I've been doing a lot of research with my friend JT Smith (CIO of Aristar Funding), trying to figure out exactly what was driving this market.
The 'this market is cheap' argument hasn't made any sense to me for some time. Cheap does NOT refer to stock prices relative to where they've been, contrary to what is implied by a lot of folks. Historically, bear markets have bottomed at roughly 7-8x earnings. We only got to 10.2x forward earnings at the bottom in March - not low enough for my liking. Now we're trading at... sit down... 17.8x FORWARD earnings. Put another way, the S&P is more expensive than it has been in the past FIVE YEARS or more.
I might be 'of a certain age,' but my memory isn't so weak that I can't remember that the economy at least appeared to be much more robust at almost any time in 2004, 2005 or 2006 than it does now. And yet we're paying significantly more for a dollar of next year's S&P earnings now? Makes no sense. Unless...
What if this market isn't discounting future earnings right now? It's my belief that a lot of times the animal spirits of the market discount things without really knowing what it is they're discounting. So, what if... just what if... this market is actually discounting the inflation that almost certain to come? Gold over $1000 an ounce is telling us that either everyone is scared to death of this market (not confirmed by the VIX), or that inflation might be rearing it's ugly head. And yesterday's rumors that two Fed officials were ready to vote to tighten! Even today's Philly Fed numbers pointed out that the Prices Paid component is ticking up. Inflation.
Yeah, I know we've been seeing deflation in food and consumables. But that can turn quickly. And more importantly... how else are we going to dig ourselves out of this debt pit unless we pay it off with cheaper dollars?
If we're heading into inflation, folks, the game plan changes.
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4 comments:
Perhaps I'll pass on your blog to my two boys - 14 & 17. They came home from school excited to open up ETrade accounts. The senior is in economics and it's his favorite class. They're are playing a stock market game with pretend money and he's dying to play with real money. Hmmm.....I'm not so dying for him to.
So, if inflation changes the game, does that mean you're more OK (not totally, but more than you were before inflation) with prices where they are now?
Hi Bradley -
Rather than saying I'm okay with prices, I would say that it is a better explanation for the valuations that we're at. It also means that we need to consider shortening up our bond duration (we've been in intermediate bonds and it's worked really nicely for us this year, but in an inflationary environment... not a good idea). Our commodity exposure still should work nicely. And it's possible, just possible, that there might be a reason to participate in equities. But I'm not convinced.
I do appreciate your comments regarding prices, although I have to say...the thought of you sounding less Bearish means I probably need to go sell some stock. :-) It's a hard tape these days, feels like nosebleed territory, but fighting the tape has gotten people run over, so it looks like mostly long with the rest neutral and little to no shorts looks like it's still the way to play this tape.
Thanks for your response.
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