Friday, September 27, 2019

Bubble Yet?

Bubblicious?
People still speak of bubbles a lot, bubble in the bond market, stock market, unicorns etc. But I still don't really see a bubble except in certain areas of technology. Otherwise, things seem to be in a normal range to me, except interest rates. They do seem a bit low, but having said that, I still see 4% as a decent 'normalized' long term rate for the U.S. (as I have said here before many times).

The Valuation Sanity Check shows the Dow trading at 20.6x current and 16.4x forward P/E,  and the Berkshire portfolio (largest holdings) trading at 17.4x and 14.3x their current and forward earnings. Browsing down that page, there is nothing really alarming about anything, really. Some things look expensive, but nothing insane.

Also, here are some charts I plucked off the internet. The first bunch is from the JP Morgan Asset Management's Guide to the Markets. This is a nice report that they put out every quarter, and is fun to flip through. 

These charts too show nothing really crazy.

I keep hearing people talk about how crazy it is that the market is up 20% this year, but given that a lot of that is recovering from losses last year, it doesn't sound crazy to me.

Also, people keep saying that the returns of the last 10 years suggests the market is overvalued. But again, given that the much of the returns is recovering from the financial crisis bear market, I think it's irrelevant. If the market had double digit returns over 10 years from a market high, then I would be more inclined to agree; something bad might be about to happen.

But this is clearly not the case here. In fact, from the October 2007 high, the market has gone up less than 6%/year (excluding dividends), and 3.4%/year since the 2000 peak. This is hardly the long term performance figures you see in a real bubble.

I won't look for them, but look at the similar figures for the 2000 peak, Nikkei 1989 peak etc. It is very different from today.




S&P 500 Index Forward P/E Ratio

The above forward P/E chart shows a normal range, nothing alarming. Of course, people will argue that the market has been consistently overvalued for the past 25 years so this is not indicative of anything. But interest rates are a lot lower now than in the past too, and this chart doesn't show any abnormally high P/E level due to lower rates. I suppose one can argue about the validity of EPS estimates a year out. That is certainly a valid point.

Forward P/E and Future Returns

This X-Y plot of forward P/E ratio versus future returns show potential returns solidly in the positive. I did something similar using Shiller's CAPE ratio and found similar results.

One year forward returns based on P/E

My analysis goes back to 1985, so is longer term than the JPM study (which goes back to 1994), but hasn't been updated (a couple of years shouldn't make a difference!).


MSCI World vs. S&P 500 Index



These charts show nothing extraordinary either. Yes, the U.S. market is doing really well versus the rest of the world. But who cares, right? Unless you are some sort of mean-reversion trader, it's not really relevant. I too tend to like investing in U.S. businesses, mostly because I live here and have access to all the filings, conference calls and things like that, and I do feel U.S. companies are more responsive to shareholders and the system works better (compared to Japan, for example, where I have very little faith that managements care about shareholders).

Median P/E Ratio
And here's something I found. The S&P 500 is market-cap weighted, so the index P/E ratio tends to be influenced by the large cap stocks. When you have a bunch of large caps that are overvalued, it tends to push up the P/E ratio of the whole index.

To get a more 'typical' P/E ratio of the random stock, a median P/E can be more useful, as half the companies would be more expensive, and half would be cheaper than this level.

I found this chart in Yardeni's September report: Yardeni P/E report

Here's the median forward P/E ratio:


Again, nothing spectacular here. Looking at this (and the other charts), if someone is net short the market, you would have to examine their brains. Why would anyone be net short in a market like this? It doesn't really make sense to me.

Just flip through these charts again, and imagine you are the head of the trading desk at a hedge fund or bank somewhere. And say some guy is massively net short the market. You ask him why he is so short, and he tells you that it's because the market is way overvalued. What would you say? Would you feel comfortable going home and sleeping well? Of course, this trader may contribute to reducing the overall exposure of your desk, but don't think of it that way as you can always adjust your market exposure with futures.

If you think of it this way, it's sort of insane.

The other non-bubble thing is that you don't hear people talking about the market at all. Usually, in a real bubble, people really like to talk about the stock market in situations where that is not normal. A couple of years ago, everyone was talking about bitcoin. I don't hear much about that anymore these days.

Also, the news flow is so negative these days, whether it be Brexit, Trump tweet, U.S./China trade, Iran... Wherever you look, it's just bad, scary news. And yes, the market responds by going down, but it comes right back up. This is not to say that the market will always come back up. We will have a bear market at some point.

But if you are net short and all these 'favorable' developments to your position is not making you money, that's kind of a serious problem.  What happens when any of these things resolves itself? What if we do get a blowoff that has happened in most other bubble tops (2007 top was not really a bubble in terms of valuations, so bear markets can happen from normal valuations too).

Value-Growth Gap
The other thing is the huge gap between growth and value stocks. I am not that big a fan of this as the division seems arbitrary and kind of meaningless. But what is encouraging is that despite this slightly higher valuation of the overall market, the gap between value and growth seems to suggest that one can avoid a lot of pain by being more in the value area than growth.

Back in 2000 when the market was actually really overvalued, value investors did fine despite a 50% drop in the S&P 500 index as the drop was driven mostly by expensive companies going down in valuation. I think value stocks actually went up back then.

This may be true this time around too.

Market Timing
Most of us value investors don't believe in market timing at all. It is so amusing to watch the market go down 200 pts (or more) on a tweet only to reverse itself within a day or two by another tweet. Why anyone would trade based on this stuff is beyond me. I am a believer that headlines almost never mark turning points in the market. If the market is making a new high and then plunges on some negative headline, you can bet that that high will not be a high of any significance. I have seen various attempts over the years to analyze peaks and troughs in the market and matching it with news headlines; there usually is no headline that marked the top or bottom of a market.

It's just silly to try to figure out when the next bear market will happen.

There is one thing, though, that I would watch out for. If the U.S. market goes into a situation like the Japanese stock market in 1989, then I would obviously react. I would definitely lighten up equity holdings (still on a case-by-case basis based on valuations, of course) and maybe even consider buying puts, going short or whatever (OK, maybe not as I watched many bears lose a lot of money in 1998-2000 period only for them to be proven right but already having lost too much money made no money on the decline).

In any case, it would be a valuation call; I would lighten up when I can't accept the valuation levels. And it would be by each individual holding, not some vague notion about the directions of the overall market or economy.

Japanification of Markets?
The other worry is the Japanification of global markets. We were all baffled by the low interest rates in Japan for decades, and here we are with multiple countries and trillions of dollars in debt trading with negative interest rates.

Many commentators thought it won't happen here, and yet here we are with long term rates under 2%.

What about the stock market? Can the U.S. go into a bear market like Japan's that lasts 30 years? This sort of thing worries me too a little. We can't say it won't ever happen here as we were wrong about interest rates. Well, I've actually been in the camp of "lower for longer" so am not really all that surprised by how low our interest rates are.

But it would not be fun if the market went into a 30-year bear market.

Here's why I don't think it would happen, at least any time soon:
  • The Japanese market went up to 60-80x P/E at the time. That sort of valuation takes decades to grow out of, and it's that much harder when there is no growth! We are nowhere near that kind of valuation
  • The Japanese government and companies spent most of the time since then hiding things rather than fixing them. When the U.S. had a credit crisis, banks were encouraged to raise capital and fix their problems, not hide them. 
  • Regulations are meant to maintain the status quo, protect large companies (who are contributors to the LDP) etc.
  • In Japan, companies are discouraged from right-sizing. They run under a system the Canon CEO, Fujio Mitarai, calls corporate socialism. He says that since the Japanese government doesn't offer much of a social safety net, that burden falls to large corporations; they are strongly discouraged from firing employees. This is why there is a word for this category of employee: madogiwazoku (google it!). Here's an article about it: Boredom Room. It's no surprise that the stock market has been dead for so long with so many zombie employees at zombie companies. This is very different than in the U.S.

There are many other problems, but those are just some big ones off the top of my head... You may think of better reasons why Japan has been stuck for so long.

None of these are true in the U.S. That doesn't mean we can't go into a 30-year bear market, of course. But it just seems to me that it is not likely at the moment.

Hard Left Turn in Politics?
Others worry about the progressive left; Leon Cooperman joked the other day that if Elizabeth Warren gets elected, the market won't open. I understand that fear, and as a big fan of JP Morgan, I totally get it.

I am actually pretty progressive myself (I used to be conservative but have been moving left over time), but I wouldn't worry about this at all.

First of all, we really have no idea what's going to happen. We don't even know who is going to be the democratic candidate; it's possible that someone else not even running now will come up out of nowhere (well, not sure if that's possible, actually, but we still have a long time to go).

We do know that Warren is as progressive as she presents herself, so this may not apply, but it's possible that she runs hard left to take Sanders' and other voters only to run back towards the middle if she wins the nomination.

We don't know what she can accomplish even if elected, right? This is a president, not a dictator. Did FDR or Kennedy destroy the country? I haven't looked at the market action around their elections, but I don't really think there is a big, visible dent or bend in the long term charts based on who was president.

So this is certainly a risk factor, but my guess is that things, as usual, will not turn out the way we expect even if Warren wins the election. It's a complex model and things aren't going to be so easy to predict.


Thursday, April 4, 2019

JPM 2018 Annual Report, Website etc.

JPM's annual report is out, and maybe a good time for another post here. I know it's been a few months. Honestly, I have been coasting recently on what's been working and haven't been digging around too much in the stock market. Most of my time recently has been spent on programming, having taken on a few freelance gigs for fun (and beer money).

Website
Anyway, I have updated my website. A lot of things there were broken, but everything broken there was just due to the Google and Yahoo Finance APIs being shut down completely. This is really annoying. There are a lot of books out there on AI, data science, quantitative finance and all that, and a lot of them depend on those APIs, so it's like those books are worthless now. Well, not really... you just have to find an alternative source of data. But who wants to deal with that hassle?

Anyway, the website is here: brklninvestor.com

The Market Today
One of my favorite pages there is this one: Valuation Sanity Check

People are still talking about how overvalued the stock market is and how it has to go down, and how valuations do matter and that perma-bulls are saying valuations don't matter.

Well, I have been telling people to ignore those people for the past few years, and I, for one, would not say that valuations don't matter. Valuations do matter. The higher the valuation, the lower the future returns. Duh. This is not rocket science. This is no different than bonds. The higher the bond price, the lower the yield, the lower the future return.

Where I disagree with the bears is their conclusion: that if the market is overvalued, then the market must go down. (I am not arguing that markets won't ever go down; they will with 100% certainty. But I doubt anyone can tell us with any consistent accuracy when it will!)

I also quantified this and put the data on the website.

Future returns in an overvalued market

I didn't update it, but since the market has been up, the conclusion would be the same or better. Plus, the analysis uses decades of data, so a couple of years is not going to make a difference.

As for all the worries and concerns, Buffett's 2018 letter has a great section called "American Tailwind", and it basically says that the market has done well over the past 77 years and there were always things to worry about, but the market did pretty well. Maybe more on that in another post.

Anyway, the home page shows the trailing P/E ratio of the S&P 500 index at 21x, and forward P/E of 17x.  This may seem high to some of us who started in the stock market business when interest rates were around 8%. They are now much lower than that. I've said in posts that with a "normalized" interest rate of 4% over the next decade, I would not be surprised if the market P/E averaged 25x P/E.   So a 21x P/E is not at all alarming or shocking to me, and the 17x forward P/E actually looks pretty attractive, even assuming that forward estimates tend to be over-estimated.

Also, looking at the Valuation Sanity Check page, the Dow 30 stocks seem to be trading at 17.5x 2019 estimates and 15.4x 2020 estimates.  The Berkshire stocks (just the stocks listed in the annual report) are trading at 15.4x and 13.4x 2019 and 2020 estimates.

Again, there are issues of the validity of 'estimates', but even still, these figures are nowhere near bubble levels.

My thoughts about the market hasn't changed at all in the past year. Yes, it was a little scary in the fourth quarter of last year, but I was not that particularly worried as none of my work (as shown in previous blog posts) has shown any rubber band stretched to it's limit that must snap back.

OK, anyway, maybe more on that another time. Going on to my next pet peeve...

Data
Google and Yahoo have no obligation to continue their finance data APIs, of course. But what is really annoying is how expensive simple financial data is. It has always been so, and Google/Yahoo made it affordable (or, well, free) for the little guys without big corporate budgets. But that is gone now.

As the world continues to move towards open source and open data (look at this great source of free data related to NYC: NYC Open Data), the financial industry continues to be closed and expensive.

There was an article in the FT today about people (even rich corporate users) complaining about stock exchanges gouging them on price for access to basic data.

As I see it, stock exchanges are basically public utilities. I don't think they should be profit-making entities so long as they are given a legal monopoly (or oligopoly or whatever).

It's just makes no sense that we stock market traders/investors must go through the exchanges to trade and the exchanges then accumulate and use that data and sell them for profit. It just makes no sense at all. This stuff should be public information and easily available to the public in various forms. It doesn't cost that much money to provide an API where people can access this information. We can see they are already making tons of money on exchange fees etc.

So this is just nuts.

OK, so it's not a huge issue for me as stock prices / data is not a big part of what I do. As you know, I am more about listening to conference calls and reading 10-K's and stuff. The only time I use financial data was when I was putting stuff up on the website for fun; I don't need that stuff to invest (and that's why I haven't paid for any data service, and don't really plan to).

The idea of open-source is that if you make the information free and widely accessible, more people can play with it and more ideas can come out of it.

OK, enough of that...

JPM 2018 Letter
No offense to Mr. Buffett, but I sort of look forward to Dimon's letter more than Buffett's these days. Buffett still writes great letters and I read them as soon as they come out. But I feel like I am very familiar with what he has to say and there are usually no surprises, and I am not sure I really learn anything from reading them lately.

But Dimon's letters are much more granular and deal with a lot of specific, current issues etc.

Anyway, I don't plan on going into detail here as you can just go read it yourself (and I know many of you won't, but I don't care... it's your loss if you don't!).

Here are my usual favorite charts.







Dimon Tenure Performance
These tables are really great; they show how Dimon has done as a CEO.

For reference, BRK BPS grew +9.5%/year from 1999-2018 and +10.0%/year from 2004-2018. So you can see that JPM has done better than BRK in both time periods, which is kind of shocking when you think about the fact that one period includes the popping of the internet bubble in 1999/2000, and both time periods include the financial crisis.  (BRK time periods are based on year-ends, so don't match up exactly, but whatever...)



Below is the same look but based on the stock price instead of TBPS. BRK's stock price appreciated around +9.3%/year in both time periods (1999-2018, 2004-2018).  This is kind of insane.


Social / Political Issues
I will not repeat them here, but Dimon goes on in great detail about how we can make things better here in the U.S. It's too bad that our system does not allow for people like Dimon to become president. He would make an incredible one.

Anyway, he does caution us away from the creeping socialism and rising progressives from the far left. I am actually very sympathetic to this recent movement even though I am a hard-core capitalist. But I can see how it can be dangerous for us to veer too hard to the left and destroy things that have worked for us.

But the fact is that what has worked for "us" hasn't really been working for a very large number of people.


Conclusion
It's been a while, but I haven't really changed my mind on anything at all. Nothing new to report, really. The market looks fine. No bubble at all as far as I'm concerned. Maybe not cheap, but not really that expensive either.

The way stock exchanges use data as profit centers is deeply disturbing and is not consistent with what I think of as their mandate as virtual public utilities. The whole system of exchanges charging money for data, and a whole industry of data vendors runs contrary to the worldwide trend everywhere else of open-source and open-data. 

OK, way back in the old days when you needed expensive mainframes to manage this stuff, it may have been understandable. But with technology where it is today, this whole data industry setup and cost makes no sense at all. The industry must be laughing their way to the bank as costs keep going down and the prices they charge keep going up.

JPM continues to do well and it looks like in may ways they are disrupting themselves, which is really great. It assures (or increases the odds) of their continued success.

They have come a long way since I opened my first bank account at Chase many years ago.

I probably told this story here before, but I'll tell it again. When I had my first job in the city, I needed to open a bank account somewhere so my employer can deposit my paycheck.

I figured all big banks are the same, so I went to the World Trade Center (near where I worked and lived) and walked into Citibank. There was a reception desk at the front and I said I wanted to open a bank account.

A big-haired girl, loudly chewing gum and filing her nails barked at me, "I'm on break. Come back later...".  She was sitting at the reception desk/booth. I was shocked at how rude she was, so I just walked across the hall to Chase and said the same thing, and someone immediately came and helped me out. Chase was not that much better; it was pure chance that the Citi employee was on break and Chase's wasn't.

This is the only reason why I started at Chase. Unbelievable. But that's how big banks were back in the 90's. Just terrible. Like the post office.

Anyway, JPM is no longer no-brainer cheap like it was when this blog first started (2011), but it still seems pretty cheap.