Valuation Metrics

[Montecfo]

There isn't any single valuation metric you can look at to know market direction.

But important data points in my estimation include key commodity pricing (e.g., copper and oil), sentiment indicators, interest rates, and cash on sidelines to name a few. These are in my opinion more useful than valuation metrics.

CAPE10 is interesting but not particularly actionable. PE and PS, cash flow yield and enterprise value multiples are useful in my opinion.

 

[Montecfo]

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..

Interest rates and rate direction are probably the most important factors affecting stock values. You can clearly see that over time. We have been in a declining to flat interest rate environment since the 1980s.

The end of that declining/flat rate era has been often predicted but those predictions have been wrong. When that DOES change (could it be now?) You will definitely see sharp declines in equity valuations, with greatest impact on the long-term secular growth stocks.

I tend to think the time is not right now given high unemployment and long growth trajectory we see before us with vaccines and reopening of the economy. But in anticipation I have pruned some high growth stocks and continued to reposition my portfolio.

I agree with you on the rollercoaster.

 

[corn18]

I've always wanted to start a thread with a one hour window to predict where the S&P 500 will close on the next trading day. I would be willing to Venmo $100 to anyone who got it right. But you would have to send me a $1 if you were wrong.

 

[twaddle]

From the OP:

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.

When the market starts falling, it eventually stops falling. It doesn't go to zero. What keeps it from going to zero? Fundamentals. These valuation metrics give you an idea of the floor. They're useless for timing.

In terms of "actionable," I personally also use them to help me choose how to deploy cash. That's because I *hope* that valuation is a reasonable indicator of long-term future expected return.

 

[corn18]

I might use these metrics to help me decide whether to pay off my mortgage with my severance in 21 days. My model makes it very clear that keeping the mortgage and investing the $$$ in the market works out great when the market is going up and will continue to go up. But it also clearly shows that paying off a mortgage right before a market dip/correction/crash is brilliant. I'll let you know what I decide.

 

[Lsbcal]

Think about "the market" as the 3x3 sided box popularized by Morningstar. Here is a picture with weightings from M* for the VTSAX, Vanguard Total Stock Market fund :

Ten years ago this style box picture was more balanced and was not too unbalanced in 2018. Here is the 10 years ago picture:
25..24..23
06..07..07
03..03..03

The SP500 is primarily the upper row (large value, large blend, large growth) with some of the midcaps too and no small caps (bottom row).

The distortion in the market has been the huge price gains in large growth (upper right box). PE's have more then doubled in this group over the last 10 years. Much of this distortion has taken place in just the last year following the crash due to the pandemic news.

So some points:
1) We could have a good run in stocks in other asset classes outside of large growth. The situation is not that stocks are generally too high. Small cap value, for instance, has PE's lower then 10 years ago.
2) Large growth could overall go flat to down relative to the SP500.
3) One does not have to sell all equities and run to cash or bonds. One should be more nuanced.

 

[twaddle]

Value has been out of favor for so long now that some people are questioning the whole "risk premium" model of expected returns.

It's pretty clear that the number of people giving up on the factor model is greater than the number of people selling everything and moving to cash. It's a weird form of capitulation.

 

[24601NoMore]

Value has been out of favor for so long now that some people are questioning the whole "risk premium" model of expected returns.

Saw something the other day (wish I could remember where..) that predicted Value would outperform Growth over the next 3-4 years, primarily because the valuations of each were so out of whack compared to "norms" (Growth way too over-valued..Value way too under-valued).

I will say that I've seen Value coming back over the last couple of weeks, and Growth - particularly Tech - has been getting crushed for the most part. Will that continue? Who knows..but that's why diversification is so important. My Value funds (especially International Value like OAKIX - ouch) have been pretty painful to hold for a long time now..Growth has of course gone totally parabolic. But that looks like it might be turning..

 

[Hans]

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

No one in this thread said it was. Glad to see we're all in agreement!