Category: valuations

Peak profits, stock prices?

Recently a respected colleague said our strategy was rational but markets, and the world for that matter, were highly irrational.  After participating in financial markets for the last 25 years I thought my experiences allowed me to see it all-wrong!  So after reflecting on our irrational state of affairs the logical side compiled some of the glaring data sets signifying a massive market top. 

First, a chart created by John Hussman ( indicates how much excess we’ve witnessed in corporate profitability vs GDP lately.  Keep in mind his data includes financials which to this day remain a subsidized black box.  (Click on image to enlarge).New Picture (1)

Of course this hasn’t stopped wall street from expecting further net margin expansion:


Profit margin growth

Before Wall Street follows Congress out the door for the holidays maybe they should scrutinize this:

profits vs labor

To derive this unprecedented profit picture both consumers and government went on a spending binge.  US national debt, through 5 years of record deficits, added almost $7.7 trillion to our balance sheet-can you say malinvestment?personal savings govt deficits profits


Now, if we remove the creators of financial alchemy we notice the real economy topped many quarters ago. 


Nonfinl corp profits

So if you care to break away from CNBS and look at the graphs above rational behavior would suggest profit taking and or short exposure.  In fact, it was just 7 years ago that many of these same signals were sent to the market yet we were labeled as the boys crying wolf.  If your timing is perfect the crowd labels you a genius but too early, a chump. 



Paired trade of the decade?

Long gold ($869.00/oz.), short the S&P 500 (1255.08). The gold/S&P ratio is currently 0.69 and going much, much higher (see above).

The catalyst? The federal government is planning to cut a check for $900 billion to bail out Fannie/Freddie and now purchase mortgage-backed securities at above-market prices. The final tab is going significantly higher, the lion’s share of which will be paid for with printed dollars. From these delusional levels, a 1930s-style collapse in real terms is all but guaranteed.

Addendum: As the graph shows, U.S. equities have been in a relentless bear market versus gold since their tech bubble highs of 1999-2000. In fact, a unit of the S&P 500 that purchased 5.23 ounces of gold 9 years ago buys just 1.45 ounces today. The S&P has lost 72% of its gold value during that time.

China: Terra firma or quicksand?

As Bloomberg reported today, China’s statistics bureau claimed its economy grew 11.5% in the 3rd quarter. Meanwhile, the 2nd quarter clocked in at an 11.9% rate, the highest in 12 years. While we have little faith in these numbers, the authorities seem intent on tempering the boom:

Central bank governor Zhou Xiaochuan said last week that steeper or more frequent interest-rate increases are possible and expressed concern at rising asset prices.

But what really caught our eye was the size of the stock market bubble:

The stock market added $2.5 trillion in value this year — the equivalent of GDP in 2006 — as the CSI 300 Index more than doubled.

In other words, China’s market cap – at $5 trillion plus – represents over 200% of GDP. This ranks right up there with past manias:

  • U.S., 1929 – ~80% of GDP
  • Japan, 1989 – ~150% of GDP
  • U.S., 2000 – ~175% of GDP

The U.S. equity market has a capitalization today of roughly 135% of GDP. Let’s see… China’s best customer, the U.S. consumer, is doped up on credit and barely responding. And its economy appears to have a severe gambling problem. Is this the foundation the global economic boom bulls are standing on?

Bloomberg: Stocks cheapest in almost 12 years

Cheapest Stocks in Almost 12 Years Greet Investors,” according to an article in today’s Bloomberg.

U.S. investors are returning from summer vacation to the cheapest stock market in almost 12 years, and some of the biggest fund managers say they’re ready to load up on shares of technology, energy and industrial companies.

The S&P 500’s average price-to-earnings ratio of 16.8 for August was the lowest since November 1995, according to monthly data compiled by Bloomberg.

The valuation plank of the bull platform was well represented by mega money managers.

AIM Investments – $160 billion:

“The market’s probably seen the worst of it,” said Fritz Meyer, the Denver-based senior investment officer for AIM Investments, which oversees $160 billion. “The Fed ultimately will ride to the rescue.”

Stocks are “on sale” and managers are “finding opportunity everywhere,” Meyer said.

Morgan Stanley Global Wealth Management – $728 billion:

The [S&P 500] index ended last week at 1473.99, up 3.9 percent in 2007. It may reach 1,600 this year should the Fed cut the benchmark overnight lending rate between banks at its remaining three meetings in 2007, said David Darst, New York-based chief investment strategist for Morgan Stanley Global Wealth Management.

The slump in stocks was “driven by psychology rather than by fundamentals or valuations,” said Darst, who oversees $728 billion. “The bull market can continue.”

LPL Financial Services – $165 billion:

Jeffrey Kleintop of LPL Financial Services recommends buying industrial and technology companies that are more dependent on the international economy than on U.S. consumers.

“The storm has passed its peak,” said Kleintop, who helps oversee $165 billion as chief market strategist at LPL in Boston. Technology and industrial shares are “going to be the leaders as we emerge and retrace our way back to new highs.”

While the lone skeptic, Wentworth, Hauser & Violich, runs a comparatively trivial $12 billion:

Valuations for many stocks aren’t attractive enough to go “bottom-fishing,” said Patricia Edwards, who helps manage $11.9 billion at Wentworth, Hauser & Violich in Seattle. The slump caused by defaults on mortgages to people with poor or limited credit has hurt the profit outlook for companies such as homebuilders and financial firms.

“Catching falling knives is a dangerous art and not one I have perfected,” said Edwards, the firm’s managing director. “They’re only cheap if the earnings hold up, and there’s not a lot of confidence with the E portion of their P/E ratios.”

My comments:

  1. Insight is often found in the lone dissenting voice and away from the consensus.
  2. The E portion of P/E was pumped up by the credit bubble. So, too, will it deflate with the bubble’s bursting.
  3. The global economic boom stocks (tech, energy, industrials) are over-owned by the elephants. Watch out when they change course.

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