Posts filed under “Valuation”
You should read yesterday morn’s commentary (here), than come back and read Inker. In particular, his piece Explaining Equity Returns.
The five takeaways are as follows:
1) GDP growth and stock market returns do not have any particularly obvious relationship, either empirically or in theory.
2) Stock market returns can be significantly higher than GDP growth in perpetuity without leading to any economic absurdities.
3) The most plausible reason to expect a substantial equity risk premium going forward is the extremely inconvenient times that equity markets tend to lose investors’ money.
4) The only time it is rational to expect that equities will give their long-term risk premium is when the pricing of the stock market gives enough cash flow to shareholders to fund that return.
5) Disappointing returns from equity markets over a period of time should not be viewed as a signal of the “death of equities.” Such losses are necessary for overpriced equity markets to revert to sustainable levels, and are therefore a necessary condition for the long-term return to equities to be stable.
Interesting stuff — worth exploring in greater depth . . .
Reports of the Death of Equities Have Been Greatly Exaggerated: Explaining Equity Returns
GMO, August 2012
“If you’re bullish and wrong, you usually have plenty of company. But if you’re bearish and wrong, it’s almost unforgivable.” -Bob Kargenian, TABR Capital Management, Barron’s DECEMBER 15, 2012 The above quote from Barron’s has been on my mind for a while. I thought of it again as the markets have made…Read More
Last week, I posted the above chart from the NY Fed’s Liberty Street Economics. This morning on Squawk Box, David Tepper of Appaloosa discussed it — and his comments reversed the futures from negative to positive. Here is a brief explanation of what this chart — a compilation of 29 valuation models — means:…Read More
Are Stocks Cheap? A Review of the Evidence
Fernando Duarte and Carlo Rosa
NY Fed, May 08, 2013
We surveyed banks, we combed the academic literature, we asked economists at central banks. It turns out that most of their models predict that we will enjoy historically high excess returns for the S&P 500 for the next five years. But how do they reach this conclusion? Why is it that the equity premium is so high? And more importantly: Can we trust their models?
The equity risk premium is the expected future return of stocks minus the risk-free rate over some investment horizon. Because we don’t directly observe market expectations of future returns, we need a way to figure them out indirectly. That’s where the models come in. In this post, we analyze twenty-nine of the most popular and widely used models to compute the equity risk premium over the last fifty years. They include surveys, dividend-discount models, cross-sectional regressions, and time-series regressions, which together use more than thirty different variables as predictors, ranging from price-dividend ratios to inflation. Our calculations rely on real-time information to avoid any look-ahead bias. So, to compute the equity risk premium in, say, January 1970, we only use data that was available in December 1969.
Let’s now take a look at the facts. The chart below shows the weighted average of the twenty-nine models for the one-month-ahead equity risk premium, with the weights selected so that this single measure explains as much of the variability across models as possible (for the geeks: it is the first principal component). The value of 5.4 percent for December 2012 is about as high as it’s ever been. The previous two peaks correspond to November 1974 and January 2009. Those were dicey times. By the end of 1974, we had just experienced the collapse of the Bretton Woods system and had a terrible case of stagflation. January 2009 is fresher in our memory. Following the collapse of Lehman Brothers and the upheaval in financial markets, the economy had just shed almost 600,000 jobs in one month and was in its deepest recession since the 1930s. It is difficult to argue that we’re living in rosy times, but we are surely in better shape now than then.
The next chart shows a comparison between those two episodes and today. For 1974 and 2009, the green and red lines show that the equity risk premium was high at the one-month horizon, but was decreasing at longer and longer horizons. Market expectations were that at a four-year horizon the equity risk premium would return to its usual level (the black line displays the average levels over the last fifty years). In contrast, the blue line shows that the equity risk premium today is high irrespective of investment horizon.
Very cool tool from ETF Database that allows you to select the least expensive way to express nearly any sector or style investment, with both lowest internal expense ratio and the median cost in that particular space. (Let me know if they missed any and I will inform ETF Database of the omission) Cheapest…Read More
Is it possible that a company that grew to be the dominant axe in Technology, became the largest capitalization firm in the world, and created many new categories of products, is still misunderstood by Wall Street and the Financial Press? The short answer is yes. Apple (AAPL) remains an enigma to much of the Street….Read More
A Year-To-Date Look At The World Click to enlarge Source: All Star Charts The chart above, from JC, shows how the world has been doing since the start of the year. I can only think of three possible future outcomes, from best to worst: 1. Rally! The rest of the world bottoms, reverses,…Read More
A quick note on some of our commentary in April — it has been an interesting month for TBP. On April 9th, I mentioned that the Great Rotation theme was incorrect: It was not stocks into bonds, as is so commonly claimed. Rather, it was a New Great Rotation: Commodities into Bonds. Since then, Bond…Read More
Yesterday morning, I mentioned the extent of cognitive dissonance surrounding the Gold was surprising (What Are Gold’s Fundamentals?). The reaction to Gold’s crash has produced some astonishing rationalizations. The refusal to acknowledge basic trading facts leads us to recognize that Gold bugs and traders have very specific rules that they MUST follow. These social conventions…Read More