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I’m Over-valuations27 July 2016
War Room
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AccountabilityScenario Updates
Market Update
Valuation at the Zero Bound
Valuation + Future Returns
Scenario: S&P Valuation
I’m Over-valuations
UPDATED
HiddenLevers
MARKET UPDATE
Market Update
sources: HiddenLevers, Fortune, UK Express, The Hill, ZeroHedge, BLS
Election Ironies
China Consumer Debt
Inflation up
- Both parties want Glass Steagall back- Trump now candidate of anti-corporate fringe- Hillary now candidate of big business / oligarchs
IMF botches brexit
HiddenLevers
VALUATION AT THE ZERO BOUND
Currencies falling against USD
Geopolitical Instability in EM / Petro states
Negative Rates In Europe + Japan
Bond Yields suffering in Low Rates regime
Lower Fed Rate = Bank Account Earns Zero
Investors looking for yield
Zero Bound: Big Picture
sources: HiddenLevers
US Equities Attractive
Zero Bound: Interest Rates + P/E
sources: Federal Reserve, Hussman Funds
“Fed” ModelS&P P/E correlated to 10y treasury yields
Current falling rates push market higher
Periods of high P/E ratios occur when CPI < 3%, when rates are also moderate
Zero Bound: Bond Yields + Housing
sources: Google, Investopedia
We are hereNear zero yieldSmall Yield movements = drastic price change
BONDS: Price vs Yield
Mortgage Rates Have fallen from 6% 3.5% Average BuyerCan get 33% more house
Zero Bound: Comparisons
sources: HiddenLevers, Hindesight, WSJ
45
20
History1980s – touched 45 on CAPE1990s – crashed to low 20s2000s – 20-30 P/E range
NowNegative ratesYen at 18m high against USDP/E sinking to 23
HiddenLevers
VALUATION + FUTURE RETURNS
Future Returns: Higher Multiples Justified?
sources: GMO (via Financial Sense), Michael Kitces
When starting CAPE is above 22, 15-year avg return is only
1.9%
Fed Model?Turns out it’s a statistical anomaly
Future Returns: Schiller P/E Tells?
sources: HiddenLevers, HiddenLevers 2
S&P index UP 2.5% Since Mar 2015
CAPE DOWN 3.5% Since Mar 2015
Long-term CAPEMean: 16.7Only pierced once in last 30 years versus regularly before
Why divergent?Earnings UP
Future Returns: US Housing Over-valued?
sources: HiddenLevers, Economist
Real US home price growth well below most other OECD countries.
Price to Income Ratio: US below 40-year average.This is slightly skewed by income inequality.
Home Prices in Real Terms
Prices against average income
HiddenLevers
SCENARIO: S&P VALUATIONUPDATED
Scenario Update: Rising Earnings + Shares
S&P Valuation FLAT P/E
RISING P/E
SINKING P/E
DROWNING P/E
S&P Valuation
GOOD: CAPE at 33
source: HiddenLevers
P/E that represents upward expansion
Late 1990sTech Boom
1960-65Industrial Height
Late 1920sRoaring Twenties
BASELINE: CAPE at 27
source: HiddenLevers
P/E flat due to rising markets on rising earnings
mid 2000s
2013-present
early 1990s
BAD: CAPE AT 21P/E that represents typical business cycle recession
source: HiddenLevers
2001-03
1990-91
1987
UGLY: CAPE at 17
2008-09Financial Crisis
source: HiddenLevers
P/E that represents a paradigm shift in economy
more than just a correction
Late 1970sStagflation
Scenario: S&P Valuation
Good:CAPE 33
Rising
Baseline:P/E 27
Flat
Bad:P/E 21
Sinking
CAPE
21S&P
-20%
CAPE
27S&P
+8%
CAPE
33
The average CAPE from Dec ‘94 to Sep ‘01 was 33 – this scenario presumes that level is attained again as a result of low rates and sustained growth.
From early 2015 to mid-2016 earnings growth enabled the S&P to return 4.5% while CAPE fell 3.6%. If valuation stays flat, EPS growth can lead to solid returns.
Recessions in 1990 and 2003 led to an average drop of 20% in valuation terms, which is reflected in this mild recession scenario.
S&P
+25%
I’m Over-valuations – Take Aways
S&P yields have exceeded 10y Treasuries since Jan 2016
ZIRP lifting Housing prices, butvaluation metrics not excessive (yet)
Earnings improved valuations pictureP/E down from 28 peak
Start at high valuations = subpar returns
let’s take all the credit
10yS&P
