September 10, 2021
By Steve Blumenthal
“This is the one thing I can never understand.
To refer to a personal taste of mine, I’m going to buy hamburgers
the rest of my life. When hamburgers go down in price,
we sing the “Hallelujah Chorus” in the Buffett household.
When hamburgers prices go up, we weep.
For most people, it’s the same way with everything in life they
will be buying–except stocks. When stocks go down and you can
get more for your money, people don’t like them anymore.”
― Warren Buffett,
Chairman and CEO of Berkshire Hathaway, Investor, and Philanthropist
I know. I’m overusing the hamburger analogy but stay with me. This week, let’s take a deep dive into the latest valuations and what the data tells us about coming one-, three-, five-, seven-, nine-, and 11-year returns for the broad indices. There are times to be more conservative and times to get more aggressive. I share with you a few ways to know exactly where we sit in the cycle at any given time.
Also, I had a lot of fun interviewing real estate expert and good friend Barry Habib. He remains bullish on the housing market, and he gave some advice on mortgage refinancing that surprised me. Another surprising insight from our time together? Barry can act and sing. And if you’ve seen the Broadway show Rock of Ages, you’re familiar with Barry’s work: he was the capital and passion behind it. You’ll find a link to the podcast episode below.
This week’s OMR prints long but reads fast. So, grab a coffee and find your favorite chair. Then grab your sneakers, plug in, and listen to the podcast on a nice walk. I do enjoy your feedback and questions. If I can’t answer one, I’ll do my best to leverage my network to get you an answer. Please know I am grateful for the time you spend with me each week.
- Valuations and Coming One-, Three-, Five-, Seven-, Nine-, and 11-year Returns
- Bull and Bear Market Cycles
- Podcast with Real Estate Expert Barry Habib
- Trade Signals – American Association of Individual Investors Bullish on Equities (Suggests Caution)
- Personal Section – A Playbook for Finding and Seizing Opportunity
Valuations and Coming One-, Three-, Five-, Seven-, Nine-, and 11-year Returns
First, let’s take a look at the valuation landscape via the following chart, courtesy of Ned Davis Research. The data, in some cases, goes back to the 1920s. NDR ranks each measure in terms of five quintiles that ranges from Extremely Undervalued (Green) to Extremely Overvalued (Red). As you can see, in looking at the most popular valuation metrics, it’s red across the board.
To put this into perspective, let’s zero in on just a few of the above. The idea here is to show you where you will get more return on your money. Red is bad, green is great.
Price to Sales
Price to Dividend Yield
The Buffett Indicator: Stock Market Cap to GDP
“The Buffett Indicator is the ratio of total US stock market valuation to GDP. Named after Warren Buffett, who called the ratio “the best single measure of where valuations stand at any given moment”. (Buffett has since walked back those comments, hesitating to endorse any single measure as either comprehensive or consistent over time, but this ratio remains credited to his name). To calculate the ratio, we need to get data for both metrics: Total Market Value and GDP.” (Source: CurrentMarketValuation.com)
I came across this last chart via Twitter. It looks at an aggregate model of eight different valuation metrics. The top section is world market valuations. The bottom section is the US. Dark line is the model return forecast, green dotted line is the actual achieved subsequent 10-year returns. Note the expected negative returns for both US and Global Equity indices.
We could keep going, but you get the picture. Bottom line: The market has never been more overvalued than it is today, except for 1929.
What then, does this mean in terms of coming returns? There are many ways to dissect it. Let’s look at a few of my favorites.
Stock Market Cap to National Gross Income
Focus in on the middle section of the chart. The dotted blue line is the long-term regression trend line from 1925 to August 31, 2021. The orange line reflects month-end value of total stock market capitalization compared to national gross income. You can see that it moves above and below the trend line over time.
Where the Buffett Indicator looks at the total value of the stock market compared to what the U.S. produces, this indicator looks at the total value of the stock market compared to what we in the U.S. collectively earn. Simply view it as another valuation metric.
The benefit to this measurement is in what it tells us about historical returns. If you buy something at a good price, you get more for your money. If you can buy it at a steep discount, you get even more value for your money. If you overpay, you don’t get as much. Warren Buffett uses hamburgers as an example. When the price of hamburger meat goes down in price, you can get a lot more hamburger meat for every dollar spent. When the price is high, you get less meat for every dollar spent. Same is true for investments.
The bottom section looks at just how far above or below the indicator is from its trend line. NDR then does something very effective. They sort the data into quintiles that range from “Top Quintile Overvalued” to “Bottom Quintile Undervalued.”
They then calculate the subsequent returns based on each quintile. Think of the dotted blue line in the center section as the average return the market has produced since 1925, which is approximately 10%. Next, focus in on the upper left-hand data box. What is shown are the actual average % changes in the S&P 500 one, three, five, seven, nine, and 11 years later based on “Top Quintile Overvalued” or “Bottom Quintile Undervalued.”
Logic tells us is that coming returns will be negative for the S&P 500 Index over the next 11 years. This doesn’t mean you can’t make money; it just means probabilities say it won’t come from popular cap-weighted index mutual fund and ETF exposures.
As you’ll see in the Trade Signals section below, investors are heavily invested in stocks; are underweighted cash; and frankly, in my view, the bubble of all bubbles is the high concentration in low-fee, cap-weighted index-based products. Stay wary, risk-minded, and very nimble.
The popular indices may move higher, but fair value is approximately 50% below current prices.
Bull and Bear Market Cycles
I am presenting to hundreds of advisors in the near future at an event hosted by ETF Trends and Alliance. I’ll be sharing the following chart with them and thought I’d share it with you as well. This one doesn’t look at stock market cap to GDP, stock market cap to gross domestic income, or P/E or price-to-sales, etc. It simply looks at current price vs. the long-term price trend. We all know the market cycles over time from bull market to bear market. We just don’t want to believe a bull market will end, and we don’t often believe a bear market will end either. But there is a way to know where we are in the cycle.
Look to the middle section of the chart. In point #1, the dotted blue line is the long-term trend. The orange line is the market price movement over time, and you can see how it moves above and below the dotted blue line over time. Think of the dotted blue line as that 10% annual return number. Point #2 shows the deviation from long term trend. It is how far above or below the orange line is from the dotted blue line. Point #3 shows the actual subsequent average percentage gain five and 10 years later.
To put those average 10-year returns into perspective, I’ve created the next chart, which uses $1 million as the starting investment.
Novice investors look at recent returns and project them forward. Now is not the time to do that. I suggest using the dotted blue line as a guide to know when the stock market is richly or inexpensively priced. Wait to get aggressive until the orange line touches the dotted blue long-term trend line. Hedge and raise cash when it’s extremely over-priced (like today). Get very aggressive when it’s in the bottom quintile.
Podcast with Real Estate Expert Barry Habib
I had the pleasure of interviewing Barry Habib recently. You’ll find a link to the podcast below. But before you jump in, let me tell you a little bit about Barry. He is an entrepreneur and frequent media resource for his mortgage and housing expertise. You’ve likely seen him on CNBC and Fox Business. A few more highlights:
- Barry is the author of an Amazon #1 bestselling book: “Money in the Streets: A Playbook for Finding and Seizing the Opportunity All Around You.”
- He was named the 2019 Mortgage Professional of the Year by National Mortgage Professional Magazine.
- He was the 2019 Finalist for the prestigious Ernst & Young Entrepreneur of the Year Award.
- He is a three-time Zillow Crystal Ball Award Winner (2017, 2019, and 2020) for the most accurate real estate forecasts, beating out 150 of the top economists in the US.
- He’s got a history in theater; he can act and sing, as I mentioned (something I look forward to seeing him do someday); and is the lead producer and managing partner for Rock of Ages—the 27th longest-running show in Broadway history.
That brings us to my discussion with Barry. There were several insights that I encourage you to focus on when you listen:
- The Fed isn’t buying $40 billion in mortgage securities each month, they are buying closer to $100 billion. Put you head around that for a second… Listen to how Barry explains it.
- Despite the massive amount of Fed money flooding the system, the dynamics are much different today than they have been in the past. Barry correctly turned bearish on real estate in 2007. He’s bullish today.
- Also, listen to what he has to say about demographics and why the number of people reaching age 33 right now is an important input when understanding the direction of housing prices.
- He also talks about the current supply-demand mismatch. Today, there are far more buyers than sellers. There is not enough inventory to meet demand, and that won’t change anytime soon.
Barry moves fast. Buckle up… I hope you enjoy the conversation with Barry as much as I enjoyed interviewing him.
Here is the link to the podcast (please click on the image below to listen to the podcast):
Trade Signals – American Association of Individual Investors Bullish on Equities (Suggests Caution)
September 8, 2021
Posted each Wednesday, Trade Signals looks at several of my favorite equity market, investor sentiment, fixed income, economic, recession, and gold market indicators.
For new readers – Trade Signals is organized into three sections:
- Market Commentary
- Trade Signals — Dashboard of Indicators
- Charts with Explanations
Notable this week:
The American Association of Individual Investors polls approximately 600 investors monthly regarding their investment allocation in percentage terms to stocks, bonds, and cash. Looking at the weightings to each can give us an indication of whether investors are extremely bullish on stocks (a warning sign for a richly priced market or extremely bearish on stocks, which is usually a better time to be a buyer of stocks).
The August 31, 2021 data shows the following:
- 71.2% Equity Allocation
- 15.1% Bond Allocation
- 13.7% Cash Allocation
You can think of cash as available money that can be used to buy more stocks. Since 1987, the mean amount allocated to cash is 22.6%. The lowest level of cash occurred in early 1999 at 11%. Investors were heavily invested in stocks in 1999, with 77% of their money allocated to equities. By 2002, cash jumped to 39% and the amount allocated to equities dropped to 43%. The selling drove prices lower (the Tech Wreck) and the money largely went into cash.
At the market peak in 2007, the percentage allocated to cash was 19% and the percentage allocated to equities was 70%. By March 2009 (at the bottom of the Great Financial Crisis), the percentage allocated to cash was 45% and the percentage allocated to equities was 41%.
Supply and demand moves markets. More buyers than sellers and prices go up. More sellers than buyers and prices go down. The largest exposure to equities was 77% in 1999. Allocations above 70% is a significant number. The August month-end of 71.2% allocation to equities is the fifth-highest reading on record. The low cash allocation of 13.7% at August month-end is the third lowest on record.
It’s best to be a buyer when everyone else is selling. It’s best to risk management equity exposure (and raise cash) when everyone else is buying. Couple this with record-high valuations, which we will look in this week’s On My Radar and well… you get the message.
The equity market signals remain mostly green. The S&P 500 Index Daily MACD moved to a sell signal (a short-term indicator). The more intermediate-term focused Ned Davis Research CMG U.S. Large Cap Long/Flat Index remains bullish. The index measures trend and market breadth across 24 industry groups. Gold remains in a sell signal. The Zweig Bond Model remains bullish on bonds.
Click HERE to read to the balance of Wednesday’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 horizon and risk tolerances.
Personal Note – A Playbook for Finding and Seizing Opportunity
“Some people think football is a matter of life and death.
I don’t like that attitude. I can assure them it is much more serious than that.”
– Bill Shankly, Footballer & Manager
(2 September 1913 – 29 September 1981)
I do hope you enjoy the podcast with Barry Habib. There is a lot to unpack in the information Barry shared. In short, he said today’s age demographics and the supply-demand mismatch tell us the bull market in housing will continue. He also shared his views on the direction of interest rates and gave some advice on how to best refinance your mortgage. I learned a lot and hope you do as well.
I’m embarrassed that I haven’t yet read his best-selling book. That will change this weekend. It’s already downloaded, and I’ll be reading it outside on the patio couch under an umbrella. The weather in the Northeast looks good, with clear skies and temperatures in the mid- to upper 70s, so I’ll also be seizing the opportunity to play some golf. Total number of rounds played this year is well above my long-term trend line. In this case, sitting in quintile 5 is a good thing.
We’ll talk more about growing geopolitical risks and some of the broader debt challenges we keep sinking deeper and deeper into in next week’s letter. There are solutions to our challenges but piling on more and more debt is not one of them. However, that’s what we are doing. I listened to an outstanding conversation with Dr. Lacy Hunt and Felix Zulauf on the subject recently. I won’t be able to share the content of the conversation, but I can offer up my personal views on the markets, interest rates and the challenges that too much debt creates. Stay tuned.
If you are a football fan, you’ll get the quote above. College football season kicked off last week and son Matt and I went nuts watching Penn State beat Wisconsin in a defensive masterpiece. Sorry to my Wisconsin friend, and a great big WE ARE to my Penn State family.
This week, the NFL season began. Last night, the GOAT and his Tampa Bay Bucs beat the Dallas Cowboys 31–29. I hear the NY Giants are a maybe this season, but the experts are predicting Washington to win the mediocre NFC East division. Go Birds! Early call is seven wins, 11 loses. Ugh.
Wishing you a cold IPA and a fine glass of red wine (or white, or a cold iced tea—whichever you prefer), success to your favorite team, and more importantly, great joy in the process of finding and seizing your dreams.
All the best,
Stephen B. Blumenthal
Executive Chairman & CIO
CMG Capital Management Group, Inc.
Consider buying my newly published Forbes Book, described as follows:
With On My Radar, 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.
If you are interested in the book, 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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