The straight line rise in stock prices is forcing many of the best and brightest investors to analyze and possibly reconsider the market’s valuations. This sort of market watch can provide useful insights for the rest of us.
For his part, Oaktree’s Howard Marks thinks values are stretched and the easy money has been made and anyone remaining bullish is betting it’s different this time.
Ray Dalio, on the other hand, thinks stocks will have a melt-up before a bursting of the bond market, which he does call a bubble, forcing a retreat in, stock prices albeit from a much higher point.
One of the favorite metrics for valuing the market, and one bears are currently pointing to, is the CAPE Schiller which at its highest level ever outside of the outlier of the dot.com bubble.
But one could also make the case that CAPE can be misleading, as the market is now comprised and heavily weighted towards technology companies that have profit margins in excess of 50 percent, well above the profits of old line industrials such as railroads that once dominated the indices.
All of this highlights trends that Michael Lebowitz identifies. To wit:
“Comparing current equity valuations to prior valuation peaks such as those of 2008, 1999 or any other period is commonplace, but remains an essential way of assessing current market prospects and potential risks.
Currently, seven of the eight traditional valuation techniques shown by Goldman Sachs below are in the upper strata of recent history. Here’s how 2018 stock valuations measure up… and he goes on to provide one of the most thorough deep dives into market valuations in this article.
In Second to None, published March 1, 2017, we opined that simply assessing valuation techniques, as shown above, is a great starting place for investors to gauge the present status of valuations. We added that it is equally important to normalize different periods of time to make their valuations comparable based on the level of economic growth which directly supports corporate profits. The result of our analysis shows that the current level of Cyclically Adjusted Price to Earnings (CAPE) is well above the levels of every other market peak, including 1999 and 1929. Essentially, investors are willing to pay more for each unit of economic growth today than at any time in modern history.
In this article, we update the data to reflect the current GDP adjusted CAPE and take it a step further to include the cyclical nature of corporate profit margins. When both adjustments are factored in, we gain a unique perspective that demonstrates the extent to which today’s valuations are, quite literally, off the charts.
GDP Trends
While the economy cycles from recession to growth and back, the long term economic growth trend, or secular GDP, has trended lower for the better part of the last 30 years.
In Second to None, published March 1, 2017, we opined that simply assessing valuation techniques, as shown above, is a great starting place for investors to gauge the present status of valuations. We added that it is equally important to normalize different periods of time to make their valuations comparable based on the level of economic growth which directly supports corporate profits. The result of our analysis shows that the current level of Cyclically Adjusted Price to Earnings (CAPE) is well above the levels of every other market peak, including 1999 and 1929. Essentially, investors are willing to pay more for each unit of economic growth today than at any time in modern history.
In this article, we update the data to reflect the current GDP adjusted CAPE and take it a step further to include the cyclical nature of corporate profit margins. When both adjustments are factored in, we gain a unique perspective that demonstrates the extent to which today’s valuations are, quite literally, off the charts.
GDP Trends
While the economy cycles from recession to growth and back, the long term economic growth trend, or secular GDP, has trended lower for the better part of the last 30 years.
There are a number of reasons for the long-term, downward growth trend about which we have written extensively. In a nutshell, the following are the three largest factors accounting for the deteriorating trend in growth:
- Debt– The amount of federal, corporate and individual debt has consistently risen at a pace faster than economic growth. As such, many debtors are unable to borrow further to keep spending. Others are hampered by interest payments which crowd out spending. The Federal Reserve has used extraordinary policies to force interest rates to historic lows to counter the debt burden, but their actions have only bought time and incentivized even more debt. The debt problem, which we call the Lowest Common Denominator, has only worsened.
- Demographics– Over the last 30 years, baby boomers provided a driving force for economic growth. As this outsized generation nears retirement, they will spend less and, in many instances, become a burden on the taxpayers that support them through social security and other entitlements. Additionally, slowing population growth and tightened restrictions on immigration are reducing the number of workers and consumers that can contribute to economic growth.
- Productivity– Partially as a result of years of poor economic, fiscal and monetary policy that dis-incentivized long-term investment in favor of consumption, the rate of productivity growth, the lifeline of economic growth is nearing zero.
It is primarily these three reasons and their longer-term projections that make us nearly certain that secular economic growth will continue to weaken in the years ahead. That does not mean there will not be periods of stronger growth. However, given that few of our nation’s leaders truly understand what drives sustainable economic growth and even fewer have the courage required to reverse the trends, we see little reason to expect change.
Given our assumption that long-term economic trends are likely to persist, we believe it is necessary to use economic growth to normalize current equity valuations to compare them to prior periods.
Continue reading the complete article here.
