First, what are we doing in Sao Paolo?
We’re checking in with colleagues who are Brazilian stock market analysts.
And we’re visiting a candidate for Miss Brazil, who just happens to be a friend’s cousin.
We’ll let you know more as things develop…
Meanwhile, US stocks were flat yesterday. Gold rose $5 an ounce. Nothing significant in that news.
For what it’s worth, we think the stock market is poised for action.
It could shoot up much higher, as dreams of “QE Forever” take hold of investors’ imaginations. Or it could drop like a stone when they realize QE doesn’t really help the economy that their stocks depend on.
Higher or lower. How’s that for a forecast? We thought you’d appreciate it.
What we don’t expect is stagnation and status quo. There’s too much tension in this bow. Either it sends the arrow skyrocketing… or the bow cracks.
Are We in a Bubble?
As the SEC might say, nothing in this should be interpreted as a recommendation to buy or sell stocks.
If you own US stocks, you’ve got a lot more confidence in the ability of the feds to control things than we do. If you don’t own them, you’re best advised to stay away.
As I’ve been discussing with members of our small family wealth investment advisory service, Bonner & Partners Family Office, we see far more long-term opportunity in higher-growth overseas markets where stocks are currently “on sale.”
We say that not because we know anything about the future, but we know something about the past. Based on history, stocks at today’s valuations cannot be trusted to deliver decent rates of return. You want to buy low, and sell high. Not buy high and try to sell higher. That’s not how the game works (at least not over the long run).
Here’s our friend Merryn Somerset Webb, editor of British financial magazine MoneyWeek:
Here’s a quiz for you. The Nasdaq has just passed its pre-crisis high. It trades on an average price/earnings (P/E) ratio of around 25 times – with a tiny dividend yield of under 1.5%.
The S&P 500 index has risen nearly 27% so far this year. Into this market, 192 companies have recently issued new shares, raising a total of $51.8 billion – a number not far off that raised back in the 2000 dotcom bubble. Based on last year’s profits, the P/E ratio has risen from 16.4 times to 19.1 times over the same period. This is not about companies being worth more. It is about people paying more.
The index, as Christopher Wood of CLSA points out, is also trading on a cyclically adjusted P/E ratio or Cape – a measure which is based on the average of the last ten years’ earnings – of 25 times. The long-term average is more like 16 times.
It’s been higher, much higher – think 44 times in 2000 and 33 times in 1929. But it is, says Wood, “just exceeding the highs reached in 1901 and 1966.” Nasty market falls – 20-year bear markets in fact – followed both of those peaks.
So here’s my question: would you call this market: (a) a bubble, b) pretty expensive, but not yet a bubble, (c) different to any market that has gone before it in myriad complicated ways, or (d) a stock picker’s market?
If you are a normal person, you will have gone for (a) or (b). If you are a fund manager, an analyst working for a stock-broking firm or someone who is hoping to be one of those things at some point in the future, you will have gone for (c) or (d).
How do you justify a market that is clearly overpriced, on any conventional or historical measure? You announce that thanks to some change or another – demographics, accounting rules, technology, one-off crises, shale gas, the fact your kids’ school just put the fees up by 9%, whatever – it should be henceforth valued in a new way.
It Should Be Breathtaking…
So, there you have it. Stocks will either go higher or lower. Probably a lot, in whichever direction they take. They could go much higher, because the Fed is a buyer…bringing $1 trillion of new money into the market each year. This could make investors very excited.
On the other hand, investors could suddenly realize there is something inherently dangerous about a market that is supported only by the authorities. The smartest investors might slip away from the theater… and then call the fire department.
Either way, it should be breathtaking. And yes, dear reader, we know it’s not much fun sitting around waiting for the show to start. And it will be even less fun if the market suddenly “melts up,” as some analysts expect.
But unless you are a speculator with an asbestos portfolio, it is better to suffer boredom and envy… than suffer the heat of a severe bear market.
The Primacy of Value
From the desk of Chris Hunter, Editor-in-Chief, Bonner & Partners
One of our core principles at Bonner & Partners is the primacy of value.
Rich profits come from buying when others are fearful (which pushes prices down versus values), not when they are greedy (which has the opposite effect).
You can make the game of investing more complicated than that. But if you only followed that one simple rule, you would have every chance of a long and profitable investment career.
As you can see from the chart below from Mebane Faber, the record is pretty clear on this. It shows the future median total returns for the S&P 500 based on starting Shiller P/E or Cape (which uses the average inflation-adjusted earnings over the previous 10 years to smooth out “noise” in earnings trends).
Over one year, it’s anyone’s guess what effect valuations will have on returns. But buying when the Shiller P/E is between 1 and 10 has produced by far the highest future returns over 3-, 5- and 10-year time horizons. By contrast, buying when Shiller P/Es are over 25 – where they are now – has produced negative returns over the next 3, 5 and 10 years.
Of course, “this time is different”… and valuations don’t matter because the Fed has forever got investors’ backs.
Don’t believe it…