but not a fluke or from something totally unsustainable. So let us say, an average of $155 in 2019. 

 

Nominal GDP is 18% larger in 2022. In addition, about 4% of net share buybacks took place over this period. Adjusting for this gets to $190 per share in 2022.

 

The massive boost to earnings you are talking about is gulp $10 more on a base of $190! Less than 5% might a tad excessive to call it a massive boost.

 

Early last year my assumption was exactly like you, that there must be a massive boost to S&P 500 earnings. It just made sense, what with all the nonsense going on with SPAC, Crypto, ARK and the general sense of exuberance. But when I looked at the data, I could not make it out in the earnings numbers.

 

I do agree that to grow from here is going to be a real headwind. 

 

Vinod

[vinod1]

7 hours ago, TwoCitiesCapital said:

 

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%?

 

 

 

Inflation is never good for any financial asset. The argument is what holds the most value long term in case of massive inflation. 

 

Just for kicks, if you model an inflation of 10% for 20 years in US. Real GDP growth of 1 or 2%. Profit margins collapsing by half to 6% range from 12% now. PE multiples falling to 10. You still end up with 9-11% equity returns. 

 

Not good at all. 

 

But most likely far better than bonds. If inflation is going to be 10% over such a long period means Fed is likely not keeping rates high. In which case, cash would suck as well.

 

Vinod

 

 

 

[vinod1]

Not very familiar with agency mortgage bonds but I would think that the 6% bonds would be called if rates dip again and you would end up with reinvestment risk. Please correct me on this.

 

Vinod

[TwoCitiesCapital]

22 minutes ago, vinod1 said:

 

Inflation is never good for any financial asset. The argument is what holds the most value long term in case of massive inflation. 

 

Just for kicks, if you model an inflation of 10% for 20 years in US. Real GDP growth of 1 or 2%. Profit margins collapsing by half to 6% range from 12% now. PE multiples falling to 10. You still end up with 9-11% equity returns. 

 

Not good at all. 

 

But most likely far better than bonds. If inflation is going to be 10% over such a long period means Fed is likely not keeping rates high. In which case, cash would suck as well.

 

Vinod

 

 

 

 

I didn't run your specific math, but what I can say is observed periods of inflation that have actually occurred did NOT end like that. 

 

In the US, during our inflation of the 70s, stocks went nowhere for a decade and you significant negative real returns. It certainly wasn't profitable in real terms buying stocks in Weimar's hyperinflation - nor Zimbabwe's - nor Venezuela's. 

 

Inflation may mean stocks outperform. Or it may mean bonds outperform (like they did in the 1970s with anything less than 10-years to maturity). It depends on how quick, how high, and how persistent it is. 

 

But I'd argue those aren't your only two options, nor do you need to commit to owning only one for the whole decade.

 

But anyone who owned cash, short-term bonds, and even intermediate bonds outperformed equities last year fairly significantly despite 7-9% inflation....even while everyone was saying cash/bonds are things NOT to own during inflation.

 

I was definitely saying equities were the last place you'd want to be if inflation was not transitory, and that proved to be true. I don't think we're done with that trend either. 

Edited January 20, 2023 by TwoCitiesCapital

[TwoCitiesCapital]

27 minutes ago, vinod1 said:

Not very familiar with agency mortgage bonds but I would think that the 6% bonds would be called if rates dip again and you would end up with reinvestment risk. Please correct me on this.

 

Vinod

 

It depends - 

 

You could buy the low coupon variants where the primary yield is the amortization to par. In that case, you're probably not going to get prepayments because those bonds are people like me with mortgages at 2.75% we're not letting go of.  But you're taking more duration risk if you're wrong on rates. 

 

If you buy newly issued, higher coupon bonds with more yield coming from the cash flow, the only way they're getting prepared/refinanced is if property values hold up - which they currently are not - because people won't be able to refinance with sub-20% equity.  Those bonds will likely be money good for a few years too, with low prepayments. If you're skeptical, buy discount bonds as in the first example. 

 

2020 basically pulled forward nearly all refinance activity for the decade IMO. 

Edited January 20, 2023 by TwoCitiesCapital

[Dinar]

2 hours ago, vinod1 said:

 

I was an indexer from 2001 to 2005 and thinking/researching ERP one of my favorite hobbies (isn't it sad?) and I picked this up somewhere in that timeframe. It might be something I read somewhere or it might be my own thinking but hardly any of my thoughts on investing are original. 

 

One of the reasons I got interested in stock picking is because of the low ERP.

 

Anyway the argument has definitely been made by Siegal and Philosophical Economics which reinforced my own conviction (no confirmation bias, of course ). But I did not see anyone make estimates of this.

 

Vinod

Go to professor Aswan Damodaran at NYU.  He did and still does a lot of work on equity risk premia at various times.

[UK]

7 hours ago, changegonnacome said:

@dealraker 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!

 

What is slight margin for you? 10 or 30? For me this bearish vs bullish positioning is somewhere betweeh 30 per cent cash and 30 per cent margin. I very rarely went to the margin side in the last years, because was constantly worried of zero rates, valuations and general too good mood in the market:). In hindsight it was mistake not to do this in the end of 2018 and start of 2020.

 

Edited January 20, 2023 by UK

[changegonnacome]

10 hours ago, UK said:

What is slight margin for you?

Portfolio margin I never allow to go beyond 12.5%….…..idea being even in a 50% drawdown…..when 12.5% margin on depressed equity base would jump to 25% it shouldn’t cause any forced selling (I’m with IBKR, they don’t margin call, they just sell ).

 

The reality however with LEAPS is that one can have a long term view and be quite levered and not worry about such things which would be my recommendation. Not unusual for me in 2020/21….to take a FULL position… 80% of which was in the underlying and 20% in leaps for the extra juice.  When the Fed speaks, I listen…..they wanted everything to go up back then…now is the opposite. Why would I stop listening now.

[vinod1]

15 hours ago, Dinar said:

Go to professor Aswan Damodaran at NYU.  He did and still does a lot of work on equity risk premia at various times.

 

I am talking about estimate for transaction/expenses/etc prior to the 1950s for holding diversified portfolio of stocks. 

 

I follow Damodaran's work and learned more from his "Investment Valuation" book than from CFA exams.

[vinod1]

16 hours ago, TwoCitiesCapital said:

 

It depends - 

 

You could buy the low coupon variants where the primary yield is the amortization to par. In that case, you're probably not going to get prepayments because those bonds are people like me with mortgages at 2.75% we're not letting go of.  But you're taking more duration risk if you're wrong on rates. 

 

If you buy newly issued, higher coupon bonds with more yield coming from the cash flow, the only way they're getting prepared/refinanced is if property values hold up - which they currently are not - because people won't be able to refinance with sub-20% equity.  Those bonds will likely be money good for a few years too, with low prepayments. If you're skeptical, buy discount bonds as in the first example. 

 

2020 basically pulled forward nearly all refinance activity for the decade IMO. 

 

Thanks! 

[Dinar]

3 minutes ago, vinod1 said:

 

I am talking about estimate for transaction/expenses/etc prior to the 1950s for holding diversified portfolio of stocks. 

 

I follow Damodaran's work and learned more from his "Investment Valuation" book than from CFA exams.

You may want to ask him whether he has the data.  Somebody else who may is professor Robert Shiller at Yale.   If I recall correctly, before 1975, retail investors paid 1% commission to buy or sell stocks.  Institutions I believe paid 5 cents per share, but I may be wrong.  The Coles foundation at Yale has a lot of old stock market data, so it may have the data that you are looking for.  Also, there is a guy named Martin Sosnoff - he has a blog, used to be a money manager, he may be in his late 80s.  Email him, may be he will be able to give you answers off the cuff.

[Luca]

I am very excited for earnings time, lets see what Mr.Market serves us

[changegonnacome]

Dont forget the 'money illusion' I've spoken about - if a companies YoY quarterly earnings per share hasn't grown by lets call it conservatively ~7-8% nominal (between friends) over Q4 2021's EPS.........the earnings have actually fallen in real terms..........inflation is a silent thief

 

 

Edited January 23, 2023 by changegonnacome

[Gregmal]

4 minutes ago, changegonnacome said:

Dont forget the 'money illusion' I've spoken about - if a companies YoY quarterly earnings per share hasn't grown by lets call it conservatively ~7-8% nominal (between friends) over Q4 2021's EPS.........the earnings have actually fallen in real terms..........inflation is a silent thief

 

 

Yet people sit on cash, or tout their 4% guvs and pretend to be rich. The narratives can’t all be correct. 

All the companies who raised prices on lumber(just using as an example) took the immediate hit, and now have better margins because of it assuming they held those price increases. Exactly what’s working for homebuilders for instance. 
 

Plus, we all know inflation wasn’t really 8-10% last year. Can we stop peddling that? Same way inflation wasn’t 6% in 2021. 

[changegonnacome]

18 minutes ago, Gregmal said:

Plus, we all know inflation wasn’t really 8-10% last year.

 

What was it then? What real versus nominal adjustments are you making?

 

It can't all be fake @Gregmal......we can definitely argue about what the inflation rate is EXACTLY right now this minute some arguements that have merit that MoM inflation is now showing 'normal' type numbers consistent with 2%.....but the US economy experienced genuine, real and recorded inflation in the 2021/2022 period...to deny that is to pretend in an alternative universe, its delusional ....so what do you think the Q4 2021 to Q4 2022 real inflation rate was if not the reported inflation rate?.....you'll see from my message I down regulated my rate to ~7-8%.

 

People who are intellectually honest with themselves have to inflation adjust in an inflationary environment.....to not do so is to trick yourself around the basket of goods and services your 'earnings' can now command.

 

 

 

Edited January 23, 2023 by changegonnacome

[Gregmal]

I ve said before I don’t think the published numbers are true. I am not sure we can ever get a real “exact” print if that’s what’s required either. Between h2 2020 and Q1 2022 there was probably 30-40% cumulative inflation with the bulk occurring in the 12 months from q42020-q42021, almost directly attributed to stimulus payments. Anyone who went grocery shopping, dining, or ventured out into the world saw it. Fueled on the low end by q2-3 2020 seeing massive plunges in just about everything and then on the backend massive shortages of same products that, like energy/oil, got panic sold in the early COVID stage, production shut/cut massive, and then didn’t get fixed til mid 2022.
 

Inflation was minuscule on 2022 but every is captivated by energy prices which, drum roll, have always been volatile. 

[changegonnacome]

4 minutes ago, Gregmal said:

Inflation was minuscule on 2022

 

Oh yeah whats your finger in the air ballpark for 2022?

 

 

[Gregmal]

It’s hard to ballpark in anything other than ranges but net I’d say 0-5% is closer than 5-10%. Energy was the big mover but commodities came down big. Housing and rental stuff mostly rose to its peak levels in Q3 2021 and it just sat there(no decline though for rents, modest for housing prices) in 2022. The only real inflation was likely heavily skewed to low-mid end blue collar work. Not aware of much in the white collar world. I don’t think any of my attorneys have raised rates since COVID started. Which is a different subject but much of white collar world was already very much aware of the ramifications of poorly performing stock markets in q1-2 of 2022. By the end, as some have already said, they’re more lucky to have jobs than be reaching for bonuses.

 

Big story, I don’t think anything worthwhile on the inflation story front become evident until late 2023 or early 2024 at best. And I think it’s a mistake to attribute real losses via inflation to valuations because it’s anchored to a short term thing. I’d even say that same phenomena is why the “sticky” aspect remains a topic. It’s just interpreted wrong. But @SharperDingaanhas mentions it before. Corporation raise prices up “because of inflation”….then they stay there or keep raising and most of its just margin. Short term pain for long term gain, hardly a negative at all.

 

Energy’s overblown too. No one has explained how 2014 had $100 oil but not a peep about an inflation crisis. So that alone I doubt does much.

Edited January 23, 2023 by Gregmal

[changegonnacome]

Yeah listen YoY earnings require some inflation adjustment to get to a true approximation of the purchasing power of those earnings & by extension true 'wealth'........................because whatever way you slice it we've had some above trend inflation the last couple of years........the average bear will look at YoY 2022 vs 2021 earnings per share growing perhaps 1-2%.....and say to themselves "not bad things going in the right direction.....value is compounding here".........but in reality thats not the case......you held an instrument that, in real earnings power, did not in fact maintain your purchasing power. It destroyed it.

 

It’s doubly painful when many have seen the multiple paid on those earnings contract also and then to think that the earning stream itself has contracted in value (inflation adjusted) is just too painful a thought. I get it.

 

I’ve got one stock in my portfolio in nominal terms everything looks ok…earnings flat-ish YoY, stock down slightly in nominal since I bought it in 2021…..but that SOB is a real dud and its destroyed at least 10-15% of purchasing power I put into…..cause it failed to outrun inflation with its earnings…..and the mark-to-market losses on the equity ticker itself are larger than just the nominal decline if i were to sell today.

 

Inflation allows those who wish to delude themselves a convenient psychological 'out' as they play the nominal game and buy into the 'money 'illusion'.......I try to be brutally honest..........

 

Edited January 23, 2023 by changegonnacome

[StevieV]

3 hours ago, Gregmal said:

Energy’s overblown too. No one has explained how 2014 had $100 oil but not a peep about an inflation crisis. So that alone I doubt does much.

 

I read that Powell claims +$10 oil = +0.2% inflation.  WTI increased about $25 from '21 to '23, which would equate to about 0.5% contribution.  So, not huge on a pretty decent increase in oil prices.

 

Last year WTI was about $95.  WTI could average $105 this year and it's impact on inflation would be a negligible contribution + 0.2%.  That's assuming Powell's rule of thumb is accurate.

 

In any event, I don't think $100 or a bit $100+ oil would be inconsistent with inflation coming down fast this year.  

[SharperDingaan]

Over the short-term (0-6 months), oil prices will move primarily according to the supply/demand forecast; inflation has a pretty small and indirect impact at best. More impactful is what happens as a result of oil being increasingly settled in either Yuan or USD.

 

Petroyuan and petrodollars at parity, mean much closer linkage with China's interest rates.

How that actually works out being something of a mystery.

 

SD 

[Gregmal]

https://www.cnbc.com/2023/01/24/greedflation-food-brands-may-be-profiteering-from-price-hikes.html

 

Just more anecdotal evidence of whats really the root of remaining inflation. Some of my favorite inflation litmus tests while strolling through the stores are frozen French fries, and canned soup. Check the generic, and the name brands and how the prices move around. Its all pretty fascinating. Both follow very similar patterns now going on 6+ months. Regular everyday price is maybe 10-20% higher than pre covid. Maybe $3-3.50 for each on the name brand side and $2-2.50 for generic. Generic never moves. Randomly the name brand goes up for a bit to about $4-4.30. It holds there for a week or two, and then like clockwork you have these massive inventory blowout sales, $1.99 for the fries and like 4/$6 on the soup. Supply and demand. 

Edited January 24, 2023 by Gregmal

[Ulti]

48 minutes ago, Gregmal said:

Just more anecdotal evidence of whats really the root of remaining inflation

https://podcasts.apple.com/us/podcast/what-the-heck-is-happening-with-the-price-of-eggs/id1056200096?i=1000596025553

 

 

[Gregmal]

16 minutes ago, Ulti said:

https://podcasts.apple.com/us/podcast/what-the-heck-is-happening-with-the-price-of-eggs/id1056200096?i=1000596025553

 

 

LOL I m waiting for the breakfast crisis headlines. We need 10% FF because eggs and OJ prices are soaring! Neither have nuffin to do with inflation....