How Do You Solve The Problem of Valuation ? How Do You Catch A Cloud And Pin It Down ?
There has been some debate on stock valuations with banks naturally bullish (for the companies are their clients) and independent observers locking horns most recently on the CAPE methodology.
CAPE stands for Cyclically Adjusted P/E which is coined by none other than Robert Shiller of the Case Shiller Index fame.
Arguments for Over Valuation
This diagram taken from a guest post in Zerohedge suggests that when profits revert to their mean, valuations would correct.
http://www.zerohedge.com/news/2013-09-02/guest-post-corporate-profits-what-jeremy-siegel-missing
That is because the outlook is a trite too overly optimistic at the moment and only made possible in the QE years on cheap funding which has led to a surge in corporate earnings in the absence of revenue growth.
Taken from another Zerohedge guest post.
http://www.zerohedge.com/news/2013-09-06/overly-optimistic-earnings-expectations-are-jeopardy
“Since 2009 the reported earnings per share of corporations, the bottom line of the income statement, have increased by a total of 222% which is the sharpest, post-recession, increase in reported EPS in history. However, at the same time, reported sales per share, which is what happens at the top line of the income statement, has only increased by a marginal 22% during the same period. ”
“In order for profitability to surge, despite rather weak revenue growth, corporations have resorted to four primary weapons: wage reduction, productivity increases, labor suppression and stock buybacks. The problem is that each of these tools create a mirage of corporate profitability. The problem, however, is that each of these not only have a negative economic consequence but also suffer from diminishing rates of return over time.
One of the primary tools used by businesses to increase profitability has been through the heavy use of stock buy backs.”
For the past months, I have been asking friends and experts what is a typical P/E we would use for a slow growth recovery and answers have been vague. Most just point me to the Nikkei lost years and told me to use those.
Zico has been more dismissive, saying that I should not even bother with P/E as he does not buy the diversified stock portfolio strategy idea.
https://tradehaven.net/market/to-diversify-or-not-investing-strategy-by-zico/
I am no expert but have been pretty bearish and wrong in the past months. Not to say I have not bought any stocks for I was bullish Google and Nokia, for small gains.
https://tradehaven.net/market/2013outlook/
“4. Equities
My equity strategy will have to change next year. I have mixed feelings about equity especially in times of austerity. Companies are cutting back on R&D and technology upgrades and spending on stock buy backs.
So short term trades for me in general stock indices and again will invest time in sniffing out the companies with intellectual know hows that will pave the way into the future.
I had small gains in Nokia and RIM this year and Facebook too !! But next year will be a year of Chips and Clouds. Am watching Intel, Google and ARM.”
Yet the issue of valuations are now getting to me.
https://tradehaven.net/market/why-no-tech-for-buffet/
https://tradehaven.net/market/why-not-tech-stocks-part-2/
Linked In is one of the companies that is difficult to value, much like Facebook. They are cashing out with another billion dollar in stock offering and the insiders are getting out too.
http://www.marketwatch.com/story/linkedin-share-sale-should-boost-growth-2013-09-06?pagenumber=1
We know how these things work by now. We have the lead manager who supports the price, wait for the public to come in and then they go away like they did for Facebook last year.
I have always approached valuation from 3 angles. 1. future earnings, 2. benchmark against risk free rate and, 3. financial strength i.e. net asset value. So you can see, Linked In is quite a dilemma and more of a “hype trading” play for me.
Errr, did I tell anyone about Inovia US 3 weeks ago ? A pure punt, of course.
The future of companies is that we will have much less cash for stock buy backs when the easy funding life line is taken back. Valuations will be increasingly important but increasingly elusive for us to pin down.
Is that not a perfect storm lying ahead ?
I think its too late to obsess about the higher cost of funding for corporates if we want to pontificate on what the bubble bursting catalyst will be for seemingly overvalued US equities. And I don’t think one of the possible catalysts will be p/e, that just dermines how far the market should fall, it doesn’t cause the fall. Tapering must be the most advertised risk in history. Bernanke didn’t just tell us, he made it sound worse than it would be. Most of the yield shock has probably already happened and how can that not be priced in. Liquid instruments have reacted.
We have seen over 100bp on the 10-year and unless we expect yields of 4%+ this year, which I don’t, then the question is what the lagged effects will be on consumption and capital investment. When yields were much lower we know that lending was also lower. Now that yields are higher we are also seeing easier liquidity. So as of yet no real hit on consumption.
The biggest dent might be via the damage done to the rest of the world and the rebound that hits the US later. Singapore is a good example. Near zero rates led to an orgy of property consumption and no doubt the baubles that go with that. The same is true for the rest of Asia. For Asia it is a one two punch, capital withdrawal and higher yields. Of course we have seen Asian equities hit but we now need to await the full hit taken by economic numbers and then, with their new found weight in global GDP, America might get hit too….smacked right back in the face by the door it just flung open.
Talking of GDP, the ratio of market cap of US equities to US GDP is extremely high, albeit lower than it was in 2000. If GDP fails to rise fast enough to justify the current market cap, so the market cap falls.
So yes, maybe a big equity correction is coming, but in the absence of new developments, it may take a while, economic numbers need time to fall first.
Agreed.
The stock market is a game of beggar thy neighbour now and the laggards are taking the fore.
Tipping points are the hardest to identify for they are natural phenomenons.
An interesting article on valuations based on discount rate, like we have been saying.
http://www.marketwatch.com/story/fed-tapering-the-math-investors-need-to-know-2013-08-15?pagenumber=1
As for Singapore and Singapore property, I visualise a 1% move as a discount of 18% for a 25 year mortgage as a rough gauge.
http://52.77.202.71/market/singapore-real-estate-menopause/
Low rates typically lead to bad investment decisions. I see many companies that think refinancing on floaters the past few years was the greatest smartest decision they have ever made.
Key question then is what is their return on investments? Is it larger than the long term fixed rate? Or are they using the floating rates to make investment decisions? Or this time it is different
No disrespect here, but if the big boys can’t understand interest rate risk, I don’t see how corporate treasurers and CFOs have a better grasped on them.
Your property price maths looks about right to me and I see no way mortgage rates wont rise by the 1% you mention, atleast at some point in the next few years. This means they will be 1% higher for the bulk of that 25 year mortgage. I was just thinking about Singapore REITS today…prior to the previous Singapore slumps in property these acted as a leading indicator. The fall so far has been in the region of 25% ish depending on which you look at. I doubt the fall is over, there could be another 10% taken out. But this fall does imply something like a 15-20% fall in real property. Whether that happens quickly or slowly depends on behaviour, but the fall seems likely to me and there is no doubt a lot of Singaporeans are going to come to realise that bricks and mortar doesn’t just go up forever…that shouldn’t need to be realised as prices fell by 40% just 4 or 5 years ago…but memories seem to be very short in Singapore.
I suspect the fall out will be uneven, separating the sheep from the goats. Reits too, will be the too big to fails vs the start ups.
The government has come a long way in managing property corrections and I suspect this one will be very well managed indeed in the new global age of political populism. Even the 40% fall in 2008-2009 was a brief affair and we will never see those days of Sars killing fields days back in 2003-2004.
I really think property prices are hard to guess. It is not just about rates, valuation. I also think it is hard to compare Asia and western world.
In Singapore,
1) HDB’s invisible hand is often underestimated… Hey, that’s why we have such a big reserve? Use it to buy back land when prices drop, has never happen but it does not mean it cannot happen.
2) Population growth, ok that has tapered somewhat. No pun intended.
3) Population density.
4) Cost of living. How to measure this? Sure our homes cost more, but other items the western folks pay more (taxes….) Leave cars out of the debate…. because on an island no longer than 50km tip to tip… Anyway Google will save us. If cars drive themselves, road capacity goes up by 5-10 times. Taxi drivers better pick up programming skills =P
5) Sure household debt is at all time high. But what about savings? Everyone is a interest rate trader these days. Learning the fine art of gapping… Get cheap loans from banks and invest in high yielding assets (sometimes you can even get higher savings rate than loan rates… go figure).
6) Safe haven status. We should have a premium for this….
I could go on. Point is, property price is idiosyncratic. Would you have imagine that prices would soar in 2010 when the world is exiting from GFC?