June 7, 2024
By Steve Blumenthal
“One of the prime lessons learned from long-term analysis is that no asset class can stay permanently detached from fundamentals.”
– Jeremy J. Siegel, Stocks for the Long Run: The Definitive Guide to Financial Market Returns & Long-Term Investment Strategies
We often hear that stocks produce the best returns over the long run. Jeremy Siegel took the data back to 1802, comparing Stocks, Bonds, Treasury Bills, and Gold relative to inflation. Stocks produced an 8.4% annualized return, and Bonds came in second, and inflation came in last. $1 dollar turned into $54.2 million over 219 years (Siegel’s 6th edition was published in 2022). Today, I attempt to shape some logic around that “long run” 8.4% return as I believe understanding where you sit in the valuation cycle can provide you with excellent information (aka edge).
The best returns come from the stock market over the long term. The trouble is the problematic long stretches of time when stock market returns are frustratingly flat to negative. The message today is that the cost of what you pay for something matters. As Siegel says in his book, “In the short run, however, stock returns are very volatile, driven by changes in earnings, interest rates, risk, and uncertainty, as well as psychological factors, such as optimism and pessimism, as well as fear and greed.”
The good news is that it is quite easy to plot and follow. Today, let’s dive into the current state of equity market valuations, as they can help us understand where we sit in the cycle and further understand degrees of risk, reward, and timing. Timing is from the sense that “We’d be better off here” means “here” is where we gain a lot more return on our money (charts in the valuation section below).
At the beginning of each month, I scroll through 55 different valuation charts. I’ve stuck to this discipline since the mid-1990s, though there were fewer charts on my list then. Today, let’s take a look at current conditions. As you review, consider when it may be best to play more defense than offense (underweight to equities and hedge long-term hold positions) and when it may be best to play more offense than defense (overweight to equities and remove hedges).
Grab your coffee and find your favorite chair. In addition to the current state of valuations, you’ll also find a few charts that map probable coming 10-year returns. Along with a few interesting news items. How about a Four-Way Presidential Race? We’ll look at that as well.
On My Radar:
- Valuations and 10-year Returns
- A Four-Way Presidential Race
- Random Tweets
- Personal Note: New York and Dallas
- Trade Signals: June 5, 2024
See Important Disclosures at the bottom of this page. 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.
Valuations and 10-year Returns
We often hear that stocks produce the best returns over the long run. Jeremy Siegel took the data back to 1802, comparing Stocks, Bonds, Treasury Bills, and Gold relative to inflation. Stocks produced an 8.4% annualized return, and Bonds came in second, and inflation came in last. $1 dollar turned into $54.2 million over 219 years (Siegel’s 6th edition was published in 2022). Today, I attempt to shape some logic around that “long run” 8.4% return as I believe understanding where you sit in the valuation cycle can provide you with excellent information (aka edge).
The best returns will come from the stock market over the long term. The trouble is there are problematic long stretches of time when stock market returns are frustratingly flat to negative; the cost of what you pay for something matters. As Siegel puts it, “In the short run, however, stock returns are very volatile, driven by changes in earnings, interest rates, risk, and uncertainty, as well as psychological factors, such as optimism and pessimism as well as fear and greed.” ― Jeremy J. Siegel, Stocks for the Long Run: The Definitive Guide to Financial Market Returns & Long-Term Investment Strategies
This is where understanding valuations can help frame where we sit in a cycle and gain a better understanding of risk, reward, and timing. Timing from the sense that the “We’d be better off here” means the “here” is where we gain a lot more return on our money (charts in the valuation section below).
Each month, I scroll through 55 different valuation charts. I’ve stuck to this discipline since the mid-1990s, though there were fewer charts on my list then. Today, let’s take an updated look at current conditions. As you review, think more about when you might think about playing more defense than offense (hedging long-term hold positions) and more offense than defense (adding cash to stocks).
Following are several of my favorite valuation metrics.
Price to Operating Earning Ratio (PE)
Here is how to read the chart:
- The upper section plots the S&P 500 Index (blue line) and the Average PE based on actual 12-month trailing earnings (dotted orange line).
- The S&P 500 Index was at 5277.51 on May 31, 2024, month end.
- The fair value at May month end is the Average PE (Median PE of 15.2) from 1926 to the present is 3242.16. See green “We’d be better here” in the chart.
- Not perfect, but think of that long-term PE as Siegel’s 8.4% annualized STOCKS for the LONG RUN number.
- Think of the “We’d be better here” as an excellent entry point (more offense than defense).
- Further, the orange boxes highlight the periods in time when PE was “Expensive” and the bottom orange boxes “Bargains.”
- The last time we hit bargains was after the 1970s inflation period. I’m not saying we’ll get there after the debt and entitlement system gets reset, but if I’m right about the current inflationary cycle, then it may be possible in the second half of this decade. If we get there, take all your chips and go “ALL IN.”
Price to Sales Ratio
Here is how to read the chart:
- The orange line in the middle section plots the month-by-month Median price-to-sales ratio.
- Note it is has has been above it’s long term trend line.
- The blue line in the lower section plots how far the orange line is over or under the long-term trend line. Currently in the “Overvalued” zone.
- Finally, the data boxes in the bottom lof the chart plot what the annualized gains were based on each zone (Overvalued, Fairly Valued – blue line in the middle zone, or Undervalued).
Median PE
Here is how to read the chart:
- “Run Forest Run…” (just kidding… making sure your lights are on) 🙂
- Note the small arrows at the bottom section of the chart.
- 3636.20 us the current Median Fair Value level of the S&P 500 which indicators a reasonable “risk on” price target.
- An even better entry level would be the “Undervalued” level at 2459.32. Required is a market decline of 53.4%. Less likely, but it can’t be ruled out.
Stock Market Cap as a Percentage of GDI (Gross Domestic Income)
Here is how to read the chart:
- In the middle section, the orange line plots the month-by-month ratio.
- The blue line in the lower section shows how far over/under the orange line is from its long-term trend line.
- The highlights in the bottom section show historical returns, 1-, 3-, 5-, 7-, 9-, and 11-years later, for the overvalued Top Quintile compared to the undervalued Bottom Quintile.
- Bottom line: The current level is not a good entry point.
Buffett Indicator – Stock Market Cap to GDP
Source: AdvisorPerspectives
I could keep going, but we’ll find the same evidence pretty much across the valuation dashboard. Let’s consider wheat this looks like in terms of probable future returns.
I share this next chart in Trade Signals each week. First, a look at the Shiller PE, then what it means in terms of probable coming 10-year returns.
Shiller PE
Source: ShillerPE
Total Return by Decile – 10-year Return Data
The following uses the Shiller PE (also known as PE10) and plots subsequent 10-year Period Returns – data from 1909 to 2022.
Here is how to read the chart:
- The green arrow is good, and the red arrow is bad.
This is not a recommendation to buy or sell any security. It is for educational discussion purposes only. Opinions are subject to change. Consult your advisor.
A Four-Way Presidential Race
Dr. Pippa Malmgren wrote a piece to subscribers last week that caught my eye. What had been a three-way race is now a four-way race. Senator Joe Manchin has entered the presidential race.
I love the way Pippa writes. Her father is Harald Bernard Malmgren. This from Wikipedia is a scholar, ambassador, and international negotiator who has been a senior aide to US Presidents John F. Kennedy, Lyndon B. Johnson, Richard Nixon, and Gerald Ford, and to US Senators Abraham A. Ribicoff, and Russell B. Long, United States Senate Committee on Finance. He has acted as an advisor to many foreign leaders and CEOs of financial institutions and corporate businesses and has been a frequent author of articles and papers on global economic, political, and security affairs.
I follow both Pippa and her father on X. Worth it!
On the “Four-Way Presidential Race, following is my summary of Pippa’s post:
Late last week, Former Senator Joe Manchin re-entered the race within hours of Trump’s court judgment. Manchin, who left the Democratic party, is running as an independent.
Note – please read the article with an open mind. Politics hits us all pretty hard. I tried my best to read Pippa’s words, suspending my personal judgments/opinions/views and simply taking in the data. Have you ever heard of the Zogby poll?
In her article, Pippa discusses the evolving dynamics of the American Presidential race between Joe Biden, Donald Trump, Robert F. Kennedy Jr., and Joe Manchin.
The three-way contest has shifted to a four-way race following Trump’s convictions and Manchin’s entry as an independent candidate. “So, now it’s a four-way race with two independents (Manchin and RFK) looking much more potentially popular than President Biden. Trump still leads them all. His polls bounced upward on the announcement of his convictions in the first of several trials against him. He now leads all others by at least 1.7%, according to Zogby.”
She adds, “This race is already hard to judge, but it sure looks set to be a nail-biter with two “long-shot” “dark-horse” candidates now in the race—not one. This further raises the risk that nobody gets the 270 Electoral College votes needed to win, and we end up in a Contingent Election in January 2025.
Not everybody understood this was a three-way race because the mainstream press refused to report Robert Kennedy’s rather astonishingly strong poll numbers. Zogby recently conducted a massive 50-state poll, with ten times as many participants as usual so as to lower the margin of error to almost nothing. They asked some 26,000 voters who they would support in a one-to-one race between only Trump and Kennedy and, separately, between only Kennedy and Biden. The results were stunning. If faced with a choice between President Biden and Kennedy, assuming there was no serious Republican contender like Trump, then Kennedy would win 367 Electoral College votes while Biden would win only 171. If faced with a choice between President Trump (pre-felony conviction/pre-appeal) it was a vastly narrower margin but, Kennedy still won against Trump by taking 270 Electoral College votes versus 268 for Trump.”
The following are several additional points:
- Trump’s Legal Issues: Trump’s convictions on 34 counts have increased his poll numbers. Despite his legal troubles, he still leads in polls.
- Kennedy’s Strong Showing: Robert F. Kennedy Jr. has strong poll numbers, especially in a hypothetical one-on-one race against Biden or Trump. His presence challenges the mainstream narrative and presents a significant threat to the traditional candidates.
- Manchin’s Independent Bid: Joe Manchin’s entry as an independent reflects a growing sentiment that neither Biden nor Trump is suitable. He aims to capture the centrist vote, which both major parties have neglected.
- Potential Contingent Election: Four strong candidates increase the likelihood that no one will secure the required 270 Electoral College votes, potentially leading to a contingent election decided by the House of Representatives.
- Mainstream Media and Polling: Pippa says mainstream media has underreported Kennedy’s poll numbers. A large-scale Zogby poll showed Kennedy winning against Biden and Trump in various scenarios. (Side note: if you try to google the Zogby poll, it likely won’t come up. Use Duck-duck-go.)
- Democratic Party’s Struggles: Despite recognizing its weaknesses, it has struggled to find a viable alternative to the Biden-Harris ticket.
- Legal and Political Implications: The article highlights how current events undermine confidence in the American legal system. Pippa says confidence in the political systems has already been shot.
- Future Implications: Pippa says the race’s outcome could significantly impact the rule of law in the U.S., with potential shifts in how power is wielded in American politics. There is a concern that political prosecutions might become more common, further eroding trust in the judiciary.
In summary, the 2024 Presidential race is shaping up to be highly unpredictable, with significant implications for the future of American politics and the rule of law.
Here is a link to Dr. Pippa Malmgren’s SubStack page.
One last comment: Please view the above through the lens of information. The views expressed are Pippa’s. I realize how hot the topic can be. I am not sharing my opinion in this piece; I am adding dialog for consideration with one hope – that leads to thoughtful discourse. I have my own personal views. I deeply love our country, see it in a tough place, see the geopolitical picture in a tough place and I ultimately believe/pray we come together in a way that better lifts the whole. I respect your views and am happy to have a thoughtful conversation one-on-one.
Not a recommendation to buy or sell any security. For discussion purposes only. Current viewpoints are subject to change.
Random Tweets
Speculative bubble signs, again:
Source: @biancoresearch @jessefelder
This is really good investment advice from Warren Buffett:
Click on the photo. Source: @tickersymbolyou
I “like” and “retweet” posts I find interesting. I enjoy X because I can easily follow people I like to keep On My Radar.
You can follow me on X (formerly Twitter) @SBlumenthalCMG.
Not a recommendation to buy or sell any security. For discussion purposes only. Current viewpoints are subject to change.
Personal Note: New York and Dallas
I have a lunch meeting this Sunday in NYC with good friends Rory Riggs, Barry Habib, and Peter Boockvar. Barry is one of the smartest real estate minds in the business, focusing on the housing and mortgage markets. Peter is one of the smartest economists I know. Rory is a successful entrepreneur, co-founder, and CEO of one of my largest personal investments, among other companies. The discussions will be wide-ranging, and I look forward to the meeting.
I’m traveling to Dallas on June 18 for two days of meetings. On Wednesday, June 19, I’m hosting a small dinner for clients and OMR readers—specific details to follow (accredited investors only). Please reply to this email if you would like to attend the dinner. Space is limited.
If you are following rounds three, four, or five of the meme stock frenzy, Roaring Kitty and his followers have been manipulating the stock in an aggressive way. GameStop announced plans to issue 75 million shares on the heels of the most recent move. That likely explains today’s 39.61% drop.
Source: YahooFinance
The following is from my friend Jim Bianco (click on the photo to link to the WSJ article):
Source: @biancoresearch and WSJ
Clearly, Roaring Kitty is not Warren Buffett.
Have a great week,
Steve
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“The blue line in the lower section shows how much the orange line is above or below the long-term trend line. It is currently in the “Overvalued” zone. Lastly, the data boxes at the bottom of the chart display the annualized gains based on each zone (Overvalued, Fairly Valued – blue line in the middle zone, or Undervalued).”Please take note of the following text:
“The blue line in the lower section shows how much the orange line is above or below the long-term trend line. It is currently in the “Overvalued” zone. Lastly, the data boxes at the bottom of the chart display the annualized gains based on each zone (Overvalued, Fairly Valued – blue line in the middle zone, or Undervalued).”