With US equity markets moving up and down at all-time highs, Scott has been writing and speaking (on our regular Tuesday 4:15pm Webinars) about why we are a bit more cautious on US stocks. Valuation metrics appear stretched and volatility, although low at the moment, has been whippy over the past 18 months.
I thought I would add a few charts to help show the bifurcation between the nominal level of US stocks and a few other valuation metrics.
First is Price to Earnings (orange), Enterprise Value to Sales (blue) and Enterprise Value to Ebitda (red). Remember, Enterprise Value = Market Cap of the stock, plus debt less cash and Ebitda = Earnings before Interest Expense, Taxes and depreciation/amortization. So when all three of these lines is rising, it is most likely that the price of the stock is rising faster than the company's underlying earnings.
So on two of these metrics (EV/Ebitda and PE), we are more stretched today than we were in 2007...and we all know how stretched we were in 1999...and what happened right after. If you don't remember the dot.com bust, focus on the middle of the above chart...
Next, we have two measurements that look at how well businesses are performing. Operating Margin and ROE (Return on Common Equity). Both have been sliding over the past two years which is obviously not good:
So if earnings are dropping (as Scott wrote about this morning) and margins are dropping, why are stocks rising to all-time highs...with GDP sitting around 2%? Maybe it is something else?
How about it's all driven by the Fed? Pretty strong correlation to the Fed's balance sheet, isn't it?
Maybe investors have run out of mattresses to stuff their cash in? Maybe they are afraid of getting taxed in their home country savings accounts? Maybe they are foreigners who are no longer going to buy Vancouver real estate?
The reason would appear to be one of relative value. Where else do you put your capital? There are well over $10BLN of government bonds around the world that have a minus sign in front of them. The problem with relative value in this particular situation is, it will not be different this time. Fundamentals always come home to roost.
At High Rock, we have arguably been pretty cautious on global stock market indices, however, we have been pretty bullish in our Tactical Model which invests in very specific, well-researched individual stocks and bonds. The Tactical Model has had some good calls on energy stocks and bonds (we have a completely unique ability to take advantage of high yield bonds in our Tactical Model) as well as a few other positions. We also have had a great call in some more traditional government and corporate bonds. The result has been very strong risk-adjusted returns for our portfolios, even though we may be under-weight some global equity indices.. We continue as is and wait for the broader market to provide us with a better entry point so as to reduce the unwanted risk.