"Stock prices have reached what looks like a permanently high plateau. I do not feel there will be soon if ever a 50 or 60 point break from present levels, such as they have predicted. I expect to see the stock market a good deal higher within a few months."
-- Dr. Irving Fisher, Professor of Economics at Yale University
October 17, 1929 (The Dow fell 85% soon thereafter)"Yet I believe the opposite is true and think that the current valuation of the stock market is very favorable for investors."
-- Dr. Jeremy Siegel
, Professor of Economics at University of Pennsylvania
April 30, 2007
First, I want to be fair. I'm sure both of these gents are qualified professors and very able contributors to society. This post is in jest but I'm attempting to make a serious generalization using a recent article by Professor Siegel
as an example. When I read the recent article on Yahoo Finance, (referenced in my prior post) it appeared Siegel
was feeling his oats. He clearly slammed a few titans of Wall Street including Jeremy Grantham who just so happens to manage a few hundred billion in cashola
and appears to be one of the few who understands what is going on from a macro perspective. Might I add, Grantham was also was very bearish into 2000 as well.
In my prior post, I had mentioned the Peter Principle. For those of you who don't know what the Peter Principle is, I'll share a quick and loose definition. I'm sure there is a better one on Wikipedia
or elsewhere if you are interested in more detail. In any hierarchical organization, successful people are continuously promoted to new challenges. Most of the time those challenges require new skills and core competencies. At some point an individual is promoted to a position they are unqualified for at best or at worst totally incapable of. The Peter Principle then surmises those people are then left to languish in that position without promotion and reign their complete incompetence on those around them and under them. In a single sentence the Peter Principle states you are promoted to your level of incompetence. For many, that just so happens to be CEO. In my estimation, the most grand example of the Peter Principle are politicians. Especially ones who take claim for creating the internet
, tell us the economy is great based on Ouija board analysis, claim to be the experts in global warming, take claim for solving world hunger and claim credit for economic growth in the American culture of innovation they so luckily live under. But, I digress. You may be a shining example of the Peter Principle. I might be an example. The Peter Principle doesn't mean the person is a fool. Just that one has reached a level of "unqualifiedness
In today's society, it doesn't just apply to organizations and politicians but to those whom the masses rely upon for expert opinion. You see it in the financial press constantly. Someone on Wall Street is asked about Google's
future or what's going on in China or ethanol as an alternative fuel. Now, some on Wall Street are qualified to give opinion but most aren't. Yet, we tend to believe what they say regardless. I'd guess it's society's application of the Peter Principle to those we view as hierarchically above us on achievement ladder. e.g., We are prone to believe an expert in economics makes them an expert in the stock market. For some that is true but it isn't what they learned as economists that makes it so. For most, the answer is just the opposite. Frankly, how do you know I am qualified to even write this? You don't. And, maybe I'm not. As I've said on here before, one goal of mine is for readers to question everything they believe to be true. If that includes what I write, so be it. I give no one a free pass and don't expect to get one in return. So, believe what I write below at your own risk. Or, don't believe it at your own risk. All people deserve respect. That doesn't mean deference. I respect Jeremy Siegel
for his achievements. I don't believe that means deference to a statement I know is not accurate. Wading through the jungle of falsities is not easy when we are hammered every day by media and messages from all directions. This includes the "experts" Yahoo pays to give us guidance on particular life matters.
premise is that stocks are cheap. In his article he shares what I view as alot
of alchemy and baloney when explaining why stocks are cheap. Share of proprietor's income is dropping? Dividend rates? Blah, blah, blah. Well, share of proprietor's income may be dropping but how is that relevant historically to equity valuations? He's stating it's different this time because of such. (By the way, the drop in proprietor's income is not a good sign and I have written about this in the past and will likely do so again in the future.) Real dividend rates are negative. How great is that? When someone uses mumbo
jumbo, it's usually an attempt at baffling us with hooey.
I interpret Siegel's
generalized strategy with equities to be that investors should buy indexed value stocks for the "long haul" to use his terminology. That's a reasonable supposition I guess. He says dividend paying stocks outpeformed
the S&P for the last forty years. Well, before the bubble, that is not true. And, if you really wanted to outperform for the last three decades before the bubble, the Nasdaq
100 really crushed dividend stocks up through 2ooo
. Post 2000 commodities crushed index based value funds. So, I guess there's a little bit of statistics, damn statistics and lies in his analysis. There is nothing wrong with buying indexed dividend stocks. They are sometimes the only voice of sanity and I appreciate some form of safety in this market. Yet, what does that have to do with market valuation metrics, market cycles, and market timing around quantitative analytics? That is what Siegel
is attempting to do by stating stocks are cheap. He is of the opinion that buying today is "very favorable for investors" to use his direct words. The
good professor has proven to me he knoweth
not what he talketh
about with his recent article.
I'll put a little fact behind some prior statements I've made on this blog. Just a little. :) Let's go back and look at a few statements I've written about. Some ad nauseam
--Earnings are the most cyclical in fifty years
--Earnings at risk and not current or expected PE more appropriately defines this market
--This market is very expensive and by implication...........
--The Fed valuation model is worthless in this cycle
--The bulls looking for their PE expansion have already gotten it in small caps, commodities,
commodity related stocks, transports, utilities, financials, consumer stocks, etc.
--The financial industry is peaking over a very long cycle
--Bubbles usually come in pairs
Now, I don't post alot
of charts based on fundamentals or specific quantitative data points. There are two reasons for that. One, because you can find fundamental data on hundreds of blogs or in the financial press and two, because I know some professional money managers read my blog and I prefer not to post work that has taken a life time to develop just so that it can be lifted at a five finger discount. Not that I mind sharing as I do share alot
on here. But, a few of us may monetize our work because I believe it is better than most anything I've seen out there. I'm going to show you a chart that I haven't seen anywhere else to stimulate your creative thinking. A picture is worth a thousand words and sometimes worth your life savings. It's not proprietary but as simple as it is, it's far from common knowledge either. Wall Street is too busy basking in its glory and telling us the S&P PE is only 17 or 18 or 21 or 15. I'm sorry, but between GAAP
earnings, core earnings, pro forma
earnings, operating earnings
, twelve month trailing earnings, as reported earnings, earnings excluding negative earnings and all of the other shenanigans now played on Wall Street, it's hard to keep up with the truth. What ever happen to plain old earnings I could use to determine the real price-to-earnings ratios? For those of you wondering, the proper measure is GAAP
Let me say I don't appreciate single variable analysis as is used by so many on Wall Street and the media. Housing tanks so the prognosticators say the Fed is going to cut. I said months ago in a post that the Fed was not going to cut rates. I don't base that on opinion. It's based on quantitative data. Now, there are moments of panic that the Fed may do ridiculous things, ie LTCM
in 1998 but without some type of out of bounds event, the Fed is not about to cut rates. Single variable analysis failed those who have been telling you a rate cut should have happened by now. How many meaningful problems were solved using a single variable? "My dog Spot was running ten miles per hour towards home. Home was two miles away. How long did it take for Spot to get home?" You get the picture. That said I am only giving you one variable in the chart below but needless to say, I don't use a single variable to determine my work.
The chart below shows corporate profits as a percentage of GDP. Simple enough. See anything unusual? How about that we are seeing the most cyclical earnings in fifty years? Sound familiar? (I don't make this stuff up that I post even if I don't always share the data points.) Earnings are at ten percent of GDP. In the mid 1980s before the great bull run they were at three percent. Seventy percent
less than today! I'm sure many who would see that chart would say earnings are so far above historical norms because of globalization. That is also hooey. So, the last time we had earnings this far out of trend, the markets peaked soon thereafter and didn't make a new high for nearly five years. That's not so bad compared to the seven years we've gone so far with the Nasdaq
and S&P not making new highs. Now is it? As I write this tongue in cheek. Look at 1973. Earnings were forty percent less than today in relative terms, the S&P had a PE of 18 and the S&P fell 50%. Don't think earnings can fall like they did in 1973? Fed killed the economy in 1973 but that cycle had some core differences. Are earnings at ten percent of GDP sustainable? New bull run starting? Time to load up for another 500% run in stocks over the next decade? GDP based earnings going to fifteen or twenty percent of GDP? (Laugh. That's a joke.) Well, if you read my post of earnings at risk a few weeks ago, you know what I think. What's Siegel's
statements based on? Mumbo
jumbo, some arcane rationalization and apparently the position of the his head in relationship to the planet Uranus. Ever been to Uranus? It's not a place where deep thought takes place.
Lack of investment, no demand for capital, capital equipment investment in the ditch, payout of huge earnings streams in the form of buybacks versus investment, borrowing money to buy back stock, hard assets at one hundred year price deviations from the norm boosting cyclical profits, global infrastructure demand expected to last forever, energy utilities still functioning under a regulated business model of majority earnings payouts in an unregulated world, every nation on earth ramping
up investment to service demand from America while doing little if anything to stimulate domestic demand by reforming their pathetic domestic economic policies. That is a marvelously long sentence and probably grammatically incorrect. Need I go on and on? Earnings and underlying economic fundamentals simply are not sustainable at these levels. Additionally, as a point of reference this global economic expansion is not as large as the World War II reconstruction effort in comparative
terms. Not everyone in India and China are getting a new house. It's generally a city based development not the entire country. At least not yet. Nor is the demand for basic materials and commodity related assets greater comparatively. Yet, it didn't help equity markets then and this mess being created won't help equity markets when someone wakes up and realizes what the herd on Wall Street has done.
So, what does this cyclicality
really mean? It means we have the mother of all corporate earnings bubbles that is going to end at some point. Earnings are up an incredible 300% this cycle. Is your portfolio up 300%? Are major averages up 300%? Not even close. Even if you bought the S&P 500 at the exact date of its low before this market started north, you are up about 80%. Is it really that hard to figure out why this is so? Think about it. Of course not. I'm going to paraphrase a Ben Graham quote because I can't remember it exactly. It goes something like this: Short term the market is a slot machine, long term it is a weighing machine. Short term is a cycle. Long term is decades. Not the impulsive view that short term is this week that global investors have developed. Mr. Market knows this isn't sustainable so he is discounting the current earnings cycle. I can also tell you that corporate balance sheets aren't as pristine as people would have you believe either. (I'll leave those data points to your own investigation but I can assure you that is a fact as well.) Needless to say, that tells me corporations aren't generally prepared for a large loss in earnings and neither is Wall Street. Are you?
Liquidity, liquidity, liquidity. That's the new mantra. We are awash in money so no need to worry. I had an acquaintance tell me there is too much money floating around to let the market go down. I guess they don't have a memory beyond six years. Remember 2000 when there was the largest global wealth creation the world had ever seen over a twenty year period? Enough liquidity to keep the Nasdaq
from going down 85%? Enough liquidity to save the home building stocks over the last few years? How about the 30-odd sub prime mortgage lenders that have gone bust or the others that have seen their stocks drop by 90%? More hooey.
tells investors the market is cheap and by inference his investment thesis of value and indexing is attractive. Well, I would say he is making that statement very close to a peak in value-based assets including equities. Again, when I say close, I'm talking this cycle not tomorrow. For when this ends, I can only guess. But, I believe it isn't very far off. I said on here quite a long time ago that bubbles usually come in pairs. Here's what I didn't say. The second bubble is a value concentrated bubble. We are in a value bubble whether you define it by dividends, basic materials, stuff stocks, hard assets or however else it is sliced.
I can't find the web site where I read it, but someone was just talking about John Maynard Keynes putting his name on a mutual fund in the 1930s. Keynes, similar to Siegel
today, was very well respected at the time. The fund went kaput as his mutual funds were brought to market near the peak and the grand Peter Principal experiment went kaput. Today, Jeremy Siegel
has recently become a financial beneficiary and shameless promoter in Wisdom Tree ETFs
focused on value investing. Is history repeating itself? Is Jeremy Siegel
the 2007 equivalent to the 1937 John Maynard Keynes? Has Siegel
overstepped his core competency into the world of the Peter Principle? I find the parallels with Keynes very interesting. Almost eery
--Both well respected economists
--Both deciding to jump into the professional money management space
--Both using their reputation as economists to parlay into investments
--Both doing so during a value bubble
--Both doing so after a bubble collapse in 1929 and the other after a collapse in 2000
--Both doing so in a liquidity driven commodity cycle
So, what happens when corporate profits return to trend or even fall below trend as they sometimes do? Do you know that this bull market started with the S&P PE at 28ish
after the 2000 bust? That's about where it was in 1929. Do you also know there has been no substantial new cyclical bull market that started with a PE of that general level? So, what does the Fed model say about stocks if these incredibly cyclical earnings return to trend or less and the market PE would again be astronomical? The Fed model every bull is relying on works when it works and that's about it. We have seen a PE and underlying asset multiple expansion in value. We will see a return to trend. Growth builds wealth for the masses. What we have now is a liquidity driven value bubble. How does inflated oil, commodities and food create wealth for the masses? The outcomes, the cycles and the consequences are not even close to being similar.
Care to guess what will happen concomitantly with a return to trend of earnings? The driver of those cyclical earnings will also return to trend.
You read it here first. Fair and balanced to steal a phrase from Fox News. I'm not a bull and I'm not a bear. I listen to what the data tells me. Or put another way my models don't lie but people do. Ha!
"Rule No.1 is never lose money. Rule No.2 is never forget rule number one."
, Berkshire Hathaway Chairman
"I think he's (Siegel) demented. He tries to compare apples and elephants in making accurate projections (about the stock market)." --Charlie Munger, Berkshire Hathaway Vice Chairman
Those who compare this to 1995's mid cycle slow down are living on Mars. Those who compare this to the mergers mania cycle in the mid 1980s are living on the moon. In this cycle, the worst of all cycles, I prefer to live by Warren Buffett's
rule. Preservation of capital is my primary objective. Feeling left behind? Want to run out and load up on equities? Believe in the Peter Principle? Enjoy the ride.
Next post will probably be a week or more away because of the time spent putting up this post.