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HR,

Nice to have you back. What is your opinion on the level of the stock market? See this interview with Bill Miller -

https://www.youtube.com/watch?v=2QNxfCNFIAw&feature=yout...
(from 17:06s).

I thought his argument made sense. Although, I recall pretty clearly (don't have the link) in 2006 he gave an interview where he said that we are in a bull market.

A lot of smart people seem to be saying that the market is overvalued/high. But the level of interest rates do matter (and Buffett has said the same thing recently in interviews as well as at the meeting). And the variant view might well be to actually agree with Bill Miller.
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you didn't ask me, but most of the universe I follow doesn't trade at 18x, it trades more like 25x. It is kinda funny - rates made a run at 3% not that long ago. It is so ridiculous to think they could make a run at 4% - eventually?

would 25x be cheap then? Esp when getting 5% top line growth is classified as exciting? The penalty for being wrong is a ask-chewing the like we haven't seen in years and years. In early 2016, stocks I follow fell 30% and more, and that was in a little 10% drop. I'm cautious and confused, and it is laughable to listen to what he saying with a straight face. Course, if rates remain under 2% then...I'm not taking that bet*.


*unless a client tells me to be invested - which is what you do when you invest in a stock index fund.
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you didn't ask me

I always monitor your cash levels (from your letters), so I already kind of know what you think. Plus I thought it might be a good way to get HR writing here again (short of linking to a Hussman post).
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fwiw, my cash levels are always linked to my age - so less and less relevant - i sold most of acn today cause it trades for 25x vs. the 17x it used to trade - but that could be a mistake for all I know

it is just so incredibly hard. Did a stalwart screen a week ago and came up 0 for the universe - in 20+ years, I can't ever remember that happening. And it isn't like these stories are exciting - many don't qualify as stalwarts any more, and even the ones with negative earnings and/or sales growth were up strongly as a group. It is so hard. Never seen it this hard.

-

thanks for posting the link - enjoyed it
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p.s.
my average 'model' account is 10 years older on average than I am...
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I thought his argument made sense. Although, I recall pretty clearly (don't have the link) in 2006 he gave an interview where he said that we are in a bull market.

A lot of smart people seem to be saying that the market is overvalued/high. But the level of interest rates do matter (and Buffett has said the same thing recently in interviews as well as at the meeting). And the variant view might well be to actually agree with Bill Miller.


I don't really think he said anything at all. Comparing a median P/E to a period that excludes the 70s because it had inflation is as big a data strangulation felony any as you'd see from a certain unnamed overvalued, overwrought, overbearish weekly commentator. But that's not an insult, that's basically a win when you're trying to be a pundit about the stock market as a whole. This Bill Miller interview is more my speed:

https://www.youtube.com/watch?v=kMZokcWDXDI

Here's my only deep truth about market valuations: There is no set of empirics or batching and chopping of empirics in our current universe that can save you from the inescapable uncertainty in what constitutes the value fair of junior rights to the world's corporate assets. The forward yield right is ~5.7%. Is a 5.7% real yield good enough? You can move your lips in response but I don't think there is much to be said with force. If it was 3% or 10%, maybe. We know the real yield available on the 30-yr UST is 1%. A 4.7% real return spread for equity risk is pretty big. In 50 years it's the difference between a 16X bagger in real terms and getting only 2/3s of the way to first base. Is it big enough? BBB bonds spreads are about a point and half. So the hypothetical very long-term equity to BBB spread is ~3.2% real. Again pretty big, especially since BBBs are no guarantee to survive a true disaster.

Because it's so hard to say anything smart about whether, say, the right real return for holding stocks instead of consuming or storing at no return is 4% or 8%, it's equivalently hard to say whether the market should trade 12X or 25X equilibrium earnings. And that leaves little to say at all. So people naturally look to history. But history is smaller than we think. It's possible to imagine a world 5000 years from now where our robot's robots chuckle at how seriously we squinted for stationarity amid just a single century of discount rates. It's not that looking at historical valuations is silly, what's silly is white knuckling a few crumbs of data amid a complex, changing world into thinking we can be more precise than we probably can about what's fair value and what isn't.

If I had to create a one punch Rip Van Winkle 30-year portfolio right now at 5.7% real yields or 1% real yields from 30 Year USTs or 2.5% from hypothetically diversified 30 YR BBBs, I'm putting most of it in stocks. When you slide the Rip Van Winkle out of the hypothetical you're just hoping you can guess that the market will offer something that is even better than what you consider fair before the cost of sitting in cash overwhelms the option value. That's okay to do, I do it myself, but I wouldn't call it market valuation and I damn well wouldn't be even a little certain about it.

The other popular variable that Bill Miller doesn't mention is the idea that the 5.7% isn't a good central expectation because earnings are too high; i.e. likely to revert. This is partially implicit in the Shiller CAPE and explicit in other popular punditry like GMO. I won't rehash why I don't find these arguments as presented very persuasive, but in short I think they rely on a similarly narrow empirical fetishism that comes closer to imposing stationarity than finding it. But of course it's also not crazy to think that current earnings are for one reason or another above the base-case long term equilibrium, I just think it's a good idea to raise the bar on what gives you the ability to predict how the capital/labor ratio and returns on corporate capital will change from where they are today. Means and medians aren't enough for me.

After all that semi-BS I feel somehow feel obligated to admit that I don't have a ton of net exposure right now. This is mostly bottom-up in that I just happen to be finding more short ideas than long ideas, and maybe it says something about the distribution of valuations in the areas I gravitate towards. But when you have a big drop in net exposure there's usually some top-down angle in there, somewhere, whether you admit it or not. And there is with me but there's no there, there. Meaning it's nothing more than market looking a little more expensive than normal despite a seemingly crazy person having become the nation's tweeter in chief. You know, the usual garbage. But if I find a few things next month, I would go back to being fully invested without blinking. Because I know I don't know.
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If I had to create a one punch Rip Van Winkle 30-year portfolio right now at 5.7% real yields or 1% real yields from 30 Year USTs or 2.5% from hypothetically diversified 30 YR BBBs, I'm putting most of it in stocks. When you slide the Rip Van Winkle out of the hypothetical you're just hoping you can guess that the market will offer something that is even better than what you consider fair before the cost of sitting in cash overwhelms the option value. That's okay to do, I do it myself, but I wouldn't call it market valuation and I damn well wouldn't be even a little certain about it.


That's a pretty perfect crystalline roarkian oblique prose summary of our universal quandary.
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When you slide the Rip Van Winkle out of the hypothetical you're just hoping you can guess that the market will offer something that is even better than what you consider fair before the cost of sitting in cash overwhelms the option value.

I read somewhere that Buffett does (something like) this too. The cost of sitting in cash is inflation right? How do you think about the option value? If I were to guess, I would say that you just have a hurdle rate for positions (given risk) that will trigger you to initiate positions - and that way of thinking implicitly takes care of these issues? So is your hurdle rate different (lower) in today's environment?

BTW, here is another interesting factoid (also in response to OEBR's comment) -

http://www.sequoiafund.com/Reports/Transcript09.htm


Question:

I think maybe 10 years ago at this meeting Mr. Ruane made the comment that the cash had been an anchor on performance. Then it appeared we saw a much smaller cash position. Do you think going forward that you have a sense of where you want cash to be?

Bob Goldfarb:

I've referred to the '80s as the lost decade because our stocks performed magnificently but our overall performance matched that of the S&P because of the drag of the cash. I think we averaged something like 40 percent in cash during that decade. One of the reasons it was a lost decade is that we kept waiting for the valuations, the single digit multiples that we saw in the '70s for outstanding companies, to return, and it wasn't going to happen except under conditions of very high interest rates
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The current S&P 500 P/E is 25.73. How is anyone expecting 5.7% real return going forward?
Back of the napkin, earnings yield of 4% - inflation of 1.5% (lowballing) = real return of 2.5% + growth = 5.7%. Expecting a growth of 3.2% year over year seems pretty optimistic.
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One of the reasons it was a lost decade is that we kept waiting for the valuations, the single digit multiples that we saw in the '70s for outstanding companies, to return, and it wasn't going to happen except under conditions of very high interest rates

how does this relate to me?

I'd be fearful of 30x and 5% eps rates even if 10 year treasuries were at 1%....if it matters, i own companies at these multiples, but they have incredible balance sheets, generated absurd ROEs, and practically mint their own cash - but when you start noticing even subpar biz models trade like this and many investors don't care if cash flow is artificially inflated by RSUs you get a bit nervous. Not predicting anything, but you can treat this as irrelevant if you want if you have a long enough time horizon. I don't.

Besides, if I ran an equity fund, I'd always be 100% invested if I could find something - always.

a much more logical quote

I think if you decide that a certain amount you've invested in the stock market will always be invested in the stock market, you'll save yourself a lot of mistimed moves and general agony".
PL, One up

--
from my last longer report

For Plus accounts, performance remains in striking distance of my benchmark, but cash levels remain a serious
detraction, especially in the current 8 year bull market. In the past, I discouraged clients from providing specific
stock minimums mainly because these directions were sometimes accompanied by an impossible directive: 1) be
more invested in rising markets, and 2) less invested in falling markets, while 3) always achieving a positive return.
As you will see below, I think the market offers few wonderful prospects but I’m a realist - if you are unsatisfied
with current returns, let me exclusively focus on stock picking instead of cash levels. You can do that by giving a
specific direction, though please consider any number carefully.
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p.s.

these last few posts of mine - maybe a week - seem strident to me, and a bit overly opinionated, esp. on topics where my knowledge is less than ideal, esp. since it is easy to be opinion on topics where one's knowledge is less than idea...

here's to better truth in the following weeks...
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and man have I begun reading thru typos before posting...
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