July 7, 2023
By Steve Blumenthal
“The stock market is the story of cycles and of the human behavior that is responsible for overreactions in both directions.”
“Patience and discipline can make you look foolishly out of touch until they make you look prudent and even prescient.”
It’s mid-year, so let’s look at the latest equity market valuations. We’ll examine several metrics, including the popular price-to-earnings (P/E) ratio.
For newer investors, think of the price-to-earnings (P/E) ratio as a measure used to evaluate the value of a company’s stock relative to its earnings. It is a simple ratio that compares the price of a single share of a company’s stock to the earnings generated by that company per share. If you are running your own business, how much did your business earn, and how much do you think you can grow your business in the future? Investors are buying a part of that earnings stream and what they believe you can produce in the future.
The P/E ratio is important because it provides insights into how much investors are willing to pay, at any given point in time, for a company’s earnings. The ratio can help you gauge whether the market or a stock is overvalued or undervalued in relation to its current and future earnings potential. A simple way to think about it is how many years it will take to recoup your investment. For example, if the S&P 500 Index earns $200 per share and its price is 4,400 per share, it will take 22 years at $200 in earnings per share per year to get back your initial investment. Historically, getting that money back in 17.6 years has been the average. A low P/E means you’ll get a better return on your money; high means you’ll earn less. As you’ll see further below, historical math is difficult to dispute. You’ll find a handful of charts translating where valuations are today (as of June 30, 2023) and what it means regarding probable future returns.
Going through this valuation ritual occasionally helps me keep my footing/discipline. I hope you find it helpful as well.
Grab that coffee, find your favorite chair, and scroll down for a fast-paced update on current valuations and what that means in terms of probable future returns. Also, my friend Ed Easterling at Crestmont Research has a great chart that shows us why we should only place little faith in Wall Street analysts’ future earnings estimates. Stick to reported figures instead. Finally, I share some thoughts on a different approach to asset allocation. This is how wealthy individuals think about their wealth. Thanks for reading.
Here are the sections in this week’s On My Radar:
- 2023 Mid-Year Valuation Update
- Wall Street Earnings Estimates Almost Always Adjust Down
- 80-20 CORE/EXPLORE
- Trade Signals: Fed Minutes and The 10-year Treasury Above 4%
- Personal Note: Independence Day Celebration
(Reminder: This is not a recommendation to buy or sell any security. My views may change at any time. The information is for discussion purposes only.)
If you are not signed up to receive the free weekly On My Radar letter, subscribe here.
2023 Mid-Year Valuation Update
Chart 1: A broad look at various valuation metrics. Red is bad.
Please note that this section is covering valuations for large index funds in general. Think S&P 500 Index. There is only so much ability for a broad index to grow it’s earnings each year. Individual stocks are different, for some have the ability for exponential growth.
Let’s first take a look at the big picture. Red is bad (overvalued)
- Focus on the orange line in the middle. At each month-end, the Median PE is plotted. Data goes back to 1964. If there are 500 stocks in the S&P 500 index, Median PE is the PE of the stock in the middle. I like it because, in some sense, it removes a lot of the accounting gimmicks corporations tend to play.
- NDR plots various zones using something called standard deviation. Think of it this way, 1-standard deviation events happen infrequently, and 2-standard deviation events rarely occur. You can see the S&P 500 has come off the 2021-22 “Very Overvalued” peak but remains in the “Overvalued” zone.
- NDR then calculates something they call “Median Fair Value.” It is the Median PE over the entire 59.3-year data set or 17.6. Note the green “We’d be better off here” arrows.
- The longer green arrow points to what the S&P 500 Index level is based on that 59.3-year Median PE of 17.6 or 3,008 based on the data through 6-30-23 month end.
- Quoting Charlie Munger, “Extreme patience combined with extreme decisiveness. You may call that our investment process. Yes, it’s that simple.”
- Keep the 3,000 level on your radar in terms of “… extreme decisiveness.” That’s a good entry target for investors.
- A market panic could take us even lower. That’d be a good thing in my view.
- Off from the 2021 record overvaluation high
- Still above 2000 high
- Stocks remain richly priced
Chart 4: Total Stock Market Capitalization as a Percentage of Nominal Gross Domestic Income
Here’s how to read the chart:
- The orange line in the center section plots the Total Stock Market Cap as a Percentage of Nominal Gross Domestic Income
- Note the blue dotted trendline
- The lower section plots the distance in which the orange line is above the dotted blue trend line or below the trend line.
- NDR breaks the data down and groups it into five quintiles. The Top Quintile is the top overvalued zone, and the Bottom Quintile is the most undervalued zone.
- Now take a look at the upper left-hand section in the chart. The best subsequent 1-, 3-, 5-, 7-, 9- and 11-year returns came when the market was most undervalued.
- Unfortunately, we remain in the most overvalued zone where returns were negative 1 to 11 years later.
Chart 5: Shiller PE Ratio
Simply note the path of the blue line over time. The current Shiller PE is 30.92. Compare the current level to prior periods.
Bottom line: Still very high.
Chart 6: Subsequent 10-Year Annualized Returns
This one is pretty cool. NDR plots the returns based on the equivalent of Shiller PE.
Here is how to read the chart:
- Note the red “We are here” arrow
- There are 1585 ten-year observations dating back to 1881.
- It is a high probability that the annualized real returns over the next ten years will fall somewhere between -1% per year to 5% per year.
- The Green line is the single best 10-year observation in each of the valuation categories. The red line is the single worst 10-year return in each valuation category.
Chart 7: Total Returns By Decile
Similar concept – data are broken into ten categories vs five and a different time period 1909-2022
Bottom line: Current high Shiller PE points to an expected total return of 1.3% per year over the coming ten years. Let’s handicap the range between -1.80% to 3.6% per year.
Chart 8: Stock Market Cap and Nominal GDI Long-Term Trend
Here’s how to read the chart:
- Simple focus on the yellow highlighted box in the upper left.
- Look at the returns that were achieved when the orange line was well below the dotted blue trend line (Bottom 20% of all readings dating back to 1925)
Chart 9: Value Stocks Looks Attractive
Chart 10: The Elite Eight
On June 15, 2023, The Total U.S. Stock Market Cap (represented by the Wilshire 5000 Index) equaled approximately $46.4 trillion. Think of it as the collective strength and performance of the U.S. stock market. The S&P 500 Index equaled approximately $36.5 trillion, roughly 79% of the Total U.S. Stock Market. The Top Ten Stocks equaled approximately $12.7 trillion. The market size of the top ten stocks equates to a staggering 34.7% of the S&P 500 Index and 27.4% of the Total Market Cap. This concentration exists in school teacher pension plans and 401ks and touches almost every investor in the U.S. and abroad. See: On My Radar: The Skip, The Size, and the Ten.
I’m not sure of the market cap of the Elite Eight, but you get the idea. So much money is concentrated in so few names and that money has driven prices and valuations higher. Here is a look at the P/E and Price-to-Sales ratios (cap-weighted adjusted) of the elite eight.
Bottom line: The stocks are richly priced relative to earnings and sales. “Party like it’s 1999!”
We’ll look again at valuations if there is a big change in the picture. Otherwise, we’ll revisit early next January. As Klarman said, “Patience and discipline can make you look foolishly out of touch until they make you look prudent and even prescient.” Indeed!
If you are not signed up to receive the free weekly On My Radar letter, subscribe here.
Wall Street Earnings Estimates Almost Always Adjust Down
Investors should focus on actual reported numbers and put less faith in Wall Street analysts’ forward earnings estimates.
Here’s why. For example, focus on the purple 2022 line in the insert in the following chart. With just nine months remaining in 2022, Standard and Poors forecast earnings for the S&P 500 Index to be approx. $220 per share. By the end of 2022, the final number came in at $176 per share. You can see that the same story is true for every year shown in the data set except for the post the Covid shock in 2021.
The other big takeaway from the chart is how far the current 2024 forecast is above the long-term earnings regression line (dotted black line). S&P forecasts earnings per share for the S&P 500 Index to be ~ $225 per share for the entire year ending December 31, 2024.
I have severe doubts about that estimate due to distrust in our supply chains, the reshoring of production, inflation, and higher interest rates.
If one is inclined to believe the earnings forecast, take the current price of the S&P 500 Index at 4,400 and divide it by earnings per share of $225, and you get a P/E ratio of 19.55. The mean forward earnings-based PE estimate over the last 40.4 years was 15.3. Bottom line: Still 22% overvalued.
(Reminder: This is not a recommendation to buy or sell any security. My views may change at any time. The information is for discussion purposes only.)
If you are not signed up to receive the free weekly On My Radar letter, you can subscribe here.
80-20 CORE/EXPLORE
The CORE portion of a portfolio is the “stay rich” money. Of course, there is risk in all investments, but some investments are safer and more senior in terms of collateral than other investments. Think senior secured lending funds yielding in the high single digits to low double digits. It seems to be a better probability than the low expected equity market returns suggested above and the low 4% yield you can earn on a 10-year Treasury. You can build a CORE portfolio that can achieve high single-digit returns.
Think about a mix of investments with no one exposure so significant that it can blow up your ship. Include 5% one-year Treasury bond exposure for liquidity needs and investing optionality should something better present. Mix in many well-collateralized specialty lending funds. You can find funds with yields ranging from 7% to 15%. Include some high and growing value like dividend-paying stocks. Look for companies that reward shareholders by increasing dividends. I’d put money with Seth Klarman if his fund reopens. There are some excellent long-short absolute return strategy funds. And we are heading into a world that favors excellent stock pickers and distressed debt managers. Overall, a mix of specialty lending funds, value stocks, and absolute return investment management. Think active management vs. buy-and-hold overvalued cap-weighted index fund investing.
As I’ve shown, there is a high probability that the next ten years will produce low single-digit returns for the popular 60-40 stock-bond portfolio. If you are paying an advisor for that sort of exposure, don’t pay them and do it for next to free at Vanguard. At least you’ll save 1% per year—however, expect the same low return probable outcome.
The idea is to get your 80% CORE wealth back to 100% in four to five years. With your wealth defended, this allows you to seek exceptional return opportunities.
The EXPLORE bucket is the fun bucket. Invest in a finite handful of companies that have the potential to grow their earnings to billions of dollars. Such companies are innovators, disruptors, and game changers. Look for companies with an edge in technology, good management, a good board of directors, and, importantly, access to capital. If those four pieces are in place, make sure that the opportunity in the market segment they seek to disrupt is so enormous that if they can capture a portion of that market, your investment reward is excellent. Your looking for companies that can create significant wealth for you. Allocate no more than 5% of your net worth to a single bet. Seek exponential return opportunities. Allocate 1% to 3%% to each. Place no more than 5% in any one risk. The CORE bucket lets you go “risk on” in your EXPLORE bucket. Great wealth is not created by investing in index funds.
As a steward of your money, seeking the best outcome for you and your family, you play an essential role in the growth of humanity.
The United States is often considered to have one of the best capital markets systems in the world for several reasons. Firstly, it boasts deep and liquid markets, such as the New York Stock Exchange and NASDAQ, providing a wide range of investment opportunities for individuals and institutions alike. The country has a robust regulatory framework, including the Securities and Exchange Commission (SEC), which helps protect investors and maintain market integrity. Additionally, the U.S. capital markets foster innovation and entrepreneurship, attracting a significant amount of investment capital and supporting the growth of companies in various industries. The transparency and disclosure requirements in the U.S. also provide investors with access to comprehensive information, enhancing market efficiency. Finally, the U.S. dollar’s status as the global reserve currency further contributes to the attractiveness and influence of its capital markets system. Overall, the United States’ combination of robust infrastructure, regulatory oversight, investor protection, and market depth contributes to its reputation as one of the best capital markets systems in the world.
Within this system, allocations to venture capital and private equity are the seed money for innovation. That is where many of the EXPLORE-like opportunities exist. And you’ll also find them in the public markets. Along the path to that hoped-for financial victory are many bumps—some periods of excitement and disappointment. Make sure you understand the fundamental potential of your investment. Hopefully, with your CORE wealth intact, it can give you the patience to provide an investment time to play out. Investing is emotional. Avoid the daily noise and keep focused on 5-10 years from now. If the fundamental potential for significant growth changes, then adjust your exposure.
If you are not signed up to receive the free weekly On My Radar letter, you can subscribe here.
Random Tweets
No random tweets this week.
(Reminder: This is not a recommendation to buy or sell any security. My views may change at any time. The information is for discussion purposes only.)
If you are not signed up to receive the free weekly On My Radar letter, you can subscribe here.
Trade Signals: Fed Minutes and The 10-year Treasury Above 4%
“Extreme patience combined with extreme decisiveness. You may call that our investment process. Yes, it’s that simple.”
– Charlie Munger
Market Commentary July 6, 2023:
The Fed minutes were released yesterday. No surprise, the meeting minutes showed the Fed sees more rate hikes ahead, but at a slower pace. I wanted to wait a day before posting this week’s Trade Signals to see how the bond market responded to the news. Not well… Interest rates spiked higher, with the 10-year Treasury note back up above 4%. The Zweig Bond Model has done an excellent job of avoiding the recent losses in the bond market. It remains in a sell signal.
You’ll find the indicator dashboard and the charts with explanations when you click through.
Subscribers can find the chart by clicking the log-in button below. If you are not a subscriber and would like a sample, reply to this email “send me a sample Trade Signals letter.”
Click on the “Subscribe to Trade Signals” picture to log in or sign up.
TRADE SIGNALS SUBSCRIPTION ACKNOWLEDGEMENT / IMPORTANT DISCLOSURES
About Trade Signals
Trade Signals provides a weekly snapshot of current stock, bond, currency, and gold market trends. We provide a summary of technical indicators to help you identify where we sit in short, intermediate, and long-term cycles. We track important valuation metrics to determine the probability of future returns (i.e. when return opportunity is best/least). Trade Signals also tracks investor sentiment indicators and economic and select recession watch indicators. Trade Signals is now a low-cost subscription service, about the cost of two Starbucks lattes every month. You can find the archive of weekly Trade Signals posts (2008 through 2-15-23) by clicking here.
100% Spam-free. No list sharing. No solicitations. Opt out anytime with one click.
TRADE SIGNALS SUBSCRIPTION ACKNOWLEDGEMENT / IMPORTANT DISCLOSURES
Not a recommendation for you to buy or sell any security. For information purposes only. Please discuss needs, goals, time horizons, and risk tolerances with your advisor. Investing involves risk. You can lose some or all of your money.
If you are not signed up to receive the free weekly On My Radar letter, you can sign up here.
Personal Note: Independence Day Celebration
Susan and I booked two nights at the Congress Hall Hotel in Cape May, NJ. We arrived late afternoon on the 4th and, to our surprise, learned that the fireworks were to launch from a barge positioned in the ocean in front of the hotel. There was a band playing old-time music, an excellent chorus, drinks, and well-dressed people everywhere.
Getting away from work for a few days was nice—feet in the sand. Needed.
We took several long beach walks, and I found myself asleep in my beach chair—the rhythm of the waves, the wonderful rhythm of the waves. Check out Congress Hall if you get a chance. The service and accommodations are outstanding.
Coach Sue and her 2023 “Opposition Analyst” Assistant Coach
Yep, I’m in. Another fall soccer season is fast approaching. Susan coaches a boy’s high school team in Malvern, Pa. (suburban Phila). She asked me to be an assistant coach with the role of “Opposition Analyst.” My job will be to understand the other team’s formations, player positioning, and player talent. And report what I see to her. I’ll stay quiet like the character Beard in Ted Lasso but without the beard. Take notes and admire her way of teaching the boys. And I’ll say “Yes, coach” a lot.
The season starts in mid-August. There is a strong freshman class this year. Several of them are likely to start. Susan is excited about the potential for a successful year—updates as the season nears.
I hope your Independence Day celebration was great fun.
Best to you and your family!
Steve
Stephen B. Blumenthal
Executive Chairman & CIO
CMG Capital Management Group, Inc.
Private Wealth Client Website – www.cmgprivatewealth.com
TAMP Advisor Client Webiste – www.cmgwealth.com
If you are not signed up to receive the free weekly On My Radar letter, you can sign up here. Follow me on Spotify, Twitter @SBlumenthalCMG, and LinkedIn.
Forbes Book – On My Radar, Navigating Stock Market Cycles. Stephen Blumenthal gives investors a game plan and the advice they need to develop a risk-minded and opportunity-based investment approach. It is about how to grow and defend your wealth. You can learn more here.
Stephen Blumenthal founded CMG Capital Management Group in 1992 and serves today as its Executive Chairman and CIO. Steve authors a free weekly e-letter entitled, “On My Radar.” Steve shares his views on macroeconomic research, valuations, portfolio construction, asset allocation and risk management.
Follow Steve on Twitter @SBlumenthalCMG and LinkedIn.
IMPORTANT DISCLOSURE INFORMATION
This document is prepared by CMG Capital Management Group, Inc. (“CMG”) and is circulated for informational and educational purposes only. There is no consideration given to the specific investment needs, objectives, or tolerances of any of the recipients. Additionally, CMG’s actual investment positions may, and often will, vary from its conclusions discussed herein based on any number of factors, such as client investment restrictions, portfolio rebalancing, and transaction costs, among others. Recipients should consult their own advisors, including tax advisors, before making any investment decision. This material is for informational and educational purposes only and is not an offer to sell or the solicitation of an offer to buy the securities or other instruments mentioned. This material does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual investors which are necessary considerations before making any investment decision. Investors should consider whether any advice or recommendation in this research is suitable for their particular circumstances and, where appropriate, seek professional advice, including legal, tax, accounting, investment, or other advice.
Investing involves risk. Past performance does not guarantee or indicate future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by CMG), or any non-investment related content, made reference to directly or indirectly in this commentary will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this commentary serves as the receipt of, or as a substitute for, personalized investment advice from CMG. Please remember to contact CMG, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. Unless, and until, you notify us, in writing, to the contrary, we shall continue to provide services as we do currently. CMG is neither a law firm, nor a certified public accounting firm, and no portion of the commentary content should be construed as legal or accounting advice.
No portion of the content should be construed as an offer or solicitation for the purchase or sale of any security. References to specific securities, investment programs or funds are for illustrative purposes only and are not intended to be, and should not be interpreted as recommendations to purchase or sell such securities.
This presentation does not discuss, directly or indirectly, the amount of the profits or losses realized or unrealized, by any CMG client from any specific funds or securities. Please note: In the event that CMG references performance results for an actual CMG portfolio, the results are reported net of advisory fees and inclusive of dividends. The performance referenced is that as determined and/or provided directly by the referenced funds and/or publishers, has not been independently verified, and does not reflect the performance of any specific CMG client. CMG clients may have experienced materially different performance based upon various factors during the corresponding time periods. See in links provided citing limitations of hypothetical back-tested information. Past performance cannot predict or guarantee future performance. Not a recommendation to buy or sell. Please talk to your advisor.
Information herein has been obtained from sources believed to be reliable, but we do not warrant its accuracy. This document is general communication and is provided for informational and/or educational purposes only. None of the content should be viewed as a suggestion that you take or refrain from taking any action nor as a recommendation for any specific investment product, strategy, or other such purposes.
In a rising interest rate environment, the value of fixed-income securities generally declines, and conversely, in a falling interest rate environment, the value of fixed-income securities generally increases. High-yield securities may be subject to heightened market, interest rate, or credit risk and should not be purchased solely because of the stated yield. Ratings are measured on a scale that ranges from AAA or Aaa (highest) to D or C (lowest). Investment-grade investments are those rated from highest down to BBB- or Baa3.
NOT FDIC INSURED. MAY LOSE VALUE. NO BANK GUARANTEE.
Certain information contained herein has been obtained from third-party sources believed to be reliable, but we cannot guarantee its accuracy or completeness.
In the event that there has been a change in an individual’s investment objective or financial situation, he/she is encouraged to consult with his/her investment professional.
Written Disclosure Statement. CMG is an SEC-registered investment adviser located in Malvern, Pennsylvania. Stephen B. Blumenthal is CMG’s founder and CEO. Please note: The above views are those of CMG and its CEO, Stephen Blumenthal, and do not reflect those of any sub-advisor that CMG may engage to manage any CMG strategy, or exclusively determines any internal strategy employed by CMG. A copy of CMG’s current written disclosure statement discussing advisory services and fees is available upon request or via CMG’s internet web site at www.cmgwealth.com/disclosures. CMG is committed to protecting your personal information. Click here to review CMG’s privacy policies.