December 2, 2022
By Steve Blumenthal
“We should say that the market is a voting machine, whereon countless individuals register choices which are the product partly of reason and partly of emotion. Hence the prices of common stocks are not carefully thought out computations but the resultants of a welter of human reactions.”
– Benjamin Graham and David Dodd, Security Analysis, 1934
I hope you enjoyed your Thanksgiving holiday and you were able to spend time with family. It’s hard to believe it’s December already. Time is moving way too fast. We have but one choice in the matter: ever forward!
Two weeks ago, I shared with you commentary by Stan Druckenmiller, delivered on CNBC in an interview with Joe Kernen. If you missed that issue of “On My Radar,” featuring Ray Dalio’s take on China along with Druckenmiller’s 2023 Forecast, you can find it here. It’s worth a read.
This week, let’s take a look at current valuations and what they fundamentally tell us about the coming 3-, 5-, 7-, 10- and 12-year returns.
As I wrote this morning, I awaited the release of the Labor Department’s November jobs report. The top line: Payroll and wage increases leaped past expectations. Cut to the bottom line: Despite the Fed’s interest rate hikes and quantitative tightening (QT), inflation remains near its 40-year high. The payroll and wage data didn’t help those hoping for the Fed to pump the brakes. Futures are down sharply, and the numbers will do little to slow the Fed. Remember, all major bear market cycle lows have occurred after the Fed’s first interest rate cut, not the last interest rate hike. Could it be different this time?
Yes—but doubtful. As they say, it’s not over ‘til the fat lady sings.
Grab your coffee and find your favorite chair. Then go grab a second cup and ready yourself for the USA vs. Netherlands World Cup game at 10 AM ET tomorrow, Saturday, December 3. I can’t wait! Let’s go, Christian Pulisic (a.k.a. “Boy Wonder”) and Team USA! Despite Pulisic sustaining an injury while scoring the winning goal at the end of Tuesday’s game against Iran, it sounds like the kid’s going to play tomorrow. If you’re Dutch, put on your orange, and let’s wager a cold IPA on the outcome—one Victory Hop Devil vs. one Heineken. Either way, best of luck to your favorite team.
(Reminder, this is not a recommendation to buy or sell any security. My views may change at any time. The information is for discussion purposes only).
What Current Valuations Tell Us About Probable Future Returns
Hussman 12-year Stock Market Return Forecast
Every security is a claim to some long-term stream of cash flows that will be delivered to the holder, or series of holders, over time. The future cash flows and the current price are linked by a long-term rate of return. You can think of the long-term return as the slope between the current price and the future payments. Pure arithmetic. Given any set of future cash flows, the lower the price an investor pays, the higher the long-term return an investor can expect.
Nothing ensures that the price is reasonable, but reasonable or not, the moment you know both the cash flows and the current price, you also know the long-term return. Even if investors pay $150 today for an IOU that will deliver just $100 a decade from today, the arithmetic still holds – in this case, the investor can expect a 10-year return of ($100/$150)^(1/10)-1 = -4% annually. Investors may be insane to pay that price, but the math is just math.
The arithmetic that links current price, future cash flows, and long-term return is equally true for stocks as it is for bonds. The main difference is that the cash flows for stocks are typically longer-term, and some amount of estimation is required. Still, given an estimate of future cash flows, the math is the same.
For individual stocks, we do a great deal of discounted cash-flow analysis. For the stock market as a whole, we can use “valuation multiples” as shorthand, but only if the fundamental is reasonably representative and proportional to long-term cash flows. Specifically, we find that earnings are poor denominators for market valuation multiples, while less cyclical measures like revenues and even GDP are much more reliable. The chart below shows our most reliable market valuation measure – nonfinancial market capitalization to gross-value added, including estimated foreign revenues – versus the actual 12-year average annual nominal total return of the S&P 500 index. Presently, we expect negative average annual nominal total returns for the S&P 500 over the coming 10-12 years, as we also projected in 2000. Source, John Hussman
See the 11/11/22 arrow lower right-hand side of the chart.
Click here for Hussman’s full commentary.
Shiller PE – Price earnings ratio is based on average inflation-adjusted earnings from the previous ten years. It’s known as the Cyclically Adjusted PE Ratio (CAPE Ratio), Shiller PE Ratio, or PE 10 — FAQ.
In layman’s terms, the current Shiller PE is at 29.56, and a much better entry point is when it’s at 16.99. Either earnings have to increase aggressively, prices have to come down, or a combination of both. Take a look at the chart and note where Shiller PE was in 2009. Somewhere between 15 and 20, stocks look like bargains again.
Source: Shiller PE
Crestmont Research puts out a number somewhat similar to Shiller PE. The following chart shows just how far Crestmont PE is from its long-term mean. For non-quant geeks, the mean (average) of a data set is found by adding all numbers in the data set and then dividing by the number of values in the set. The median is the middle value when a data set is ordered from least to greatest.
This chart shows valuations have come down from crazy high nosebleed levels to moderately high nosebleed levels. Note in this chart how PE reverts back towards its long-term mean.
A Look at PE and Inflation
Prior to the tech bubble and current rally, the only other months with P/E above 25 were August and September of 1929. Note the “We are here” yellow dot.
S&P 500 Median PE (NDR Calculation)
The Median PE was at 24 in November 2022 month end. That’s down from a high of 34, reached in March 2021, and down from a PE of 27 on December 31, 2021.
To put this in perspective:
- The 58.8 years Median PE is 17.5.
- It was at 20 near the Tech Bubble market low in late 2002 and 13 at the Great Financial Crisis low in 2009.
NDR does something interesting that I find useful. They plot the amount of decline required to reach “Fair Value.” That’s the 58.8-year Median PE number of 17.7.
The S&P 500 was at 4,080.11 on November 30, 2022. Here’s some data that helps to set good buying opportunity levels:
- A correction of 27.2% is needed to get us to “Median Fair Value,” which is 2,970.32 on the S&P 500 Index
- A correction of 50.8% is needed to get us to “Undervalued,” which is 2,007.41 on the S&P 500 Index
Bottom line: The getting gets good again, around 3,000 in the S&P 500 Index. Undervalued can’t be ruled out though I think it is unlikely. If we get there, back up the truck and go all in. I believe 3,000 is a good entry target.
Price to Gross Domestic Income
Note the 1-, 3-, 5-, 7-, 9-, and 11-year return data in the upper left-hand corner of the chart. Valuations by this measure currently sit in the “Top Quintile.” Bottom line: Expect flat to negative annualized returns over the coming 11 years. Note we’d be better off in the “Bottom Quintile.” A good entry point is the upward-sloping blue dotted line in the center of the chart.
Stock Market Cap to GDP (The Buffett Indicator)
Current level as of November 30, 2022: 160.70%
To put this into perspective, prior bull market peaks were:
- 1968 at 74%
- March 2000 at 167.5%
- May 2007 at 125.6%
- December 2021 at 204.9%
Prior bear market valuation lows were:
- February 2009 at 57.4%
- October 1990 at 42.2%
- July 1982 at 31.4%
- September 1974 at 35.3%
Data source: NDR
Bottom line: The current level is well off its December 2021 all-time valuation high but only slightly below the second-highest reading (data back to 1924) of 167.5%, reached at the top of the Tech Bubble in March 2000. If you’d like a copy of the chart, please reach out to me (SBlumenthal@cmgwealth.com), and I can share it one-on-one.
We can look at Price to Sales, Price to Book, Price to Operating Margins, and even Price to Forward PE (a summary of analysts’ forward PE forecasts), and they’re all overvalued. As a side note, I don’t like using “Forward PE” because analysts tend to be overly optimistic. Especially today, if we get the hard recession landing, I expect actual earnings will decline a lot in 2023.
Let’s keep an eye on valuations every few months as time moves on. Stay tuned.
A different take on valuations from Longview Economics courtesy of The Daily Shot.
The economic patient remains ill, with a very high fever. The recession is on the horizon (if not already started). Hard landing ahead!
Follow Charlie on Tweeter; he’s excellent.
First came the valuation correction. Next up is the earnings correction. Keep your defense on the field.
QE – A Colossal Policy Mistake
Reversing QE – Bloomberg’s Estimate for Rate Hike Path into 2023
Taking the punch bowl away:
SBF. A fraudulent mess:
We’ll conclude with the strong employment data:
More Random Tweets next week. Please follow me on Twitter, where I do my best to tweet, retweet, and like what I feel is most important… @SBlumenthalCMG
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Trade Signals: Fearful When Others are Greedy
November 30, 2022
S&P 500 Index — 4,076
Markets move in cycles, and cycles will always exist. Trade Signals is a weekly snapshot of current stock, bond, currency, gold, and investor sentiment trends. It is a concise summary of indicators to help you identify where we sit in a cycle, manage risk, and position accordingly. Skillful investors have a sense of the presence of risk and the best investment opportunities present when investor fear is extreme. It is wise for investors to be “Fearful when others are greedy, and greedy when others are fearful,” as Warren Buffett often reminds us. Stay on top of the current trends with “Trade Signals.”
Notable this week: Equity markets surged higher Wednesday as the S&P rose over 3% (a two-month high); tech outperformed once the Nasdaq rose nearly 4.5% after Fed Chair Jerome Powell signaled they plan to slow tightening as soon as December. He also said there will be further hikes to combat inflation, with December likely bringing a 50bp hike. Economic data was mixed, and job openings fell last month, which is another good sign for the Fed as we head into Friday’s non-farm payrolls data, which is expected to show 200k added workers to payrolls this month. (Source: My friends at WallachBeth, “End of Day ETF Snapshot 11/30/2022”). Though it may be different this time, history is worth noting: Markets have historically bottomed after the Fed makes its first interest rate cut and not its last rate hike.
Friend David Rosenberg put it this way: “[Wednesday’s] manic response to the lack of new commentary from Powell shows just how desperate markets are for a Fed pause.”
As measured by the NDR Daily Sentiment indicator, investor sentiment has reached an “Excessive Optimism” reading, which rarely occurs. Excessive optimism is bearish for stocks. Excessive pessimism is bullish for stocks. The idea is to do the opposite of the majority at points of extreme. Extreme caution is advised.
This post from The Weekly S&P 500 Chart Storm paints the picture well. The market has rallied back to just above its 200-day moving average line, which syncs perfectly with its YTD downtrend (red line).
The Dashboard of Indicators follows next. The bond signals have been excellent and remain bullish. The dollar remains weak. Gold looks to have bottomed.
Click HERE to see the Dashboard of Indicators and all the updated charts in this week’s Trade Signals post.
Not a recommendation for you to buy or sell any security. For information purposes only. Please talk with your advisor about needs, goals, time horizons, and risk tolerances. TRADE SIGNALS SUBSCRIPTION ACKNOWLEDGEMENT / IMPORTANT DISCLOSURES
Personal Note: Christine McVie
As Susan and I sat at our kitchen table last night, she told me Christine McVie from Fleetwood Mac passed away on Wednesday. Having grown up in the ’70s and ’80s, Fleetwood Mac was everywhere. I played so many of their songs over and over again that I nearly wore out the album. I didn’t know until Susan told me—though I should have—that Christine wrote so many of the band’s songs.
We ate a late dinner with a glass of wine and listened to song after song until it turned late. Sometimes you’re just caught in a wonderful moment. Great lyrics, great vocals, great music. Welcome home, Christine. Welcome home, and thank you.
To honor and celebrate her, here’s a list of some of McVie’s best and “most essential” songs from Rolling Stone.
Florida and California
John Mauldin and I are hosting dinner in Palm Beach, Florida, on Tuesday, December 6, to discuss the economy and investment outlook for 2023. We see a number of opportunities and will share our ideas that evening. There’s limited capacity, but if you’re interested in attending, we’d love to see you. Please email email@example.com.
I’ll be in California in the middle of December for business and to visit Brianna and Kyle. Warm weather sounds pretty good right now. It’ll sound even better in a couple of weeks.
Peace to you and yours!
Have a wonderful week,
Stephen B. Blumenthal
Executive Chairman & CIO
CMG Capital Management Group, Inc.
OMR Audio Replay and Podcast Link
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Not a recommendation to buy or sell any security. See important disclosures below and on the Spotify On My Radar home page.
Forbes Book – On My Radar, Navigating Stock Market Cycles. Stephen Blumenthal gives investors a game plan and the advice they need to develop a risk-minded and opportunity-based investment approach. It is about how to grow and defend your wealth. You can learn more here.
Stephen Blumenthal founded CMG Capital Management Group in 1992 and serves today as its Executive Chairman and CIO. Steve authors a free weekly e-letter entitled, “On My Radar.” Steve shares his views on macroeconomic research, valuations, portfolio construction, asset allocation and risk management.
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