Are stocks cheap or expensive?
For months now, I have been advocating holding higher equity positions than conventional valuation metrics suggest. I still believe this to be true, but you should always know where the exit doors are. Overweighting stocks is a very crowded trade with a small way out. Using Bloomberg data and looking at the SP500’s nearly 100-year history, our current book value of 4.6 times, a 1.3% dividend yield and 25 p / e over the past 12 months, s ‘accumulates as one of the most cherished moments of all time. At the peak of 2007, we were at 2.9x book value, 1.7% return and 17.3xp / e. The only more expensive market is in March 2000, when the SP500 was at 5x pound, 1.1% yield, and 27.8xp / e. Therefore, it will take a lot of growth over the next few quarters to bring today’s valuations down to even reasonable levels. By the way, investors actively involved in the 2000 episode will recall everyone vowing never to pursue these valuations again. Sure!
So today, as I write this on Halloween, I wondered why not write about the spooky bear market to come? Maybe, but because American companies continue to generate incredible profits and, by one key indicator, stocks are still cheap. First off, kudos to American companies. Profits for the past 12 months at the start of the year were $ 123 / share for the SP500. Now after low GDP 3rd quarter, they are at $ 177 / share. With more than half of companies reporting third-quarter profits, sales are up by around 18% and profits by around 39%. That’s astonishing given the third quarter delta variant and headwinds in inflation. In addition, it looks like 4e quarter will be up sequentially in GDP and that means the cycle still favors owning these amazing American profit machines.
But cheap, how’s that? Have I stolen too many Halloween candy and am in brain fog? Let’s see. One of my favorite cyclical valuation metrics is to look at earnings yield (the inverse of p / e) and compare it to the amalgamation of treasury bill yields, government bond yield to ten years and the performance of Moody’s Baa Corporate. Certified by Ned Davis Research, it shows an excellent track record of predicting key market turns and good short-term valuation metrics. Right now, the inverse of the SP500 p / e is yielding a profit return of 3.7%, which is still cheap compared to the 1.6% interest rate mix. If profits were to hold steady, as unlikely as that may be, it would take an interest rate well north of 2.25% to make the market expensive.
Why not ditch caution and diversification for all stocks if stocks are cheap? First of all, they are cyclically cheap, which means that eventually the business cycle will backfire and profits will weaken. Second, I compare stocks to a set of interest rates manipulated by the Fed that are insanely priced. But these are real interest rates, so if you want to be bearish on something, hate bonds that offer much lower returns than zero real return. If the bond market were to achieve zero real return (which would still be of little interest to bulk investors), my bond mix would hit a minimum of 3% and stocks would be 20 years old. expensive level. So don’t give up on your hard currency / precious metals / bitcoin just yet.
Halloween 2021 doesn’t seem so scary. 2022 on the other hand …