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Jean-Marie Eveillard There Are Absolutely Terrifying Risks Facing Global Markets


indythinker85
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What we’ve had in the US over the past 5 years , both from a monetary and from a fiscal point of view, is the most stimulative economic policies ever -- completely unprecedented.  The printing of money, QE, etc, the budget deficit, the tremendous increase in government debt, and yet the economic recovery continues to be weak.

 

Is this even true?  It looks like the government debt went from 40% GDP to 110-120% during world war 2.  08-present, roughly 40% to 80%.  There is also the ramp up in federal reserve holdings which might add another 10-15%.  Combined it seems the current situation is very much comparable to back then.  I don't understand the hyperbole, you can make a strong case without it.

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quoting:

Now, the stock market is up sharply because some of the excess liquidity being created by the Fed is going into stocks.  Some of it has also gone into things such as the real estate and fine art markets.  But the money goes particularly into the stock market.

 

Hmm...

 

Well... the forward P/E ratio of the S&P500 is only 16x.

 

He could instead argue that the forward prediction of earnings is wrong for X,Y,Z reasons, but I would argue that you don't need excess liquidity to pump a market up to 16x earnings expectations. 

 

In fact, the market has traded at 16x expected earnings many times in history without the presence of excess liquidity being created by the Fed.

 

So his argument that the market is being artificially jacked up to 16x earnings expectations is not well supported by the claim he makes. 

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Maybe this will be the comment that sets off the crash.. I don't really see any speculative bubble fever in the market.  Maybe I'm naive, and those smarter can correct me, but I think we're in this middle market.  The easy gains are over, many things are fairly valued or slightly overvalued.  I know in a lot of areas I used to find bargains are fairly valued.  Some junk if flying, but other junk that was selling at 2x earnings is now 7x earnings, is that crazy? 

 

I've also seen a lot of companies that looked like they had a foot in the grave finally start to report earnings and shore up their balance sheets.  Hopefully they'll have enough time to right the ship before things turn south again, but you never know.

 

I think the pain for value investors is that the easy finds are over.  Since 2009 we've been shooting fish in a dixie cup, that's four years of easy hunting.  I'm still finding some relatively cheap stocks out there, it's just that I have to look a lot harder than before.

 

I commonly trawl through all the pink sheet companies that file each week, in the past I'd find a few potential purchases, now I might read through a month's worth of filings before finding a name, out there, just more work.

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In fact, the market has traded at 16x expected earnings many times in history without the presence of excess liquidity being created by the Fed.

 

This is true but the anticipated growth was higher than it is today. USA is coming to maturity in term of development.

 

I am in the camp that we are in a "new normal" environment with normal growth of 2-3% instead of 4-6% it used to be.

 

And as you know growth is a big input in determining the right P/E multiple to assign on earnings to get IV

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...the forward P/E ratio of the S&P500 is only 16x.

 

Eric,

 

Not to say that the market is crazy expensive, but I think it's probably more appropriate to talk about GAAP earnings when we talk about aggregate PE ratios, and compare them to history.

 

There is a nasty trend that has developed in the past 30 years or so where the operating earnings quoted from S&P have been 15-20% higher than GAAP earnings on a pretty much continual basis.  So when someone says a 15-16x PE is fair or average or whatever for the market, this historically was a GAAP PE (TTM, not forward).  If you want to quote forward earnings that's fine, if you want to quote non-GAAP / non-one-time charge earnings, that's also totally fine, but if you want to quote both together I personally think that 16x sounds pretty high to me.  That's probably the equivalent of 20x TTM GAAP PE for most years.

 

Seems that ROE for corporate America is high-ish given the low rate / cost of capital environment.  I could see a lot of factors that could keep stocks doing well near term, but bargains do seem challenging to find. 

 

I do agree with Oddball though, it doesn't seem that people are crazed about stocks or anything.  Most amateur investors I know are mostly fully invested in stocks, but nervous as they just don't have other good options from their perception.

 

I think stock returns will be low from current prices, but so will the returns of most other assets.  The killer for stocks will only come if the normal ROE of corporate America starts to come under pressure due to interest rate gravity / competition... but not sure I see that today.

 

Plenty of people with great records are cautious though... JME and Klarman are two to listen to if you don't like losing money...

 

Ben

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...the forward P/E ratio of the S&P500 is only 16x.

 

Eric,

 

Not to say that the market is crazy expensive, but I think it's probably more appropriate to talk about GAAP earnings when we talk about aggregate PE ratios, and compare them to history.

 

There is a nasty trend that has developed in the past 30 years or so where the operating earnings quoted from S&P have been 15-20% higher than GAAP earnings on a pretty much continual basis.  So when someone says a 15-16x PE is fair or average or whatever for the market, this historically was a GAAP PE (TTM, not forward).  If you want to quote forward earnings that's fine, if you want to quote non-GAAP / non-one-time charge earnings, that's also totally fine, but if you want to quote both together I personally think that 16x sounds pretty high to me.  That's probably the equivalent of 20x TTM GAAP PE for most years.

 

Seems that ROE for corporate America is high-ish given the low rate / cost of capital environment.  I could see a lot of factors that could keep stocks doing well near term, but bargains do seem challenging to find. 

 

I do agree with Oddball though, it doesn't seem that people are crazed about stocks or anything.  Most amateur investors I know are mostly fully invested in stocks, but nervous as they just don't have other good options from their perception.

 

I think stock returns will be low from current prices, but so will the returns of most other assets.  The killer for stocks will only come if the normal ROE of corporate America starts to come under pressure due to interest rate gravity / competition... but not sure I see that today.

 

Plenty of people with great records are cautious though... JME and Klarman are two to listen to if you don't like losing money...

 

Ben

 

I didn't realize that about the market P/E.  Okay, so you think it is more in the 20x range versus 16x.  I am glad you took the time.

 

I have to admit that I was less critical of what he had to say until I got towards the end of it with the talk of Neo-Keynesian and gold being the new/old currency again.  I just can't listen to people who talk like that.  The dollar has lost value through my entire life.  Gold skyrocketed when I was a young child, but I remember those years fondly -- people always smile at a cute baby no matter what gold is doing, so perhaps that creates a bias that high gold prices doesn't equate to misery.  Gold has increased by a large amount over the past decade once again, but it hasn't made me miserable.  I don't mind if he doubles his money in gold once again over the next 7 years -- I think he could do better owning Wells Fargo (less macro study needed), but to each his own.  Some of these guys are academics of macro, or enjoy it immensely enough as an economic pursuit, and seem to do well following it.  But I don't think I need to do that to make money, so I tend to roll my eyes when I see how long their commentary about it is.  It was very interesting for a while, but it's been a decade of it now it seems.

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What we’ve had in the US over the past 5 years , both from a monetary and from a fiscal point of view, is the most stimulative economic policies ever -- completely unprecedented.  The printing of money, QE, etc, the budget deficit, the tremendous increase in government debt, and yet the economic recovery continues to be weak.

 

Is this even true?  It looks like the government debt went from 40% GDP to 110-120% during world war 2.  08-present, roughly 40% to 80%.  There is also the ramp up in federal reserve holdings which might add another 10-15%.  Combined it seems the current situation is very much comparable to back then.  I don't understand the hyperbole, you can make a strong case without it.

 

Yes, but in that time the private sector deleveraged hard: total debt / GDP actually fell during WW2.  Taxes rose and the public were encouraged to put money into war bonds rather than to spend it.  And the Fed monetised debt, but not as much.  (And it is worth saying that production rose but it was largely things that got shipped abroad and blown up rather than things that created value.)  So yes, I think it is fair to say that this is the most stimulated economy ever, and that particularly goes for the consumer.

 

I'm currently reading David Stockman's The Great Deformation, which is very interesting on this topic and essentially argues that the US has been getting more stimulative fiscally and monetarily ever since it originally came off the gold standard.

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There is a nasty trend that has developed in the past 30 years or so where the operating earnings quoted from S&P have been 15-20% higher than GAAP earnings on a pretty much continual basis.  So when someone says a 15-16x PE is fair or average or whatever for the market, this historically was a GAAP PE (TTM, not forward).  If you want to quote forward earnings that's fine, if you want to quote non-GAAP / non-one-time charge earnings, that's also totally fine, but if you want to quote both together I personally think that 16x sounds pretty high to me.  That's probably the equivalent of 20x TTM GAAP PE for most years.

 

 

Interesting.  Also, as we all know, margins are high and mean-reverting for good reason.  If I take current S&P revenues (i.e. if I assume they are not inflated by stimulus) and multiply by the long run average net margin and P/E multiple, I come out at a target index value of about 1,000.  I'm not saying that's the right number, but it makes me nervous in the context of a) fiscal and monetary stimulus that must one day be withdrawn and b) staggering total debt loads that we know correlate with slower GDP growth.

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The comment about how GAAP earnings have gone down due to write- offs over the past 10 years is true.  I perform these write-off analyses for a job and before 12 years ago these for the most part did not exist.  Operating earnings accounts for these write-offs so you can compare to history, GAAP does not.  Comparing GAAP now to GAAP in history is like comparing apples and oranges. My question is who buys the whole market?  So unless you are buying index funds how relevant is the S&P 500 PE ratio?

 

Packer

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There is a nasty trend that has developed in the past 30 years or so where the operating earnings quoted from S&P have been 15-20% higher than GAAP earnings on a pretty much continual basis.  So when someone says a 15-16x PE is fair or average or whatever for the market, this historically was a GAAP PE (TTM, not forward).  If you want to quote forward earnings that's fine, if you want to quote non-GAAP / non-one-time charge earnings, that's also totally fine, but if you want to quote both together I personally think that 16x sounds pretty high to me.  That's probably the equivalent of 20x TTM GAAP PE for most years.

Operating/adjusted EPS aside, it's crucial not to compare forward PE to trailing PEs. The market will in almost all years look cheaper than it is as analysts rarely forecast contracting earnings (from a historical perspective). S&P 500 EPS are forecast to grow 9.9% over the next 12 months (on the adjusted number). If you argue with a forward PE vs. historical trailing PEs you're already off by 10%.

 

The numbers I get off Bloomberg are:

Trailing GAAP EPS: $96; PE: 18.6x

Trailing adjusted EPS: $106; PE: 16.9x

Next 12M adj. EPS: $117; PE: 15.3x

Seems like the WSJ/Birinyi has a different number of 16.2x forward.

http://online.wsj.com/mdc/public/page/2_3021-peyield.html

 

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Eric,

 

I have to admit that I was less critical of what he had to say until I got towards the end of it with the talk of Neo-Keynesian and gold being the new/old currency again.  I just can't listen to people who talk like that.  The dollar has lost value through my entire life.  Gold skyrocketed when I was a young child, but I remember those years fondly -- people always smile at a cute baby no matter what gold is doing, so perhaps that creates a bias that high gold prices doesn't equate to misery.  Gold has increased by a large amount over the past decade once again, but it hasn't made me miserable.  I don't mind if he doubles his money in gold once again over the next 7 years -- I think he could do better owning Wells Fargo (less macro study needed), but to each his own.  Some of these guys are academics of macro, or enjoy it immensely enough as an economic pursuit, and seem to do well following it.  But I don't think I need to do that to make money, so I tend to roll my eyes when I see how long their commentary about it is.  It was very interesting for a while, but it's been a decade of it now it seems.

 

To be clear, I should clarify that I didn't listen to the interview that started the thread.  My comment about JME was just from a historical context of his focus on not losing - I think him and Klarman are good examples of those who identify  9 recessions for every 3 that happen.  Not necessarily the path to riches as you note, but I find it helpful to listen to make sure I'm not missing anything. 

 

I would tend to agree with your eye rolling based on what you said above.

 

Fenris,

 

Operating/adjusted EPS aside, it's crucial not to compare forward PE to trailing PEs. The market will in almost all years look cheaper than it is as analysts rarely forecast contracting earnings (from a historical perspective). S&P 500 EPS are forecast to grow 9.9% over the next 12 months (on the adjusted number). If you argue with a forward PE vs. historical trailing PEs you're already off by 10%.

 

The numbers I get off Bloomberg are:

Trailing GAAP EPS: $96; PE: 18.6x

Trailing adjusted EPS: $106; PE: 16.9x

Next 12M adj. EPS: $117; PE: 15.3x

Seems like the WSJ/Birinyi has a different number of 16.2x forward.

http://online.wsj.com/mdc/public/page/2_3021-peyield.html

 

Thanks for the data from BBG.  S&P's site spreadsheet stops showing EPS through Q2 '13 at this time, so appreciate you showing the latest.

 

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My comment about JME was just from a historical context of his focus on not losing - I think him and Klarman are good examples of those who identify  9 recessions for every 3 that happen.  Not necessarily the path to riches as you note, but I find it helpful to listen to make sure I'm not missing anything. 

 

I understood that.  The funny thing is if you asked him whether or not to own gold a year ago, would he have said yes?  Probably, yet such advice has led to a 25% loss.  I'm sure it is just a temporary loss given that gold will be higher in 10 years, 20 years, or 100 years.  The S&P500 could fall 25%.  It could fall farther than 25%, as could gold.  But both losses will be temporary when held for long periods of time (and partly for the same reason, given that nominal earnings growth will over time raise stock prices).

 

One could use his excess Fed liquidity comment to explain that gold is at risk of decline as well.  Excess liquidity can't raise gold prices?  I remember when liquidity dried up in late 2008 gold went into a tailspin, just like the S&P500.

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Guest wellmont

FWIW, I saw a headline earlier that Klarman is returning $4 BN to investors. That certainly says something about the current dearth of opportunities.

 

it says more about His dearth of opportunities.

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I think, as Benhacker and Packer say, you have to adjust for GAAP versus operating, and forward vs trailing P/E. Then you have to adjust the E because as Petec said...

 

"Interesting.  Also, as we all know, margins are high and mean-reverting for good reason.  If I take current S&P revenues (i.e. if I assume they are not inflated by stimulus) and multiply by the long run average net margin and P/E multiple, I come out at a target index value of about 1,000."

 

... corporate profit margins (and corporate profits as a percentage of GDP are at all time highs) so I am not sure you can trust the E long-term.

 

So I think Klarman and Eveillard do not want to assume that the "E" is in balance (ie that somehow profit margins won't get competed or taxed away) and this in the context of already rich 18-20x P/E multiple (ie once adjusted for GAAP vs operating and ttm vs forward). So if you take that all together, its not exactly a compelling situation from a macro valuation perspective.

 

In fact, it could be that the only more expensive markets in rough order were 2000, 2007, 1929, sometime in the 1960s and this market would be #5 in the past 110 years. Not necessarily, but maybe - I think that is why they are cautious.

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Yes, but in that time the private sector deleveraged hard: total debt / GDP actually fell during WW2.  Taxes rose and the public were encouraged to put money into war bonds rather than to spend it.  And the Fed monetised debt, but not as much.  (And it is worth saying that production rose but it was largely things that got shipped abroad and blown up rather than things that created value.)  So yes, I think it is fair to say that this is the most stimulated economy ever, and that particularly goes for the consumer.

 

I'm currently reading David Stockman's The Great Deformation, which is very interesting on this topic and essentially argues that the US has been getting more stimulative fiscally and monetarily ever since it originally came off the gold standard.

 

The private sector deleveraged during the past 5 years as well.  Total debt to GDP has actually fallen during the past 5 years.  The thing is the US isn't even the most extreme case, if you look at Britain they took on an ever great debt load during WW2.  Or, if you go further back in time the UK had a 50 year period where their government debt to GDP was in excess of 150%, peaking at 250%.  That was at a time of the gold standard when they couldn't slowly print their way out of things.  I don't think the current situation is so unusual.  It may not be the best days ahead but there are precedents.

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I'm gonna to try an another way to value the market. And I know there is many flaws in this thinking. But I like doing those line of thinking to give me gross idea for things:

 

Pre crisis, the S&P500 peaked at about 1525 in july 2007.

 

Obviously, earnings were boosted by leverage, bad loans,etc..

The market was overvalued at that time because even if P/E was reasonable, (E)arnings were overstated.

 

US Banks profits specially, were overstated because they were booking profits while the poor loans they were making were sitting on the balance waiting to materialize into future losses.

 

Dick Bove said in december 2012 that US banks would post their highest earnings ever in the fourth quarter of that year at a collective $38 billion. See this article:

 

http://www.moneynews.com/StreetTalk/Bove-banks-record-profits/2012/12/18/id/468160

 

If we assume that today's bank profits are solid and real compared to 2007, then this mean that it took 5 1/2 years to return to same profitability than 2007. So following this logic, we could say that at the end of 2012, Intrinsic value for S&P500 was 1525. Add in 7-8% profit growth and  this gets you to 1525*1,08=1647 IV for S&P500 today.

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So following this logic, we could say that at the end of 2012, Intrinsic value for S&P500 was 1525. Add in 7-8% profit growth and  this gets you to 1525*1,08=1647 IV for S&P500 today.

 

Another way of looking at it is Jeremy Grantham himself declared the fair value of the S&P500 to be about 1080 -- he said that in October 2008.

 

Okay, so here we are 5 years later.  That would be 1,514 fair value today if you assumed 7% profit growth over the 5 year period.  That's not that far off your 1,647 number.

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Ray Dalio also saying stocks are pumped up by the Fed -- predicts 4% returns for the next 10 years, which he claims will still be better than the return from bonds:

 

http://finance.fortune.cnn.com/2013/11/12/dalio-stocks-disappoint/?iid=obnetwork

 

That article also says that former Fed official Andrew Huszar claims the market is pumped up -- and he's the guy who was hired in 2009 to help execute the Fed's bond buying program.

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