Mar

24

"If the best horse always won, this stuff would be so easy," the Old Frenchman used to tell me.

But it sure helps when the best horse is running against a field of nags. Similarly, I don't recall, in forty years, what appears to be a easier setup than right now in equities.

Not even close. Ever.

Let's start with the backdrop, which is decidedly negative at least in terms of recent news - global slowing, yield curve inverting, earnings trailing off etc.

Great.

Now, let's just look at the reality. In terms of what's going on with rates–a contrived situation on the short end, entirely inconsistent with quality spreads which have narrowed in the past couple of months, considerably, even with respect to junk.

Whatever global slowing was going on in 2018 has decidedly and abruptly turned. Since the first of the year, Shanghai is up 24%, Oil is up 27%. Global Slowdown?

To think we're still in a slowdown period is to miss what's already going on.

Employment in the US is very strong, evidenced again by this past week's jobless claims, and should be evermore evident after the next monthly jobs number where it should become clear the February number was a shutdown-induced aberration.

In fact, the basic indicator I keep (and many others do, of essentially the same thing, in various forms) of commodities prices relative to employment has again turned up–and at already high levels. This is very strong.

Earnings, here we are, end of Q1 and month-on-month S&P earnings are still growing. That;s right, despite the 21 1/2% growth in earnings on the S&P 500 last year, and the fact that they were to be contracting by now, are STILL growing, month-on-month.

The sentiment is still quite negative, and there are actually people out there who, for whatever natural-glass-half-empty they harbor, think the December lows will be challenged here. In December, we saw sentiment readings in surveys, in the press, in put/call ratios and in VIX futures that were negative along the lines of what we saw in late 2008! Such readings occur, typically, before protracted gains, bull runs that last many months. The following chart shows the 13 week rate-of-change of the S&P, as percentage, as of this Friday's close.

We haven't seen a move this vigorous, up and outta here, since 2009 Q2. Does this look like a market about to roll over? All of this backdrop, historically, set the stage for a prolonged bull run–which we are again in the early throes of it would appear.

"Roy's Red" –the six week coefficient of variance (I call it that after my late friend and fellow trader, Roy Klopper, who cooked it up with me years ago trading value line futures on hourly data) has again dipped below .10, indicating an imminent move (i.e. we're coming up and out of this congestion we've been in the past month or so–a congestion which has had an upward bias, indicative of strength coming when we break up out of it). The last time we had a reading this low in Roy's Red, this imminent of a move, of an impending and imminent trending move, was in early October last year.

The volume bars of Friday (tight, profitable-quarter-ending-stops being played) indicate one should be a buyer on weakness Monday - even if things collapse Monday, you gotta be a buyer. ESPECIALLY if you can be a buyer below Friday's close (I don't know if we'll get this chance, or if Monday is a further collapse, on heavier volume–I doubt it, the setup is such that Friday should be made up and then some in the coming week). Even if things work a little lower, the bigger picture is so strong right now, that backdrop story so counter to what's actually going on in the numbers, and the forecast so strong here, and the daily so set up for a buy I just don't recall things ever being easier than right now.

Could I be more unequivocal?

Alex Forshaw replies:

Ralph,

A few devil's advocate arguments:

1. Shanghai composite was trading at 10x forward earnings 3-4 months ago with aggressive supply side government stimulus. that has historically always been a good time for a trading bounce. There hasn't been a material shift in on the ground economic fundamentals in China.

2. By my math the SPX is trading at 17x 12m forward EPS. The range has been 15-18x in the past 3 years. The SPX traded over 18x forward earnings 4 times in the last 100 years — 1929, 1936, 1999, and january 2018. In each of those occasions, the SPX's sharpe ratio for the following 12-36 months ranged from quite bad to historically atrocious. so unless there's a massive expansion in earnings in the near term, the SPX is not valued attractively right now.

3. Earnings season just ended. There won't be material movement in the "E" for another month.

4. While the yield curve doesn't historically correlate with fwd 12m equity returns, how do forward 12-month returns look when we are at least 6 years into an economic expansion and the yield curve has flattened? It's one thing for the yield curve to flatten 2 or 3 years into a bull market. but 10 years? Seems like the context is materially different from a lot of the past contexts around this statistic, although I haven't studied it closely.

5. Employment is a coincident to very slightly leading economic indicator, but hasn't it decelerated very markedly recently?

6. Europe is clearly slowing down dramatically again. China has had a valuation bounce but economic activity there is still quite weak judging from company earnings reports and anecdotal. The US has managed 3.1% GDP growth with a 5% deficit/GDP that dwarfs the OECD average.

7. Why would you pay 17x ftm eps for 3-5% estimated earnings growth? 17x for 20% eps growth (12% organic), a la 1h18, is one thing…

8. Given the volume of corp borrowing and debt issuance, and the peaking of the current rate cycle, why wouldn't the next downturn be much worse than the 2008 one? I think the "next downturn" risk is maybe 20% in next 6-9 months, but even if it's 20%, why would you pay 17x for that?

Ralph Vince writes: 

Alex,

All good points.

I'm considering valuations with respect to competing assets more so than historically, the notion being the investment dollars move someplace. Is the the "right" way to asses these? I don't know, it's how I usually try to look at it, but time will tell.)

Consider the long bond which is selling at a "multiple" of about 35 here vs the S&P 500 (whose earnings, as I say, are STILL rising; actual earnings, not future prognostications of events which have not transpired) of 21.48 (S&P500 PEs were riding above the long bond "multiple," dipped down and touched it around 88 and again in 95, by mid '05 the S&P500 PE dipped below the bond multiple, and has remained there ever since save for a period in 08-9 where the PE for stocks went haywire for several months. So one cannot say that the bond multiple naturally belongs above stock PEs, but they have for nearly a decade and half).

That's with the VERY rich US yields, relative to the rest of the world. The Bund, of course….a different animal here. Investment dollars flow someplace, the US, with earnings still gaining (despite the incredible gains of the past 14 months or so) look very attractive by comparison.

Employment is extremely healthy, so much so that wage pressure is finally returning. By my measures, last month was an aberration caused by the shutdown. A more accurate assessment, a proprietary one with respect to equities prices reveals: We're not even close to a sell by my employment measures.

On the more near-term, the next few weeks should see an end to this congestion we've been in for a month or a little longer in equities prices, per Roy's Red. Whereas it COULD be to the downside, I don't see it, the technicals (and sentiment) are acting far more lie 2009 Q2 here. Further, the pattern of volume (which is no different than how one might have read the tape 35, 40 years ago or before– only now we have the benefit of seeing bigger swaths of time, e.g. I look at yearly, monthly, weekly volumes as well) are ALL bullish here, all buy any weakness here. If I had to rely on jut one indicator, this would be it.

Alex Forshaw writes: 

To me, the S&P 500 is trading at almost the same valuation as it was in January 2018, except

1) S&P estimated earnings growth is 3-5%, instead of 20%
2) the 1yr/10yr spread (the most predictive of all the yield curve spreads) is slightly negative today, vs +80bps a year ago
3) all macro fundamentals have decelerated everywhere, and the rate of negative surprise has dramatically accelerated
4) SPX earnings yield minus 10 year yield (attached) is inline with its average over the past 10ish years, although if you go back further, it looks more favorable
5) there is no prospect of further policy stimulus until after the 2020 election, which remains a complete wild card, and seems like a "lose/no-win" coin toss for investors (the possible outcomes being untethered socialist idiocy or the dysfunctionally mediocre status quo)

In my experience, stocks-vs-bonds valuation logic is not very useful when stock valuations are rich by their own historical standards. It would have said to be aggressively buying through 2017/1h18 (if you were looking at the past 20 years of data) and the sharpe ratio would have been quite poor. It only takes 1 bad stretch to seriously derail one's financial career…

Ralph Vince writes: 

Re: "there is no prospect of further policy stimulus"

The transportation bill, likely to be proposed very soon, and highly stimulative. Think QE5. Giant barrel of uncooked pork.

China, among other things, agreeing to buy 500bln/yr ag and etc over next 6 years(my cheap seats guess), highly, HIGHLY stimulative (2 1/2% yr on a 20 trln economy, before any kind of a multiplier, which is at least 2, as that is just export, but goes into either consumption or investment 1x over 12 months, and that accumulates going forward).

Effects of "New Nafta" not yet felt online. We could go on and on hereon these various recent changes all of which are stimulative.

If you take away energy, and go back to our being a net importer of oil, and take away the repatriation effect of the recent tax bill (and AAPL agreeing to invest 350 bln, and Foxcon, and etc) , we would likely be at a GDP deficit here. Things haven't really gotten going yet is my point, but these are real numbers coming online. I don't for the life of me understand Atlanta Fed GDP projection.

Steve Ellison writes: 

Since 2010, the S&P 500 has not strayed too far in either direction from the level implied by a 2% dividend yield (see attached chart). From this perspective, the S&P got a little ahead of itself in 2017, and the 2018 correction overshot. In fourth quarter 2018, there was a plausible argument that the required dividend yield ought to adjust higher (implying the trend line should be pushed down lower), but the recent move in 10-year yields to multi-month lows seems to have taken that possibility off the table for now.

Dividends have been growing at roughly 8% per year recently.


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4 Comments so far

  1. Etaoin Shrdlu on March 26, 2019 5:11 pm

    “the 1yr/10yr spread (the most predictive of all the yield curve spreads)”

    Is there published evidence of this?

  2. Mr Axe on April 5, 2019 12:41 am

    All wrong. Axe Murder commeth. Straight to 1500

  3. Sam Smith on April 5, 2019 3:07 am

    Interesting and ultimately correct musings Ralph.
    Please could you elaborate on your favoured, desert island, indicator of LT volume/price?

  4. Michael McGrath on April 8, 2019 5:17 pm

    Alfred Lee Loomis

    The life of Alfred Lee Loomis seems to have escaped widespread notice, but is still of interest to speculators and scientists alike.
    The obscurity is not strange because Loomis himself was a patrician who considered any publicity as vulgar. The man’s achievements are worth noting. A Wall Street Lawyer who became extremely rich in the 1920’s, his prescient move into cash on the cusp of the 1929 crash allowed him funds to devote his life to science. Loomis was likely the last of the gentlemen scientists. Generous with funds to support science and having built a world-class laboratory in Tuxedo Park, New York he built a substantial body of research work into areas as diverse as sleep and the measurement of time. Loomis was a proficient inventor and held patents for the Aberdeen Chronograph (invented during this World War 1 military service) and LORAN (a World War II era aircraft navigation system which was used into the 1970s).
    None of the above describes the main work of Loomis’ life, the Radiation Lab. This was a major project to supply the Allies with superior RADAR. Historians regard the development of radar as at least as significant as the atomic bomb, enabling the turning of the tide against the Nazis in the air and the sea.
    Loomis wound up his public commitments at the end of the Second World War and lived in obscurity for the rest of his life.
    This short summary does not do justice to Loomis but those interested can follow the link below to a more detailed account.

    http://www.nasonline.org/publications/biographical-memoirs/memoir-pdfs/loomis-alfred.pdf

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