tag:blogger.com,1999:blog-5389144729834496735.post1934122701842616632..comments2024-03-17T05:15:55.634-04:00Comments on The Brooklyn Investor: Market Valuation (Scatter Plot)Unknownnoreply@blogger.comBlogger24125tag:blogger.com,1999:blog-5389144729834496735.post-6994623248376875762022-09-23T09:22:09.427-04:002022-09-23T09:22:09.427-04:00Thank you so much for your excellent blog! I reall...Thank you so much for your excellent blog! I really enjoy to visit your very interesting post, Well done!<br /><a href="https://srislawyer.com/chapter-7-bankruptcy-lawyer-near-me/" rel="nofollow">Bankruptcy Lawyers Near Me</a><br /><a href="https://srislawyer.com/legal-separation-virginia-separation-agreement-divorce/" rel="nofollow">Divorce Without Separation Agreement</a>Sruthi Karanhttps://www.blogger.com/profile/17059406463629405366noreply@blogger.comtag:blogger.com,1999:blog-5389144729834496735.post-40401864909657088702015-06-03T15:41:29.346-04:002015-06-03T15:41:29.346-04:00Hmm.... further reading on this topic? I can't...Hmm.... further reading on this topic? I can't think of anything off the top of my head. It's just a simple comparision of interest rates versus earnings yields. <br /><br />As for the source of the raw data, it all comes from Shiller's website so you can google Shiller P/E or something like that. kkhttps://www.blogger.com/profile/06299974418283948333noreply@blogger.comtag:blogger.com,1999:blog-5389144729834496735.post-79243201757199559322015-06-03T13:52:11.441-04:002015-06-03T13:52:11.441-04:00I really enjoyed this blog post. It's nice to...I really enjoyed this blog post. It's nice to have someone relate stock market's valuation to our current interest rate environment in a clear, thoughtful way. <br /><br />I was wondering if you could give your thoughts on additional reading (books, articles, etc.) on this topic that you could recommend or point to? Also, if I wanted to reproduce this analysis could you include a footnote with links to your data sources?<br /><br />Thanks again! Larry D.noreply@blogger.comtag:blogger.com,1999:blog-5389144729834496735.post-13545974835647861012015-05-21T21:35:54.750-04:002015-05-21T21:35:54.750-04:00Forget for a moment that a P/E ratio is about stoc...Forget for a moment that a P/E ratio is about stocks. Let's just say that you have a choice between owning a bond that promises to pay you 5%/year for the next 10 years (or whatever). And then you also have a business that you can buy that earns $50,000 per year. The opportunities would be equal if you could buy the business for $1,000,000. In each case, you would get $50,000/year if you invested $1,000,000. <br /><br />So that's why they are related. <br /><br />The reality is not so simple. Earnings often doens't equal free cash, for example. But in aggregate, earnings tend to be a good proxy for it, and over time as in the charts above, earnings yield and bond yields have been related closely.<br /><br />I can't really help you any more than that... <br /><br />Oh, and if you are stuck on dividends versus earnings, theoretically, it doesn't matter too much. If management reinvests what's not paid out in dividends, then the shareholder is sort of still earned the EPS; it's just that part of it was paid out as dividends and the rest of it was reinvested. In either case, the earnings still belong to shareholders. <br /><br />Of course, if management makes bad investments, then that may not be true. But again, over time, if you look at the aggregates, I do think that reinvested earnings do increase value to shareholders (even though the returns on investment may or may not be good). <br /><br />Anyway, I would suggest reading the Benjamin Graham books (Intelligent Investor, Securities Analysis) if you still don't understand... <br />kkhttps://www.blogger.com/profile/06299974418283948333noreply@blogger.comtag:blogger.com,1999:blog-5389144729834496735.post-13472553601933087842015-05-21T18:46:46.032-04:002015-05-21T18:46:46.032-04:00I read that and still don't get it. Kinda fee...I read that and still don't get it. Kinda feel dumb now, but thought I would still ask. How is PE related to interest rate? Is there a link between them. I get that the earnings "yield" is the inverse of PE. I just don't understand how the earnings yield means anything. I mean, you don't get money from the stock unless it has a dividend yield and that is different from the earnings yield.tuliptownhttps://www.blogger.com/profile/16565056838125230478noreply@blogger.comtag:blogger.com,1999:blog-5389144729834496735.post-49256252269783743362015-05-20T18:09:58.551-04:002015-05-20T18:09:58.551-04:00The statement that stocks are not overvalued by hi...The statement that stocks are not overvalued by historical standards hinges on the fact that historically high operating margins will be sustainable. History has clearly shown us that these margins tend to be mean-reverting, hence the normalized EY - interest rate spread is lower than the actual spread (besides there is also a high probability that interest rates are below its normalized levels). Since stocks are forward looking, it wouldn't suprise me if the stock market would already dip sooner or later, in anticipation of lower margins.Willem de Vochthttps://www.blogger.com/profile/05215649362836325522noreply@blogger.comtag:blogger.com,1999:blog-5389144729834496735.post-53969310608116723642015-05-18T13:58:30.612-04:002015-05-18T13:58:30.612-04:00Good point. I've seen many variations of this...Good point. I've seen many variations of this over the years but the total picture looks more or less the same. You can use longer term bonds but it won't make much difference, I don't think. Same with credit spreads; over time they average out to some constant percentage over treasuries etc. It might make a better fit, though, in some time periods when the market/economy was weak (and credit spreads blow out) I suppose. But we aren't looking for an accurate model or anything; just wanted to see what would happen if treasury rates went up. <br />kkhttps://www.blogger.com/profile/06299974418283948333noreply@blogger.comtag:blogger.com,1999:blog-5389144729834496735.post-68130146471070972842015-05-18T12:18:40.084-04:002015-05-18T12:18:40.084-04:00Stocks are long duration assets - so I think at th...Stocks are long duration assets - so I think at the very least - you need to add some term structure premium (use a 50yr bond or a 100 yr bond!) when doing the Fed model type analysis.<br />Secondly, rather than using risk free rates, use BBB at the very least - since stocks are lower down the capital structure and hence need to "yield" higher.<br />Of course, what offsets this is the assumed growth rate (which stocks enjoy, and bonds don't).<br /><br />Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-5389144729834496735.post-38449343945062130052015-05-18T09:47:48.717-04:002015-05-18T09:47:48.717-04:00OK, so I read the whole paper. He makes some good...OK, so I read the whole paper. He makes some good points, like the DDM; if you lower interest rates, then you have to lower growth rates too as some of the growth comes from inflation. If rates are lower (and inflation expectations are lower), then prospective growth rate should be lowered too (to reflect lower inflation). So things like that make sense and he is right. However, others would argue that growth rates are based on ROE x earnings retention, and ROE has been in a constant range for a long time regardless of inflation. But I don't want to argue about this stuff; I don't spend much time on it. <br /><br />As for the conclusion, it's a bit strange. He acknowledges that PE and bond yields trade together. On a risk-adjusted basis, that relationship has held for more than 100 years. But he claims the market is wrong in doing so. This may be true. Again, I don't waste time arguing who is right or wrong. If something holds true for 100 years, I'm fine with using that as an indicator of some sort. I'm not going to jump up and down and say people have been wrong for 100 years. Of course, that's possible. But I don't really care.<br /><br />His main claim is that the bond yield earnings yield (fed model) fails to predict future market returns, and raw P/E is better at doing so. I totally agree with that too. The lower the P/E, the higher the future return. Duh. I wouldn't use the Fed model to predict future returns, so he is sort of proving something that nobody is really claiming (to my knowledge). <br /><br />And finally, (and the reason I ignore economists and academics), he wrote this paper in 2002 and said the market is overvalued at 24x p/e versus a historical 14x average and said the fed model proponents are wrong claiming the market is fair thanks to lower interest rates. He even said that the market (in 2002) was 2x - 3x higher than it should be. <br /><br />Well, the market is up 9.5%/year since 2002. <br /><br />As Buffett said, if you have one economist in your company, you have one employee too many. <br /><br />Oh, and he said the Fed model proponents are confused because they compare real (earnings yield) versus nominal (bond yields). Earnings yields are "real" because earnings are expected to grow with inflation whereas bond coupons do not. Well, this is true too, but I don't care because that only works in favor of stocks. If bond yields are 5% and earnings yield is 5%, then in reality, stocks are even more interesting because real bond yields might only be 2-3% versus the 'real' earnings yield of 5%. <br /><br />Of course, with inflation (if it goes higher), we have problems of depreciation being too low and earnings reported too high and higher capex to replace equipment etc... <br /><br />Anyway, this discussion is sort of interesting but really academic and not relevant to most stock-picking value investors, I don't think... <br /><br />Thanks for posting the link, though. kkhttps://www.blogger.com/profile/06299974418283948333noreply@blogger.comtag:blogger.com,1999:blog-5389144729834496735.post-69111791147883750972015-05-18T00:05:42.316-04:002015-05-18T00:05:42.316-04:00I too was worried about the market valuation until...I too was worried about the market valuation until Friday when Buffett's 13-F came out. For the first time in at least 2 years, Buffett added to his already massive bank positions:<br /><br />http://investingden.com/showInv?cik=0001067983<br /><br />Buffett already had more than half his portfolio in WFC +USB + BAC (I am sure he will buy the 700m BAC shares because he had been buying BAC on his own in 2008 until it bought Merrill Lynch, also he took a tiny 6% interest rate from BAC when he lent them the money). Why would Buffett buy another $500 million worth of WFC and USB for the first time in two years in Q1 2015. He already had $31 billion worth of WFC + USB before his Q1 purchases. Add another $11.5 billion for BAC and it comes to more than half his portfolio.<br /><br />Buffett has never bought a single concept so heavily ever in his career, it could only be that he thinks the yield curve will widen. His banks have had depressed net interest margins and flat loan growth for a long time. Because Buffett can't be wrong, I think the yield curve would widen. A steeper yield curve would have to be positive for the economy overall due to increased lending by banks like WFC, BAC, USB. Investing Denhttps://www.blogger.com/profile/10947359293936060278noreply@blogger.comtag:blogger.com,1999:blog-5389144729834496735.post-8536062948878931572015-05-17T05:24:53.030-04:002015-05-17T05:24:53.030-04:00If interest rates rise, the earnings will fall. Al...If interest rates rise, the earnings will fall. Also everybody goes from stocks to bonds. With the higher interest rates the companies have to pay more for the debt and they have less income because of the inflation. This plus the selling market will cut the stock market by 40 to 50 percent. Value Investing 2050https://www.blogger.com/profile/04448763664662801073noreply@blogger.comtag:blogger.com,1999:blog-5389144729834496735.post-61145893113123614622015-05-16T17:01:40.882-04:002015-05-16T17:01:40.882-04:00Hi,
I'm not surprised; he's a quant so he ...Hi,<br />I'm not surprised; he's a quant so he should be all over things like this. I read the summary and none of it surprises me, really. Look at the data above and see how scattered it is. He makes some good points too. <br /><br />The difference is that I am not trying to predict anything. Asness' primary reason for being is to be able to predict things. I can see how earnings yield/bond yield would be totally useless as a timing device. Also, of course the raw, absolute earnings yield is more predictive of future returns than a bond yield / earnings yield measurement, just as a bond's coupon is the best predictor of future performance on the bond (assuming investment grade). <br /><br />He raises a good point about nominal and real coupons too, which benefits stocks (as earnings will rise with inflation whereas bonds won't). <br /><br />So it doesn't really matter to me. I am not looking for accurate predictions or a timing device when looking at things like the above. For me, just historical facts such as, "when rates are in the 4-6% range, stocks tend to trade at 20x P/E" is useful, but it doesn't really change my behavior with regards to anything. I'm not going to switch back and forth between stocks and bonds based on it (unless things go really out of whack, then I might!). <br /><br />Anyway, I don't spend much time on this sort of thing, but I'll read Asness' paper. I haven't read anything like this in a while so it might be fun, and if I have anything to add, I'll come back and make a comment. <br /><br />Thanks for posting the link. <br />kkhttps://www.blogger.com/profile/06299974418283948333noreply@blogger.comtag:blogger.com,1999:blog-5389144729834496735.post-30151324676765220172015-05-16T16:55:38.554-04:002015-05-16T16:55:38.554-04:00Hi,
Buffett talks about comparing earnings yield ...Hi, <br />Buffett talks about comparing earnings yield to bond yields in one of his annual reports that I excerpted extensively in the Buffett on Valuation post which is linked in the above post so go read that. That should give you an idea. kkhttps://www.blogger.com/profile/06299974418283948333noreply@blogger.comtag:blogger.com,1999:blog-5389144729834496735.post-18756665019780376392015-05-16T10:32:45.159-04:002015-05-16T10:32:45.159-04:00You probably know this but Cliff Asness wrote an e...You probably know this but Cliff Asness wrote an excellent paper on the Fed model: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=381480<br />The conclusion is pretty interesting (can't copy it), but the whole abstract is well worth reading!<br />maxnoreply@blogger.comtag:blogger.com,1999:blog-5389144729834496735.post-84772485849922348182015-05-16T09:41:27.837-04:002015-05-16T09:41:27.837-04:00I have seen before the use of the inverse of inter...I have seen before the use of the inverse of interest rates to project sustainable PE's. I never understood the connection. Is there a mathematic reason that the two are related? Is it just an economic shorthand that works over a certain range? good article, thanks.tuliptownhttps://www.blogger.com/profile/16565056838125230478noreply@blogger.comtag:blogger.com,1999:blog-5389144729834496735.post-47170147999430233692015-05-16T07:16:42.020-04:002015-05-16T07:16:42.020-04:00I wouldn't call that cheap. I am just pointin...I wouldn't call that cheap. I am just pointing out history. Most analysis these days just point to the high current valuation saying things are going to crash or whatever, but I just wanted to point out that even if rates moved up a lot from here, the market valuation is not out of line with history at all. <br /><br />kkhttps://www.blogger.com/profile/06299974418283948333noreply@blogger.comtag:blogger.com,1999:blog-5389144729834496735.post-31028073916353591592015-05-16T07:14:09.649-04:002015-05-16T07:14:09.649-04:00Yeah, but that's a static, all-else-equal anal...Yeah, but that's a static, all-else-equal analysis (some will make more money, particularly banks). If rates go up on stronger economy and more inflation, there can be more pricing power too so you can have increasing revenues and better earnings too. Of course, this may not happen, I'm just saying... kkhttps://www.blogger.com/profile/06299974418283948333noreply@blogger.comtag:blogger.com,1999:blog-5389144729834496735.post-1535234641173662952015-05-15T23:21:32.323-04:002015-05-15T23:21:32.323-04:00You have to think of the S&P as a 10yr bond. Y...You have to think of the S&P as a 10yr bond. You are merely clipping the earnings each year+ the growth in corporate profits. Assuming 6% on the 10yr, you are saying the S&P earning 5% + 4-5% (long term growth) is still cheap? I'll be switching to treasuries in a heart beat. At that point Treasuries become a cheap option on future opportunities (aka recessions).<br /><br />On the other hand if rates stay where they are at for the next 10yrs then the S&P is really cheap when you discount the future cash flows. There's a huge difference in the NPV between discounting at 6% vs 1%.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-5389144729834496735.post-74239704445409189962015-05-15T22:41:11.844-04:002015-05-15T22:41:11.844-04:00You may not see P/E ratios compress if interest ra...You may not see P/E ratios compress if interest rates jump up, but you will definitely see earnings go down because of the higher debt service. I would guess 10-20%.... http://csimarket.com/Industry/industry_Financial_Strength_Ratios.php?sp5Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-5389144729834496735.post-38441518612075866762015-05-15T21:15:49.841-04:002015-05-15T21:15:49.841-04:00Hmm... I just created the chart but don't know...Hmm... I just created the chart but don't know where to put it. I can't paste it here for some reason. If you google it, I think you can find it. Everyone looks at that so it's sort of all over the place. kkhttps://www.blogger.com/profile/06299974418283948333noreply@blogger.comtag:blogger.com,1999:blog-5389144729834496735.post-12125086681148827452015-05-15T20:32:38.619-04:002015-05-15T20:32:38.619-04:00Can you post a graph showing the ratio of (bond yi...Can you post a graph showing the ratio of (bond yield : earnings yield) on Y-axis and the year on the X-axis? It would be interesting to see if the ratio has changed through the years.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-5389144729834496735.post-49248833941318308122015-05-15T18:39:38.645-04:002015-05-15T18:39:38.645-04:00Yeah, there will be some volatility, taper-tantrum...Yeah, there will be some volatility, taper-tantrum etc... but over time if rates settle at around 4-6%, then current valuations wouldn't be a problem. <br /><br />But then again, this is not a prediction or anything like that. I have no idea if the market will crash tommorow or if it will launch into a parabolic run or whatever; these are just observations given certain facts and data... <br />kkhttps://www.blogger.com/profile/06299974418283948333noreply@blogger.comtag:blogger.com,1999:blog-5389144729834496735.post-46647532206308449592015-05-15T15:40:29.813-04:002015-05-15T15:40:29.813-04:00Thanks for the comment, I had been feeling uneasy ...Thanks for the comment, I had been feeling uneasy about the market's current valuation, but this is a good defense of it. I suspect higher interest rates (at least 4-6%) would mean reduced earnings and a pretty bad bond market that the market would have trouble digesting for a while. But longer term I think you're right.Benhttps://www.blogger.com/profile/17565336056962586657noreply@blogger.comtag:blogger.com,1999:blog-5389144729834496735.post-55336088908018277392015-05-15T14:45:09.990-04:002015-05-15T14:45:09.990-04:00Buffett said "extremely cheap" if rates ...Buffett said "extremely cheap" if rates stay here. Anonymousnoreply@blogger.com