Charts of the Week: Valuation Inflation
Valuation Inflation is one of Mauldin's best "Thoughts From The Frontline" columns ever.
Mauldin posts charts from Jim Bianco, Peter Boockvar, Doug Kass, Tony Sagami, Jesse Felder, Ed Easterling, Ned Davis, Doug Short, and Jill Mislinski.
Here are a few of my favorites.
Jim Bianco - 3 Year Forward PE
Mauldin picked that up from a series of Tweets by Jim Bianco.
Inventing a New Metric
The Price-Earnings ratio look so terrible the bulls invented a new metric, the 3-year forward PE that supposedly shows what earnings would be were it not for Covid.
Much of the S&P 500 returns come from just 10 companies: Microsoft, Apple, Amazon, Google, Facebook, Visa, Mastercard, Nvidia, Netflix, and Adobe. As a group they are up 35% since the beginning of the year. As a group, the other 490 are down more than 10%.
The chart is Mauldin's post also comes from Twitter.
Here is another one from Tony that was not in Mauldin's list.
Ed Easterling - Crestmont
The idea behind the 10-year smoothed PE is that earnings revert to the mean over time. They always look terrible at the bottom of the cycle and great (relatively) at the top.
This is a very expensive market. Advisor Perspectives comes to the same conclusion.
Maludin presented a chart from Advisor Perspectives, Jill Mislinski, Is the Stock Market Cheap?
Here is another chart and commentary from Advisor Perspectives.
PE 10 From Geometric Mean
Relative to the mean, the market remains quite expensive, with the ratio approximately 70% above its arithmetic mean and 84% above its geometric mean.
Wouldn't Valuations Be Much Lower If We Exclude the Financial Crisis Earnings Crash?
This is an often asked question, the assumption being that the unprecedented negative earnings of the Financial Crisis skewed the P/E10 substantially higher than would otherwise have been the case. While that may seem a reasonable assumption, a simple experiment shows that the earnings plunge did not dramatically impact the ratio. Let's assume that the December 2007 TTM earnings of 66.18 remained constant for the next 29 months, totally eliminate the collapse in earnings of the Great Recession. What impact does this have on the P/E 10? The mean (average) only drops from 16.6 to 16.5. The lower bound of the top quintile drops from 21.2 to 20.8.
The above excellent comments from Jill Mislinski.
Mauldin comments "Overvalued markets don’t turn down on their own. Something usually triggers them. What could it be this time?"
While there is always a chance of an oil shock, Covid shock in this case, or some other shock triggering a decline, more often than not, sentiment suddenly changes and that is the trigger.
If you think back to 2006 people were standing in line for hours waiting to enter a lottery for the right to buy a condo. The next month, there were no lines at all. Builders offered massive discounts.
But the market advanced for more than another full year.
Mauldin commented "Back in 1999, I and many others thought there was no way the bull market could go on. Yet it did, with the Nasdaq actually doubling in 1999."
When Covid hit, many thought it would be like an oil shock only much bigger. Instead it triggered massive speculation in tech stocks.
As with the housing bubble that actually burst in 2006 (but stock kept running anyway) we did it again, only bigger.
This blowoff top pattern is not so unusual after all.
Sentiment is the Trigger
Think back to November of 2007 when the S&P 500 hit a then all-time high. Recession hit the next month.
What was the trigger?
There was none that anyone can point to. Here's the "trigger" if you think carefully: The pool of greater fools ran out.
People stopped buying houses a year earlier but commercial real estate and the stock market kept things humming for another year.
Then sentiment changed. There was no other reason then or on 2000, or now.
What about jobs?
Over 30 Million People About to Lose $600 in Unemployment Benefits
Congress is debating on whether or how to extend Covid benefits. Note that Over 30 Million People About to Lose $600 in Unemployment Benefits.
That's about $18 billion a week in benefits.
Also note that Unemployment Claims Rise for the First Time in 4 Months
Unprecedented Recession Synchronization and What it Means
Please consider Unprecedented Recession Synchronization and What it Means.
In the article, I discuss comments by Lacy Hunt at Hoisington Management.
He explains the deflationary consequences of the current global situation.
I too expect a deflationary outcome based on demand destruction. Meanwhile, my other comments apply.
Unwanted Inflation Easy to Find
Actually, inflation is easy to find. Look no further than the stock and bond markets.
The Fed's balance sheet expansion coupled with trillions of dollars of fiscal stimulus (both unprecedented) has resulted in stock market speculation also at unprecedented levels exceeding the housing bubble boom in 2008.
Inflation is not where the Fed wants it.
The Fed can print money and Congress can hand it out, but neither can dictate where the money goes.
In 2020, money has found a home in rampant speculation in stocks and bonds. In 2008 money primarily went into a housing bubble.
But bubbles burst. Thus, speculation too is inherently deflationary.
Why expect anything differently this time?
People will blame jobs as the trigger, but if that was the trigger it would have happened already.
The Fed blew its third major bubble in 20 years. Bubbles always burst with deflationary consequences.
They burst when sentiment changes. The pool of greater fools always runs out.