“It is really going to end badly,” is the ominous warning that Damien Cleusix has issued to his clients as he believes we are now reaching the top of the secular bull market. Crucially, he sees US stock markets as “grossly over-valued” but that it is hidden from most people’s perceptions because (just as in 2000 and 2007) there are marginal sectors that make the ‘aggregate’ seem reasonable (not to mention the dreams of forward earnings.) His novel approach of a point-in-time Price-to-Sales comp shows the median valuation its highest in 23 years.. and Alan Greenspan’s infamous “exuberance” valuations in 1996 were 40% below current levels of elation. Today, the big difference with 2000 and 2007 is that government and central banks have already spend a lot of firing power to “make believe” that everything is fine again. He concludes, “there will be no place to hide when the tide turns.”
Via Damien Cleusix,
It is really going to end badly…
What if we are indeed only now reaching the top of the secular bull market… What if
It is no secret that we view the US stock markets as grossly over-valued. In recent meetings, as in the Spring of 2007, we have insisted that not only are markets more overvalued than what they seem, the overvaluation is also general. Ed Easterling wrote a provocative article not long ago on the subject. Those who have read his two books, “Unexpected Returns” and “Probable Outcome” know the quality of his research.
- In 2000 while TMT companies were reaching absurd valuation, small caps and quality value stocks where cheap. Remember that Berkshire Hathaway made its low the same day as the Nasdaq made its top or the same month as Julian Robertson, one of the best value stock picker of history, liquidated his fund.
- In 2007, the overvaluation was general but here again you had a sector distorting the various valuation ratios – financial companies. In the bear market that ensued, nobody who was long, even the best conservative value stock pickers, made money if they were long-only. There was carnage.
Today our contention is that markets are more overvalued than in 2007.
There will be no place to hide when the tide turns. No place. The best value managers will lose a lot of money, factors which have historically worked well will suffer a lot too (small caps will be crushed and could lose more than 60% from current levels, high dividend paying and shareholder yield stocks too as they are expensive relative to an expensive markets, quality stocks will outperform but not by much and given the concentration of hedge fund investors in some of them, they will be liquidated without mercy when blood will run in the street).
Margin factors are also the highest against the markets they have been since we have data in the early 90’s (and we doubt they were more expensive on a relative basis before).
In the graph below you can see 3 different valuation ratios where we try to remove the margin and sector overvaluation effect.
Data is based on Point in Time S&P 500 constituents since 1990. The red line is the median Price-to-Sale (P/S) ratio. The light blue line is the average of each components PS (an equal weighted P/S if you want) where the overvaluation of 2000 still stands out because of the SUN Micro of the time. The dark blue line is the average of the and and third quartile PS (we used Bloomberg for the components and the P/S data).
Remember Alan Greenspan’s irrational exuberance? It was in December 1996 and at the time it was indicating that the market were extremely expensive compared to history. Well in December 1996 the 3 ratios where 40% below current levels.
Today, the big difference with 2000 and 2007 is that government and central banks have already spent a lot of firing power to “make believe” that everything is fine again.
The current environment is structurally deflationary and real trend growth is much lower than what the Fed and most analysts are believing. For many, many years we have talked about this (demography, overindebtness, oversupply,…). It means that inflation rate will be lower and unemployment higher than what the Fed is predicting. It also means that this is structural and not cyclical. It also means that the Fed, as long as it does not realize this, is going to continue what it has been doing for a very very long-term.
We have long said that investors bias causes them to sometimes struggle to see the world as it is and instead prefer to see it as it should be. Investors are too naive. Current policies are not what they should be (productive investment, deleveraging to move away from this culture of speculation and easy money) and we need a trigger to make this change. Could it be a more hawkish Fed with new governors nominated next year and/or realizing that they have created a fantastic bubble in the equity and corporate bond markets (both linked as most of the borrowing is done to buyback shares or other companies and hence the productive capital base is not increased further lowering long-term growth potential ceteris paribus).
With regard to the short-term markets movement we can only repeat what we said recently:
“Market short-term volatility (intra-day) has increased markedly in the past few weeks. Important tops (cyclical) are made when valuations are extended (check), important divergences are forming (check), market uniformity decreasing substantially (check), exuberant optimism (check and congrat to R. Shiller…), markets overbought (check but could be more extreme on the daily time frame) and, finally, increased short-term volatility (check). You can use some pattern (serie of small range days) if you really want to be cute.
The only ingredient missing here is a sell signal from our cyclical models which have stayed stubbornly positive since 2009 with the exception of a short-lived sell signal during the 2011 route. By definition, those cyclical signals will miss the first part of the decline which make a 10-12% drawdown at the beginning of an cyclical bear market a rule rather than the exception. The above checks are all warnings that cyclical signals could turn down during the next correction (or at least in the near-term).”