"Macro" Musings

[bmichaud]

I was using the S&P Industrials index that was used in the charts I attached yesterday.

 

The PE is related to the ROE via the Dividend Discount Model. Say a model company has $10 of normalized earnings power, a 12% ROE and a 50% payout ratio. With 50% of earnings reinvested at 12%, you get 6% growth. If you command a 10% return at fair value, then your "fair value" PE is 12.5X. At fair value, the dividend yield would be 4%, plus the 6% growth gets you to your 10% required return. $5 dividend divided by 4% is $125, or a PE of 12.5X $10 EPS.

 

Were this model company to have a 30% ROE ala Coke, and it grows in line with the economy at 6%, it only needs to retain 20% of its earnings in order to grow at that rate. So an $8 dividend (80% payout ratio) divided by 4% yields a $200 fair value per share, or 20X earnings.

 

Hence my skepticism as to why the market should trade above 15X earnings with an ROE of 12%.

 

 

Say the S&P 500's normalized profit margin is 7% versus the 9% projected (which is only 30% higher than the 7%). "normal" eps would be $77. With low rates forever, say it's worth 18X, or $1,386.

 

Assuming rates get to somewhat normal levels and the PE is 16X, fair value is 1,232.

 

The possibilities are endless. And why after years of remaining above fair value should the market stop at fair value? Don't assets usually overshoot? What if we get a sustained bout of above-average inflation and the market races down to 10 or 12 times earnings and stays at that valuation for a decade?

 

Who knows.

[vinod1]

I was using the S&P Industrials index that was used in the charts I attached yesterday.

 

The PE is related to the ROE via the Dividend Discount Model. Say a model company has $10 of normalized earnings power, a 12% ROE and a 50% payout ratio. With 50% of earnings reinvested at 12%, you get 6% growth. If you command a 10% return at fair value, then your "fair value" PE is 12.5X. At fair value, the dividend yield would be 4%, plus the 6% growth gets you to your 10% required return. $5 dividend divided by 4% is $125, or a PE of 12.5X $10 EPS.

 

Were this model company to have a 30% ROE ala Coke, and it grows in line with the economy at 6%, it only needs to retain 20% of its earnings in order to grow at that rate. So an $8 dividend (80% payout ratio) divided by 4% yields a $200 fair value per share, or 20X earnings.

 

Hence my skepticism as to why the market should trade above 15X earnings with an ROE of 12%.

 

Got it. If we have low interest rates far out into the future, required return for stocks should be far less than 10%. If 3% bond yields are going to here to stay, a premium of say 4% over bonds I think should be adequate. So that puts required stock market returns at 7%. That should support higher PE multiple.

 

Say the S&P 500's normalized profit margin is 7% versus the 9% projected (which is only 30% higher than the 7%). "normal" eps would be $77. With low rates forever, say it's worth 18X, or $1,386.

 

Assuming rates get to somewhat normal levels and the PE is 16X, fair value is 1,232.

 

The possibilities are endless. And why after years of remaining above fair value should the market stop at fair value? Don't assets usually overshoot? What if we get a sustained bout of above-average inflation and the market races down to 10 or 12 times earnings and stays at that valuation for a decade?

 

Who knows.

 

Do not disagree at all. It is a struggle we have to live with.

 

I would understand if you do not want to answer, but how is your stock/cash allocation?

 

I am nominally long 75% stocks via LEAPS and some stocks but also have around 70% in cash.

 

Vinod

[giofranchi]

Very good paper by Mr. Hay.

 

Gio

EVA+4.4.2014_NA.pdf

[Guest hellsten]

J.P. Morgan's Guide to the Markets:

https://www.jpmorganfunds.com/blobcontentheader/202/900/1158474868049_jp-littlebook.pdf

 

Russia is cheap. Current P/B 0.6. 10-year average P/B 1.4. China also cheap.

[Guest]

Ron Insana is predicting a "nasty pullback" then a return of a bull market.

 

http://www.cnbc.com/id/101531463

 

He even says things like "Market leaders tech and biotech have become tech and bio-wrecks" Cute.

 

"I have rarely missed a real bubble like the ones we have seen in the past. I don't believe this bull market is ending its five-year run, but I do believe it will pause to take a very deep breath."

 

He started a hedge fund...yeah... in 2006. Then went to work at SAC. Classy (and honest) fella, I'm sure.

[Guest]

http://www.schroders.com/tvp/archive?id=Flashinglite

 

 

props to value walk

 

[rkbabang]

It looks like we don't quite have the enthusiasm for stocks that we had before the last two large crashes.

 

From: Gallup.com Stock Market polls

 

 

If you had $1000 do you think investing in the it in stocks would be a good idea?

 

DATE	Good Idea	Bad Idea
2014 Jan	46%	50%
2007 Apr	50%	46%
2000 Jan	67%	28%

 

 

 

Do you, personally, or jointly with a spouse, have any money invested in the stock market right now?

 

DATE	Yes	No
2014 Jan	54%	44%
2007 Apr	65%	34%
2000 Apr	62%	37%

 

 

[Liberty]

http://www.thereformedbroker.com/2014/03/10/the-easy-money-myth/

[PatientCheetah]

It looks like we don't quite have the enthusiasm for stocks that we had before the last two large crashes.

 

From: Gallup.com Stock Market polls

 

 

If you had $1000 do you think investing in the it in stocks would be a good idea?

 

DATE	Good Idea	Bad Idea
2014 Jan	46%	50%
2007 Apr	50%	46%
2000 Jan	67%	28%

 

 

 

Do you, personally, or jointly with a spouse, have any money invested in the stock market right now?

 

DATE	Yes	No
2014 Jan	54%	44%
2007 Apr	65%	34%
2000 Apr	62%	37%

 

Market is fairly but not overvalued only if we reach the same euphoria that we did back in 2000 and 2007. Do you have the number from 1998? I think the current macro condition is more similar to 1998 than 2000 - Russian/Asian crisis, low interest rate, etc. 

[rkbabang]

It looks like we don't quite have the enthusiasm for stocks that we had before the last two large crashes.

 

From: Gallup.com Stock Market polls

 

 

If you had $1000 do you think investing in the it in stocks would be a good idea?

 

DATE	Good Idea	Bad Idea
2014 Jan	46%	50%
2007 Apr	50%	46%
2000 Jan	67%	28%

 

 

 

Do you, personally, or jointly with a spouse, have any money invested in the stock market right now?

 

DATE	Yes	No
2014 Jan	54%	44%
2007 Apr	65%	34%
2000 Apr	62%	37%

 

Market is fairly but not overvalued only if we reach the same euphoria that we did back in 2000 and 2007. Do you have the number from 1998? I think the current macro condition is more similar to 1998 than 2000 - Russian/Asian crisis, low interest rate, etc. 

 

 

With 1998 included:

 

 

If you had $1000 do you think investing in the it in stocks would be a good idea?

 

DATE	Good Idea	Bad Idea
2014 Jan	46%	50%
2007 Apr	50%	46%
2000 Jan	67%	28%
1998 Apr	65%	28%

 

Do you, personally, or jointly with a spouse, have any money invested in the stock market right now?

 

DATE	Yes	No
2014 Jan	54%	44%
2007 Apr	65%	34%
2000 Apr	62%	37%
1998 Sep	60%	39%

 

 

[wisdom]

http://www.economonitor.com/blog/2014/04/chinas-shadow-banking-system/

 

Good read on local govt borrowing in China by Das:

 

Many of the LGFVs do not have sufficient cash flow to service debt, being reliant on land sales and high property prices to meet debt obligations. The LGFVs also have significant mismatches between short term borrowings and long term investments being financed. With cash flow insufficient, many LGFVs now use new borrowings to repay maturing debt.

 

Probably something more than 50% of LGFVs have unsustainable debt levels and face the risk of insolvency.

 

Local governments also may not have the financial capacity to guarantee the solvency of their LGFVs. According to the World Bank, China’s local governments have responsibility for 80% of total spending but only receive about 40% of tax revenue.

[jouni1]

has anybody else noticed how everyone is a great investor these days? every time i see a news article of some never-heard fund manager, he's done over 20% for 12 months running or something. now i know this isn't impressive (even if they have beaten me lol), but people in track suits are reading these articles and eating up their advice like a hard-core buffetian at the berkshire agm.

 

everybody is doing great and investment success is measured over 1-3 year periods. stocks will keep going up and you add on dips.

 

people on internet forums are finding easy doubles and are going to triple their money in the market after a +40% year. the masses are investing in price action, not businesses.

 

i'm starting to see the investor enthusiasm that was around when i started investing in 2007. almost everybody knows that everyone should invest in stocks.

 

in a way it's frustrating reading about all these great investment ideas, and just not seeing it. hand-sitting is the hardest part.

 

sorry for this incomprehensible rant. was just reading some seekingalpha etc and i was wondering if anybody else feels like there's just too much optimism.

[Packer16]

Although, I see some of this I see a bigger love of bonds.  We have had negative real rates in the US for a few years now and people have been just buying more bonds.  I also hang out at another passive investor sight called "Bogleheads".  They also have a net worth demographic similar if not higher than here and the conventional wisdom is to have your age or your age less 10 years in bonds.  So if your 50, you allocation is 40 to 50% in bonds.  Some of these folks have a pretty strong conviction that portfolios with large portions of bonds are the way to go, some even recommend a 50/50 stock/bond mix to younger investors.  If this is the what the typical investor is investing in I understand why there are negative real yields.  My take is to run away from these popular assets and buy asset that have slightly more risk but much higher returns like triple-net lease properties.

 

Packer

[jouni1]

funny you mention that. i have been following a finnish investment forum for quite a while now and i have seen a trend there too.

 

nobody does bonds, but the hottest thing for the past two-three years has been american dividend aristocrat investing. people write daily about their 100-500 dollar purchases of "exon mobile" and american water utilities. whenever somebody asks them if they should do any real analysis, they get shot down by people who have been reading a dividend growth blog for a few months.

 

i mean, the market just seems so irrational now. people are piling in on assets on emotional reasoning. i have no idea if these new investors are causing overvaluation, or if it's just a normal cyclical thing. anyway i find it interesting that the P/E investor (after burning his fingers with low p/e cyclicals in 2008/09) is now looking at dividend/earnings ratio and historical dividends. it's like there's a magical number to look at and get rich. it just changes every 5 years or so.

 

don't know if this phenomena is global, but 4/5 finnish investment blogs are pure dividend blogs, no real analysis, just listing historical dividends. we didn't even get the indexing boom here in between. i have no idea how to profit from these observations, other than to stay extra cautious and miss out on some gains.

[Packer16]

I am not sure the market is ever totally rationale.  If so, we would not be able to earn returns higher than the market.  If folks are focusing on dividend investing maybe the other areas of value investing are being ignored.  Have you been able to find smaller Nordic value stocks?  As an American, the one cheap Nordic stock I own is Awilco Drilling. 

 

Packer

[One World Trader]

What about about the GNP to total mkt cap ratio? Could this be compared to the data from rkbabang? Is there data in the months before and after the poll that shows how many months it took to get to those levels?

It looks like we don't quite have the enthusiasm for stocks that we had before the last two large crashes.

 

From: Gallup.com Stock Market polls

 

 

If you had $1000 do you think investing in the it in stocks would be a good idea?

 

DATE	Good Idea	Bad Idea
2014 Jan	46%	50%
2007 Apr	50%	46%
2000 Jan	67%	28%

 

 

 

Do you, personally, or jointly with a spouse, have any money invested in the stock market right now?

 

DATE	Yes	No
2014 Jan	54%	44%
2007 Apr	65%	34%
2000 Apr	62%	37%

 

 

[no_free_lunch]

http://www.economonitor.com/blog/2014/04/chinas-shadow-banking-system/

 

Good read on local govt borrowing in China by Das:

 

Many of the LGFVs do not have sufficient cash flow to service debt, being reliant on land sales and high property prices to meet debt obligations. The LGFVs also have significant mismatches between short term borrowings and long term investments being financed. With cash flow insufficient, many LGFVs now use new borrowings to repay maturing debt.

 

Probably something more than 50% of LGFVs have unsustainable debt levels and face the risk of insolvency.

 

Local governments also may not have the financial capacity to guarantee the solvency of their LGFVs. According to the World Bank, China’s local governments have responsibility for 80% of total spending but only receive about 40% of tax revenue.

 

A China crash is definitely concerning but then it's been widely predicted since 2007.  Nevertheless, it could happen and it could be ugly.  I am just trying to figure out what the impact would be on western economies?  Since China is a net exporter, from a US perspective wouldn't the impact be fairly muted?  China is certainly going to continue to produce and ship goods in the event of an economic downturn.  There will be a stronger effort to weaken the currency which involves buying US government debt so it could push US yields down.  Maybe the banking crisis would spill over to western banks?  Canada/Australia could get hit if demand for iron goes down I suppose.  I don't know, I am just not sure how much it would impact my investments.

[jouni1]

I am not sure the market is ever totally rationale.  If so, we would not be able to earn returns higher than the market.  If folks are focusing on dividend investing maybe the other areas of value investing are being ignored.  Have you been able to find smaller Nordic value stocks?  As an American, the one cheap Nordic stock I own is Awilco Drilling. 

 

Packer

OT:

 

i have, but they have been bought out. in the 7 years i've been investing, i have lost 5 great small caps to buyouts. the number of listed companies has been going down, not up, since the crash. there are a few good ones left, but they're valued pretty high.

 

wilh. wilhelmsen holdings (norway) is at 0.6 book, but i'm not sure if it's actually cheap yet. i'm trying to do some work on it atm. they do ro-ro and automotive shipping around the globe through subsidiaries and joint ventures. they also have some port services etc.

 

the car shipping market didn't crash like rest of shipping, so i'm not sure if the correction is ahead or not coming at all. it's a much less competitive environment than dry bulk for example.

 

konecranes is the world's leading industrial crane company (manufacturer and service). it's my largest holding. i'm not sure about the valuation right now, seems like some growth is expected. it's a wonderful business, they've stayed profitable through the turmoil in 2008-9 and 2011. super hard times, they're still making profits and innovating. they have a GE-style "internet of things" -project which helps them monitor the service needs of their cranes. chairman was around when the business was formed in 1988, ceo till 2005, now chairman. he gave his stock as a pre-inheritance (without dividend or voting rights) to his children in 2011. pekka lundmark has been the ceo ever since. he spent a few years in south east asia trying to understand where the world is going. overly simplified, he came back with the idea of making mid-price high-quality cranes for emerging markets. i thought i'd give a short summary but it got out of hand.

 

been planning on starting threads on a few companies i believe have great business models, leadership and appreciate shareholders. but nothing is priced quite right so i'm waiting.

 

and now for some on topic macro stuff: i get 1.38 dollars for every euro i have. right now i feel like investing in north america might make more sense.

 

 

[investor-man]

Although, I see some of this I see a bigger love of bonds.  We have had negative real rates in the US for a few years now and people have been just buying more bonds.  I also hang out at another passive investor sight called "Bogleheads".  They also have a net worth demographic similar if not higher than here and the conventional wisdom is to have your age or your age less 10 years in bonds.  So if your 50, you allocation is 40 to 50% in bonds.  Some of these folks have a pretty strong conviction that portfolios with large portions of bonds are the way to go, some even recommend a 50/50 stock/bond mix to younger investors.  If this is the what the typical investor is investing in I understand why there are negative real yields.  My take is to run away from these popular assets and buy asset that have slightly more risk but much higher returns like triple-net lease properties.

 

Packer

 

I stop by Boggleheads every now and then too. I find the general reluctance to being "active" kinda frustrating. It's foolish to make macro predictions but when interest rates are as low as they are now it's a fair certainty that they will go higher at some point, like when the fed stops QE as they've clearly indicated it will.  And the sophistication behind their (boggleheaders) arguments for thier bond allocations is doubly frustrating. If they spent as much time investigating businesses as they did investigating why they shouldn't investigate businesses then they'd be much better off

[frommi]

and now for some on topic macro stuff: i get 1.38 dollars for every euro i have. right now i feel like investing in north america might make more sense.

 

Thats one of the reasons i have only a very small portion of stocks in the EU. Its just a matter of time that the ECB has to print money or that whole things collapses with people rioting on the street in spain and greece. The situation in these countries has not really improved, but nobody talks about it and the going back to the capital markets in greece was much to early in my view. In some years they have to be bailed out again. And germany has a massive problem with its pension system that will come to the surface in 10-20 years. For me that are enough reasons to avoid the euro zone. But thats probably because i am living here, the grass is always greener somewhere else. :)

[yadayada]

Although, I see some of this I see a bigger love of bonds.  We have had negative real rates in the US for a few years now and people have been just buying more bonds.  I also hang out at another passive investor sight called "Bogleheads".  They also have a net worth demographic similar if not higher than here and the conventional wisdom is to have your age or your age less 10 years in bonds.  So if your 50, you allocation is 40 to 50% in bonds.  Some of these folks have a pretty strong conviction that portfolios with large portions of bonds are the way to go, some even recommend a 50/50 stock/bond mix to younger investors.  If this is the what the typical investor is investing in I understand why there are negative real yields.  My take is to run away from these popular assets and buy asset that have slightly more risk but much higher returns like triple-net lease properties.

 

Packer

 

I stop by Boggleheads every now and then too. I find the general reluctance to being "active" kinda frustrating. It's foolish to make macro predictions but when interest rates are as low as they are now it's a fair certainty that they will go higher at some point, like when the fed stops QE as they've clearly indicated it will.  And the sophistication behind their (boggleheaders) arguments for thier bond allocations is doubly frustrating. If they spent as much time investigating businesses as they did investigating why they shouldn't investigate businesses then they'd be much better off

Well i dont find that frustrating, let them do it, less competition!

 

I see it like this, why the hell bother with bonds if you put a decent amount of time in investing? If you find good ideas with lots of upside and limited risk then you will do better then bonds anyway.

 

Maybe if your alot more passive because  you dont have time or get bored with it, then bonds are something worht looking at.

 

I think the reluctance to actively look for cheap stocks for certain people is a fear that the market is efficient. They think they cannot do it, because like 98% cant do it. But then I always think that of that 98% that can't do it, most are dumb as a rock or lazy or they just dont follow a system like value investors do. Most people cant even be bothered to look at earnings and lack basic understanding of accounting statements. So if you look at those, and understand return on capital, you already have an edge over most of the market participants.

[Guest]

I don't know why people are talking about euphoria in 2007, at least in the US for equities. It was not euphoric. Things were complacent sure, but not euphoric. People were moving money to international equities due to the dollar becoming less valuable. Oil was also very popular. People kept talking about how $150 barrel of oil would throw us into a recession. Just because the market dropped doesn't mean people were euphoric. ;)

[ERICOPOLY]

I don't know why people are talking about euphoria in 2007, at least in the US for equities. It was not euphoric. Things were complacent sure, but not euphoric. People were moving money to international equities due to the dollar becoming less valuable. Oil was also very popular. People kept talking about how $150 barrel of oil would throw us into a recession. Just because the market dropped doesn't mean people were euphoric. ;)

 

I agree.  Anyone who is old enough to remember 1999 can tell the difference in atmosphere versus 2007.

 

Stocks were the rage in the late 90s -- they weren't a "rage" in 2007.  The late 1990s were all about the stock market, and once that blew up people were raging about real estate.

[jouni1]

in 2007 i knew people who invested in stocks and talked about them. in 2009-2011 i only knew one person in addition to me. now i start hearing people talking about stocks again. we already had a ipo cue outside a bank this year(like in 1999). and it was an online retailer for 43 p/e. i'm not sure it has to be the techno bubble all over again to call it optimism.

[giofranchi]

Easy Eurozone Trades Are Running Out Of Road by Mr. Charles Gave

 

 

Gio

Daily+4.22.14.pdf