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Bill Gross on Equity Valuations
Old 12-02-2008, 05:42 PM   #1
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Bill Gross on Equity Valuations

I know Bill is a bond guy who is prone to talk his book. But he usually backs up what he says with an understandable logic. Here he seems to miss something pretty important in my view.

PIMCO - IO Dow 5000 Gross Dec 08

His argument boils down to the notion that although traditional equity valuation measures, like P/E and the Q ratio, suggest stocks are cheap, they really aren't because we are entering into a new world of less leverage, higher taxes and higher regulation. But equities aren't just cheap when compared with the more favorable regulatory and tax environments of the late 90's, but also when compared against many periods going back over 100 years (as evidenced by the charts he provides). Is his argument that we are entering a period of taxation and regulation unlike anything ever seen before, such that traditional valuation metrics lose their meaning? Seems a bit extreme to me.
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Old 12-02-2008, 07:21 PM   #2
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IMO, he misses the same point he missed when he made his last forecast of Dow 5000. Back then the S&P 500 yielded more than money market funds - this time it yields not only 25% more than 10-yr Treasuries, but more than 30-yr Treasuries.

But, as you said, he's a bond guy.
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Old 12-02-2008, 07:46 PM   #3
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With no gridlines on the chart it isn't easy be sure, but to me it appears that his summary of wht the chart shws is different from what it in fact shows. He says
" “Q” should mean revert to 1.0. If so, then oh, oh what a “Q”! Today’s Q ratio has almost never been lower and certainly not since WWII, implying extreme undervaluation, as seen in Chart 1."

While Q is low, especially if Gross is correctly calculating it, it looks to me that it was lower several times since WW2, last time in the mid-eighties.

Still, it is low, and for me that means we are in a buying range rather than a selling range. I think his objections are nonsensical. Does he really think there were no special concerns at other low points?

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Old 12-02-2008, 07:53 PM   #4
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Part of the problem is that valuation with P/E isn't everything. You should probably look at P/E 10 -- price to average earnings over ten years -- AND you need to consider the prevailing so-called "safe" interest rate at the time. Often that "safe" return is determined by Treasuries.

A PE10 of 12 isn't cheap when Treasuries are yielding 10% as in th early 1980s. In fact, it's highly valued.

A PE10 of 15 is pretty cheap when Treasuries are yielding 4%.

A PE10 of 12 is dirt cheap when Treasuries are yielding 3%.

Ben Graham-style securities analysts commonly compare stock earnings yields to the so-called "risk-free" rate (not completely risk free, but close) to help determine whether a stock (or by extension, a market) is priced fairly. Most often I see that as earnings yield (the reciprocal of P/E or PE5 or PE10) compared to, say, the yield of 10-year Treasuries. With the latter yielding less than 3%, an earnings yield (based on PE10) of about 6-7% looks quite attractive.
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Old 12-02-2008, 08:03 PM   #5
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He's basically correct. The important point he's trying to get across is that we're experiencing a generational shift in the markets.

Look - forget all the ways of measuring stock valuation for a moment, and consider the following. Over the last 25 years the shadow banking system (hedgies, institutionals, foreign nationals (Iceland ...)) have blown a credit bubble approximately the size of our depository banking system. And in the space of a year it's rapidly exploded. The boom of the last few decades was in large part driven by this ever expanding supply of credit.

So considering that, aren't stocks still priced for a continuation of the trend, after this 'correction'? Is that trend (leveraging up) still going to continue? If you think it's business as usual next year, than it's time to buy. If you don't, than caution is warranted.

Here, try this

http://www.nakedcapitalism.com/2008/...not-be-so.html
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Old 12-02-2008, 09:11 PM   #6
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He's basically correct. The important point he's trying to get across is that we're experiencing a generational shift in the markets.
I don't think that anyone participating in this thread is unable to understand what he is trying to say. But there are a lot of suppositions in the chain leading to his conclusion that stocks are expensive. You choose to accept them. That doesn't make them right, as you may be wrong.

Fortunately these things are not decided by argument on internet boards, but rather in the markets. In due time, we will know.

Ha
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Old 12-02-2008, 11:13 PM   #7
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Here's another take on his piece

Bad Dream? | The Big Picture
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Old 12-03-2008, 04:00 AM   #8
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There could be some merit to his hypothesis. Although is might not be exactly the way it ends up, he could be more right than wrong.

Another phenomenon (regarding leverage) that could affect company valuations is consumer deleveraging. In the US consumers have been spending more than they can afford. That may be ending... not because of the consumers, they are probably still willing to borrow and spend. But because institutions are likely to be more conservative and new tighter regulations on consumer credit.

On the consumer side (in the US), we can hope that foreigners buy US goods and services to pick up the slack (i.e., China, India, etc).


But I thought his ending statement was a little telling.

Quote:
Better to own corporate bonds than corporate stocks, but that’s a story for another Investment Outlook.
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Old 12-03-2008, 10:36 AM   #9
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Here's another take on his piece

Bad Dream? | The Big Picture
This is not another "take", it is another guy agreeing with Mr. Gross. As I said, arguments are nice, but to the extent that they are compelling they are in the price.

You, this other anonymous guy, and Mr. Gross think the investing public is being too optimistic.

Your group could be right. But the "analysis" seems to miss that whenever stocks reach these objectively low levels, (Q, PE,etc) there are always reasons. And there are always people like Gross putting forth the "This time it's different" song and dance. They don't have to be wrong, but in the past they have been, given a reasonable time, and from these low levels.

Ha
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Old 12-03-2008, 10:38 AM   #10
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But I thought his ending statement was a little telling.
Certainly it seems a little self-serving -- a bond fund manager recommending bonds over stocks.

That strikes me as similar to someone who owns 1000 shares of KO telling people Coke is better than Pepsi.
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Old 12-03-2008, 10:40 AM   #11
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Certainly it seems a little self-serving -- a bond fund manager recommending bonds over stocks.

That strikes me as similar to someone who owns 1000 shares of KO telling people Coke is better than Pepsi.
He's a bond homer. I also think he has been bearish for 30+ years......
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Old 12-03-2008, 12:30 PM   #12
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everyone is afraid of regulation, but the Dow went from somewhere around 50 to around 1000 from 1932 to 1979 or so and this was a period of heavy regulation
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Old 12-03-2008, 12:37 PM   #13
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Part of the problem is that valuation with P/E isn't everything. You should probably look at P/E 10 -- price to average earnings over ten years -- AND you need to consider the prevailing so-called "safe" interest rate at the time. Often that "safe" return is determined by Treasuries.

A PE10 of 12 isn't cheap when Treasuries are yielding 10% as in th early 1980s. In fact, it's highly valued.

A PE10 of 15 is pretty cheap when Treasuries are yielding 4%.

A PE10 of 12 is dirt cheap when Treasuries are yielding 3%.

Ben Graham-style securities analysts commonly compare stock earnings yields to the so-called "risk-free" rate (not completely risk free, but close) to help determine whether a stock (or by extension, a market) is priced fairly. Most often I see that as earnings yield (the reciprocal of P/E or PE5 or PE10) compared to, say, the yield of 10-year Treasuries. With the latter yielding less than 3%, an earnings yield (based on PE10) of about 6-7% looks quite attractive.
they had Graham on CNBC this morning, he said to look at corporate debt that's secured. in some cases it's selling for less than unsecured corporate debt of the same company.

i don't remember the exact numbers but in 1980 when t-bills were yielding around 20% i think that PE ratio was around 10. I think it bottomed out at 7 in 1977, but don't remember the exact chronology. and the market took off in 1982 and i think t bills were still yielding more than whatever the PE ratio was
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Old 12-03-2008, 04:44 PM   #14
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they had Graham on CNBC this morning,
I love CNBC, now they are bringing back people from the dead to help their ratings I might have to pick up some GE stock
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Old 12-03-2008, 06:25 PM   #15
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Look - forget all the ways of measuring stock valuation for a moment, and consider the following. Over the last 25 years . . .
But aren't you making the same mistake Gross is? We are using valuation metrics that span a continuum long before the recent credit bubble. I don't have to assume that conditions return to 2005 or even 1995 levels for stocks to be cheap. All I have to assume is that conditions going forward are consistent with the conditions we've faced over the past 100 years when stocks priced at current levels proved to be cheap. Those periods included a great depression, 2 world wars, wage & price controls, income tax rates over 90%, race riots, etc. etc.
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Old 12-03-2008, 06:39 PM   #16
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So considering that, aren't stocks still priced for a continuation of the trend, after this 'correction'? Is that trend (leveraging up) still going to continue?
On what basis do you argue that stocks are priced for a continuation of leverage?
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