Mish's Global Economic Trend Analysis

Valuations: Maybe I am Crazy
Sad News For Greece? Will Greece Kiss Troika's Ass?
6th Straight Negative New Orders Reading for Dallas Fed Manufacturing Survey

Posted: 27 Apr 2015 11:57 PM PDT

Relative vs. Absolute Value

As I watch valuations on stocks soar higher and higher into the stratosphere, I keep asking "where is the value?"

The problem for most is confusing "relative" value vs. absolute value. Stocks may be "cheap vs. bonds" but what does that matter if bonds are ridiculously overpriced?

Fair Value Has Three Digits

John Hussman has an interesting post this week entitled Fair Value on the S&P 500 Has Three Digits.

The last time I quoted Hussman, a manager for a prominent investment firm emailed something on the lines of "Mish, please do yourself a favor and stop referring to Hussman".

Actually, that was likely be good advice. The problem I have with the advice is simple: I happen to agree with Hussman.

Right, wrong, or in between, I say what I believe. I do not say things I disagree with to get blog traffic up, investments up, or page hits up. I say what I believe, and I suspect it has cost me traffic because I upset Republicans and Democrats, equity bulls and bears, and US treasury bulls and bears.

Life would be so much simpler for me if I was obnoxiously one sided, if I never offended anyone ever, or if I purposely offended everyone all the time.

It's tough annoying half the people half the time, yet here we go again.

Value Investing: Is it Possible? What Does it Mean?

Please consider a few snips from Hussman. Emphasis in bold by Hussman.

Last week, the Nasdaq Composite finally clawed its way to breakeven, 15 years after its spectacular bubble peak in 2000. It's a testament to the overvaluation of technology stocks in 2000 that it has required the third equity bubble in 15 years to reclaim that 2000 high, at least briefly.

Where is "fair value" today? We have to be careful here because the concept of "fair" depends on your assumptions about what a reasonable investment return should be. If I show you a security that's expected to pay out $100 ten years from today, and I tell you that the current price is $82, you can quickly calculate that the expected return on that security is 2% annually – and you don't need to know anything about interest rates to do that arithmetic. Interest rates come in after you do that arithmetic. Interest rates then matter only because they give you something to compare with that 2%. Now, if you decide that a 2% annual return over the coming decade is just fine with you, in view of competing alternatives, then it's fine to call that security "fairly valued." But even if you decide that the security is fairly valued, you should still expect a 2% annual return over the coming decade. If you viewed a 10-year return of 8% as reasonable, you'd peg "fair value" at $46.32.

On the basis of valuation measures best correlated with actual subsequent market returns, we can say with a strong degree of confidence that the S&P 500 would presently have to drop to the 940 level in order for investors to expect a historically normal 10-year total return of 10% annually. That 940 figure for the S&P 500 would not represent some extreme, catastrophic outcome. It's not a level that would even represent undervaluation from a historical perspective. It's the level that we would associate with average, historically run-of-the-mill long-term equity returns. As we observed at the 2000 peak, "if you understand values and market history, you know we're not joking."

Last month, Stan Druckenmiller recounted his own experience with capitulation and performance chasing when he was the lead portfolio manager for George Soros and the Quantum Fund:

"I'll never forget it. January of 2000 I go into Soros' office and I say I'm selling all the tech stocks, selling everything. This is crazy... Just kind of as I explained earlier, we're going to step aside, wait for the next fat pitch. I didn't fire the two gun slingers. They didn't have enough money to really hurt the fund, but they started making 3 percent a day, and I'm out. It's driving me nuts. I mean, their little account is like up 50% on the year. I think Quantum was up seven. It's just sitting there.

"So like around March I could feel it coming. I just – I had to play. I couldn't help myself. And three times during the same week I pick up a – don't do it. Don't do it. Anyway, I pick up the phone finally. I think I missed the top by an hour. I bought $6 billion worth of tech stocks, and in six weeks I had left Soros and I had lost $3 billion in that one play. You ask me what I learned. I didn't learn anything. I already knew I wasn't supposed to do that. I was just an emotional basket case and couldn't help myself. So maybe I learned not to do it again, but I already knew that."

Not Predictions

Please note that 940 is not a prediction by Hussman or by me. It is a value judgment. The S&P "fair value" number would be higher at an 8% discount and even higher at a 6% discount.

And regardless of the discount rate, stocks can overshoot or undershoot. Stocks can also go sideways for 8-10 years doing much of nothing. Japan is proof enough.

Please don't tell me "It cannot happen here". It can.

Pension plans would be destroyed if stocks go nowhere for 8 years. Moreover, I suspect the Fed would be relatively pleased at such a benign outcome (assuming that was the only adverse outcome).

Where is Value?

Value is always in the eyes of the beholder. People saw valued in dotcom companies in 2000, in housing in 2006, in gold in 1980, in Japan in 1990.

Today people see value in negative yield government bonds, in junk bonds that pay interest in debt, and in equities that have a smoothed valuation as high or higher than 1929, 2000, and 2007.

Maybe I am Crazy

I see value in in gold and gold miners, in yen-hedged Japanese equities, and in Russian equities at a PE of 6 (see Readers ask "How Does One Invest in Russia?")

But hey, maybe I am crazy. Maybe we see government bonds trading at -5.0% yield and smoothed PEs at 35, topping valuations of 2000 and 1929.

Things are nearly always cheap "relative" to something else. There's a chance the "something else" of the future refers to peak valuations, not now, but rather in 2016.

Feelin' lucky?

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

Sad News For Greece? Will Greece Kiss Troika's Ass?

Posted: 27 Apr 2015 06:55 PM PDT

I am convinced the best thing for Greece is to tell the troika where to go. And recent events (at least until today) suggested Greece would do just that.

On the other hand, extreme sentiment is usually wrong. It may not be, it just usually is. So please consider the British betting site, William Hill.

Sentiment is so lopsided that the British betting site William Hill No Longer Accepts Bets On Greece.

"No player seems interested in betting that Greece remains in the euro zone until the end of the year."

Greek Capitulation?

Wow. Zero bets is mathematically as lopsided as it gets.

Meanwhile, please consider Tsipras Reshuffles Negotiating Team to Sideline Varoufakis.

Greece's outspoken finance minister Yanis Varoufakis has been sidelined after three months of fruitless talks with international creditors to unlock €7.2bn in bailout funds, heartening investors and sparking a rally on the Athens stock market.

Eurozone officials said they were encouraged by the move by Alexis Tsipras, Greece's prime minister, to overhaul his bailout negotiating team in the wake of an acrimonious meeting of eurozone finance ministers in Riga last week.

The shake-up comes as Athens faces questions over whether it can meet this month's wage and pension bill of nearly €2bn as well as a €750m loan repayment due to the International Monetary Fund on May 12.

The Athens stock market rose nearly 4.4 per cent on the news and borrowing costs on Greece's July 2017 bonds were down almost 4 percentage points from Friday's close to 21 per cent. Yields on Greece's benchmark 10-year bonds were down a full percentage point at 11.4 per cent.

The socialist opposition Pasok party said the government was "emasculating Mr Varoufakis . . . and attempting to send a message to the Europeans and the IMF indicating political will for an agreement".

While Mr Varoufakis retained his position as finance minister, Euclid Tsakalotos, deputy foreign minister for economic affairs, was appointed coordinator of the new team. The Oxford-educated economist is close to Mr Tsipras and his appointment was seen as an attempt to shield the new team from Mr Varoufakis.

A government official insisted the finance minister would remain involved, heading a new "political negotiating team" and would remain "in the frame of collective decision-making and execution" by the leftwing Syriza-led government.

Negotiation Shuffle

Betting sites and reality are not exactly the same thing.

Yet, given the "negotiation shuffle" the odds Greece is willing to kiss the Troika's ass just moved up quite a bit, even without German Chancellor Angela Merkel injecting herself into the picture.

This is not a good development for Greece in my opinion.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

6th Straight Negative New Orders Reading for Dallas Fed Manufacturing Survey

Posted: 27 Apr 2015 10:50 AM PDT

New orders in the Dallas Fed manufacturing survey came in negative for the sixth straight month today.

Weakness was expected due to collapse in oil prices, but the business activity range number was lower than any Bloomberg Consensus estimate.

Bloomberg Consensus

Texas Manufacturing Weakens Again

The Dallas Fed reports Texas Manufacturing Activity Weakens Again

Texas factory activity declined in April, according to business executives responding to the Texas Manufacturing Outlook Survey. The production index, a key measure of state manufacturing conditions, posted a second negative reading in a row, coming in at -4.7.

Other measures of current manufacturing activity also reflected continued contraction in April. The new orders index edged up but remained negative at -14. The growth rate of orders index held steady at -15.5, posting its sixth consecutive negative reading. The capacity utilization index pushed further negative to -10.4, its lowest level since August 2009, and the shipments index edged up but stayed below zero at -5.6.

Perceptions of broader business conditions remained quite pessimistic for a fourth month in a row. The general business activity index stayed negative but ticked up to -16 in April, while the company outlook index moved down to -7.8, reaching its lowest reading in nearly two and a half years.

Dallas Fed Results

click on chart for sharper image

Weakness remains nearly everywhere one looks. The one bright spot had been the monthly jobs report, at least until last month. That "weather" report comes out Friday.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

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Mish's Global Economic Trend Analysis

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