Valuation Metrics

[twaddle]

Honestly, it's been years since I paid much attention to valuation metrics, but it seems like a good time to take a peek at a few.

Got any favorites?

Everybody loves Tobin's Q, right? Just checked, and it's indicating the market is a bit overvalued. OK, way overvalued. The most overvalued ever.

What do I do with this info? Nothing actionable. I use it to set expectations of magnitude of a correction if/when we get one.

 

[twaddle]

Buffett's favorite is apparently market cap to GDP:

 

[twaddle]

Hussman basically capitulated a couple years ago, I think. But here's his latest on expected returns.

 

[twaddle]

Shiller PE10 is actually not quite as bad.

https://www.multpl.com/shiller-pe

 

[twaddle]

Price:Sales ratio is closing in on twice what it was at the dot-com bubble peak.

 

[Lsbcal]

Shiller PE10 is actually not quite as bad.

https://www.multpl.com/shiller-pe

Shiller within his Excel spreadsheet data posts another measure of valuation nowadays. This includes the current 10 year Treasury rate. Here is the chart he has included:

I think this just compares the inverted value of the PE10 (CAPE) to the current 10 year Treasury rate. So if the PE10=30 this means 3.33% compared to a 10 year Treasury of around 1.5% right today corrected by the 10 year earnings. Or some such formula. Perhaps Shiller is hedging a bit to account for the extremely low rates?

Anyway according to this we are not at extremes like in 1929 or 1970 or 2000. The extremes are where I would get concerned.

 

[FREE866]

If you look at history, valuations are not such great indicators of where stocks are headed. If it were only that easy!

 

[twaddle]

That Shiller metric is good to see. I think everybody is adjusting their models after being so wrong for so long. I see Shiller now calls this "rational exuberance."

Shiller likes international a lot more than US stocks. Me too.

The ECY is close to its highs across all regions and is at all-time highs for both the UK and Japan. The ECY for the UK is almost 10%, and around 6% for Europe and Japan. Our data for China do not go back as far, though China’s ECY is somewhat elevated, at about 5%. This indicates that, worldwide, equities are highly attractive relative to bonds right now.

 

[corn18]

According to this, we are in a recession and don't even know it:

 

[Lsbcal]

That Shiller metric is good to see. I think everybody is adjusting their models after being so wrong for so long. I see Shiller now calls this "rational exuberance."

Shiller likes international a lot more than US stocks. Me too.

The ECY is close to its highs across all regions and is at all-time highs for both the UK and Japan. The ECY for the UK is almost 10%, and around 6% for Europe and Japan. Our data for China do not go back as far, though China’s ECY is somewhat elevated, at about 5%. This indicates that, worldwide, equities are highly attractive relative to bonds right now.

If one looks at small and midcap value stocks in the US I think the argument for international valuations is less compelling. Currently my small/midcap US stocks are beating international small stocks. But they both have been doing great especially in February so no complaints on diversifying a bit.

Both small/midcap value and international small have been out of favor as the SP500 (really the large cap growth) has been the star performer in recent years. But I am hoping this story is changing and will be generally recognized in the months to come.

 

[twaddle]

That's a good point. Shiller's looking at the S&P500, and those cap-weighted holdings really exaggerate the valuation craziness. (TSLA!!1!!)

 

[target2019]

When I capture month-end account values, I also fill in a column with Shiller PE10 and S&P500 data.

I thought everyone was aware of the on-going recession? The FRED Blog covers interesting data at times, and shows one how to build the graph. Here's an example:
https://fredblog.stlouisfed.org/2019/08/the-stock-market-is-not-the-economy/

 

[twaddle]

Here's an obscure metric: ratio of NASDAQ to NYSE volume. Not an indicator of valuation as much as tech exuberance.

 

[audreyh1]

When I capture month-end account values, I also fill in a column with Shiller PE10 and S&P500 data.

I thought everyone was aware of the on-going recession? The FRED Blog covers interesting data at times, and shows one how to build the graph. Here's an example:
https://fredblog.stlouisfed.org/2019/08/the-stock-market-is-not-the-economy/

I didn’t realize FRED had a blog! Cool!

 

[Hans]

If you look at history, valuations are not such great indicators of where stocks are headed. If it were only that easy!

The chart in the post just before yours seems to be a "good" (if not "great") indicator.

Other valuation metrics are reviewed in this article from Mauldin Economics (see the list of metrics credited to Doug Kass):

https://www.mauldineconomics.com/frontlinethoughts/forecast-2021-the-stock-market

There's some interesting commentary, but I don't agree with all of the article's conclusions (like their opinion against 60/40 indexed portfolios).

The article also quotes Jeremy Grantham, who often has interesting things to say (even if he's criticized as being a perma-bear). Grantham once wrote that there was a shift in the equity market around 1995 or so (you can see evidence of that in the various valuation charts in this thread). My guess is that the mid-90s was around the time large market participants became convinced of the "Greenspan put" (which continues to be alive and well today, apparently), and therefore became willing to accept higher valuations than previously.

Personally, I like price-to-book and price-to-sales ratios as valuation metrics (available on multpl.com), but one has to keep in mind the mid-90s valuation shift.

Considering all of the above, I'm somewhat underweight equities at the moment.

 

[target2019]

I didn’t realize FRED had a blog! Cool!

I use the RSS feed and get a perfect copy in my email reader once or twice a week. It really is a great blog, much different than the usual tripe.

I think it may have been one of your posts in a discussion about which economic indicators to follow that led me to FRED.

 

[FREE866]

The chart in the post just before yours seems to be a "good" (if not "great") indicator.

Other valuation metrics are reviewed in this article from Mauldin Economics (see the list of metrics credited to Doug Kass):

https://www.mauldineconomics.com/frontlinethoughts/forecast-2021-the-stock-market

There's some interesting commentary, but I don't agree with all of the article's conclusions (like their opinion against 60/40 indexed portfolios).

The article also quotes Jeremy Grantham, who often has interesting things to say (even if he's criticized as being a perma-bear). Grantham once wrote that there was a shift in the equity market around 1995 or so (you can see evidence of that in the various valuation charts in this thread). My guess is that the mid-90s was around the time large market participants became convinced of the "Greenspan put" (which continues to be alive and well today, apparently), and therefore became willing to accept higher valuations than previously.

Personally, I like price-to-book and price-to-sales ratios as valuation metrics (available on multpl.com), but one has to keep in mind the mid-90s valuation shift.

Considering all of the above, I'm somewhat underweight equities at the moment.

Couple things....


Anyone who has taken Granthams views and applied that to their investment mix has done extremely poor in the markets. Permabears always sound good, but following their advice can be financial suicide.


Shiller himself has even stated that his CAPE theory should not be used to time the market.


Interesting you brought up price to sales. The "inventor" of that metric is Ken Fisher who is the sources below.



Here are a couple things worth viewing and reading.



https://www.cnbc.com/video/2017/10/...nvestments-executive-chairman-ken-fisher.html


https://www.realclearmarkets.com/ar...time-tested_path_to_lousy_returns_495670.html

 

[twaddle]

Valuations matter if you're investing.

They don't matter if you're speculating.

Apparently Ken Fisher thinks euphoria matters. What does euphoria look like? See the ratio of NASDAQ to NYSE volume above.

 

[FREE866]

Valuations matter if you're investing.

They don't matter if you're speculating.

Apparently Ken Fisher thinks euphoria matters. What does euphoria look like? See the ratio of NASDAQ to NYSE volume above.

Heavy volume of one index over the other does not constitute "euphoria".


Valuations are one measure I think is his point. Not the end all as some are led to believe. It's not that simple. The 1 , 3 and 5 year returns show that.




Take 2009. The S&P 500’s trailing 12-month P/E soared to levels unseen since the dot-com crash, thanks to putrid late-2008/early-2009 profits dragging down the P/E’s denominator more than prices fell. Yet that formed the beginning of history’s longest bull market—a generational buying opportunity.

 

[twaddle]

Oh, no question about it, "E" is volatile. A lot of the metrics in this thread take that into consideration.

What's the euphoria metric? Kids yelling "gamestonk!" seems pretty good to me.

 

[Hans]

Anyone who has taken Granthams views and applied that to their investment mix has done extremely poor in the markets. Permabears always sound good, but following their advice can be financial suicide.

The point of my Grantham reference was not to repeat a bearish mantra, it was to highlight his commentary that there seems to have been a shift in acceptable valuation norms around the mid-1990s. The intent was to offset widely-held assumptions about "reversion to the mean", as it might no longer be a good idea to expect reversions to pre-1995 valuation levels. In this case, those who are still committed to that expectation might commit financial suicide by ignoring Grantham's commentary on that.

Don't throw out the baby with the bathwater.

Heavy volume of one index over the other does not constitute "euphoria".

The article at the link I posted contains an interesting euphoria chart from Citi Research. It's been going parabolic.

Valuations are one measure I think is his point. Not the end all as some are led to believe.

I didn't see anyone trying to make the case that valuations are the end-all. As far as I've seen, the question being addressed was whether valuations matter. Charts such as the one posted above by Lsbcal are pretty good indications that they do.

For those who aren't fans of valuation metrics, I'm wondering if there's any valuation that would ever have you underweight equities. If someone wants to claim "no valuation is too high", that would be interesting to know. Otherwise, what would you consider as too high?

 

[FREE866]

The point of my Grantham reference was not to repeat a bearish mantra, it was to highlight his commentary that there seems to have been a shift in acceptable valuation norms around the mid-1990s. The intent was to offset widely-held assumptions about "reversion to the mean", as it might no longer be a good idea to expect reversions to pre-1995 valuation levels. In this case, those who are still committed to that expectation might commit financial suicide by ignoring Grantham's commentary on that.

Don't throw out the baby with the bathwater.



The article at the link I posted contains an interesting euphoria chart from Citi Research. It's been going parabolic.

I didn't see anyone trying to make the case that valuations are the end-all. As far as I've seen, the question being addressed was whether valuations matter. Charts such as the one posted above by Lsbcal are pretty good indications that they do.

For those who aren't fans of valuation metrics, I'm wondering if there's any valuation that would ever have you underweight equities. If someone wants to claim "no valuation is too high", that would be interesting to know. Otherwise, what would you consider as too high?

I went back and looked at the link you posted. Its from a publication called "Maudlin Economics" with literally almost every article predicting doom and gloom for the markets throughout this entire bull market. When you have that type of track record, yes it cheapens your credibility.



Again CAPE isn't predictive and Shiller admits that. I didn't say valuations didn't matter, but they are just one element of the bigger picture.



I have a 30+ year , hopefully, investment time horizon so I'm not concerned with what are perceived as "higher valuations". I'm a long term investor with a very simple approach.

 

[Hans]

I went back and looked at the link you posted. Its from a publication called "Maudlin Economics" with literally almost every article predicting doom and gloom for the markets throughout this entire bull market. When you have that type of track record, yes it cheapens your credibility.

In fact, I don't know much about Mauldin, I only read the article because Doug Kass pointed to it. Kass turned bullish a few days before the 2009 bottom, so I think his track record is better than some people's.

I posted the link in response to the OP, who asked for valuation indicators, and Kass was the source of the valuation indicators listed in the article. The OP asked for indicators, not whether they're useful or not, so I was replying to the request that was made.

I'm not claiming that everyone should pay attention to them. I'm only suggesting that Kass's indicators might be interesting to those who are looking for valuation indicators. I don't claim that they should be interesting to you in particular.

I haven't noticed anyone "predicting doom and gloom". Healthy corrections happen sometimes in a normally-functioning market, and it's reasonable to expect that. Additionally, some people think there's some degree of correlation between those occurrences and certain market conditions (and some don't, of course). And, from what I've read, those who see those correlations have been careful to allow that it might not happen anytime soon.

I haven't noticed anyone making a firm prediction, only suggesting that certain things are more likely under certain conditions than under other conditions... with no guarantees. I don't see anything unreasonable in that.

Again CAPE isn't predictive and Shiller admits that.

Again, without making a prediction, I'll only suggest that certain charts, such as the one posted by Lsbcal, indicate some degree of correlation.

I guess it's up to each person to interpret the chart as showing correlation or not.

 

[corn18]

Read a chart, know the future. If only it were that easy.

 

[24601NoMore]

I haven't noticed anyone "predicting doom and gloom".

Well, they're out there..

1) Contrarian MacroEconomist David Hunter predicts a 65-80% "repricing" (ie: crash) this year - possibly as early as Q2, due to Valuations and the end of a nearly 40 year cycle of decreasing rates.

https://www.peakprosperity.com/a-stock-market-crash-of-65-80-this-year/

2) MacroEconomist Stephanie Pomboy draws similar conclusions..

"Highly-respected economic analyst Stephanie Pomboy of MacroMavens.com notes that the discrepancy between today’s record financial asset prices and the underlying economy they’re supposed to reflect are the farthest off she’s ever seen in her entire career."

https://www.peakprosperity.com/most-overvalued-stock-market-ever/

I realize that these are just two opinions out of countless others across the entire spectrum from doom and gloom to euphoria, but it IS interesting and perhaps actionable that there are some pretty experienced folks out there raising the alarm that valuations have gotten more excessive than anyone has seen to this point - by a LOT.

I'm candidly pretty darn concerned about valuations at this point, and it would appear the market is starting to be also with some tech stocks already 20+% off their recent peaks (including my former employer - I still hold a small handful of shares of that and the recent 20+% drop has been painful and surprising on how FAST it happened). It also appears that Value stocks are starting to come back into vogue and Growth stocks are going out of favor - at least based on the daily Morningstar charts and what I see happening with various Growth and Value stocks and funds that I hold..

We've had a great run..I'm not so sure that the next 10 years will be anything like the last 10. In fact, I'm for the most part convinced it won't be so am sitting at less than 25% equities and starting to buy inflation protection assets like Gold trust funds and other funds geared toward inflationary environments. That's more a defensive position as I don't expect the 10+%/yr returns on equities to continue, and I do think there's a significant risk that we'll see perhaps not a 65-80% drop as Hunter is forecasting, but could easily see a 30-50% drop in 2021 due to valuations being so incredibly stretched..and I for one don't want to ride that rollercoaster again now that we're in ER..