January 31, 2014
By Steve Blumenthal
“Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can’t buy what is popular and do well.” – Warren Buffett
So where are we today? I thought about the above quote as I listened to Dr. Jeremy Siegel, author of Stocks for the Long Run and famous professor from the Wharton School, present to a crowd of nearly 1600 at the 7th Annual Inside ETFs Conference in Florida this week.
Dr. Siegel outlined why recent Nobel Prize winner Robert Shiller’s “Shiller PE” methodology is flawed and concluded his presentation suggesting PEs are moderately high yet he believes there is “more juice left in the book”. I included a link to an article on the subject in this week’s piece.
So let’s take a quick look at the current PE and what it might mean for the market. I suggest what I believe are logical upside and potential downside price targets for the S&P 500 Index. Additionally, I share a few thoughts from the conference and update on investor sentiment (optimism is abating given the recent market indigestion).
I hope you enjoy this week’s On My Radar:
- Professor Siegel on the Shiller PE – More Juice Left in the Book
- Median Price/Earnings Ratio
- Trade Signals – Investor Sentiment
- Concluding Thoughts on the Inside ETFs Conference
Professor Siegel on the Shiller PE – More Juice Left in the Book
Several notes from Dr. Siegel’s presentation:
- 19 times 2013 actual expected earnings puts the S&P 500 target at 2043.
- He chose 19 times because he looked at the average historical PE when the 10-year Treasury yield is less than 8%.
- The average PE over time is 16.7. 19 is the average when the 10-year is less than 8%.
- 19 times 2014 Wall Street earnings per share estimate of 123.63 puts the S&P 500 at 2349.
- 16.7 times 2014 Wall Street’s earnings per share estimate of 123.63 puts the S&P at 2065.
- Personally – I don’t trust Wall Street estimates. SB comment
- Corporations have $2 billion in cash on their balance sheets and they have locked in low long-term rates on their debt.
- The ratio of liquid assets to liabilities has nearly doubled.
- The public is still not in this market.
- The market is not at frothy valuations.
- In every equity market around the world, going back 112 years, stocks are still the best asset class.
- He concluded his remarks noting that the market is modestly overvalued and there is still “more juice left in the book”.
- On Stanley Fischer joining the Fed: he is a good counterpart to Yellen; he did a fantastic job in Israel and is one of the brightest minds on money.
- On banks – got to get them lending. Reduce Fed Funds rate to zero.
On Shiller’s cyclically adjusted PE ratio (CAPE), Dr. Siegel explained that changes in the accounting standards in the 1990s forced companies to charge large write-offs when assets they hold fall in price, but when assets rise in price they do not boost earnings unless the asset is sold. Somehow the way CAPE averages this data distorts its ability to compare PE vs. the historical cyclically adjusted PE ratio data. Also, it is important to note that just a few companies reporting large write-offs can completely skew the data. For further understanding, click here for Don’t put faith in Cape crusaders, by Jeremy Siegel.
I favor Median PE based on actual reported earnings as a guide to market valuation. Median PE removes the large outliers to give a better sense of the whole.
As you’ll see in the next section, the markets are moderately overvalued. Note the Overvalued dotted line, the Median at 16.7 (green line). Also note, fair value based on this means of measurement put fair value on the S&P at 1479 with an upside (Overvalued) target of 1937 and a downside (Undervalued) target of 1020.
Median Price/Earnings Ratio
A note on PE: PE valuation-based indicators are often used as a sentiment indicator, with high valuations indicating high optimism and low valuations indicating pessimism. Extreme deviations from the norm, or median, are watched for to signal high or low risk periods. The Standard and Poor’s 500 Stock Index typically performs better when the Standard and Poor’s 500 Stock Index Median PE is below its historical median than when valuations are far above average.
Trade Signals – “Correction in Place”
Click here for a link to Wednesday’s Trade Signals.
Trade Signals identifies the equity and fixed income markets’ cyclical trend and suggests ways to hedge your long-term focused equity exposure tied to periods of excessive investor optimism. Charts are posted weekly on Wednesdays.
Concluding thoughts on the ETF Conference
The first ETF was launched in 1993. Total assets today are $1.7 trillion. The last three years have seen acceleration in growth and the popularity is expanding. Matt Hougan, the President of ETF.com, kicked off the conference stating, “The ETF revolution is just getting started”. He is projecting total assets to grow to $15.5 trillion in ten years. In comparison, the financial industry in general projects growth to $5.5 trillion in ten years. I later sat down for a discussion with Brandan Conway from Forbes. We both felt $15.5 to be an aggressive target; however, significant growth there will be.
Hougan sited the low fees of ETFs and the advanced tax structure as compared to mutual funds as the primary drivers to growth. He believes ETF AUM will eclipse mutual fund AUM in eight years. What is clear to me is that it is an outstanding tool to be used to deliver important and broadly diverse exposure.
Coming in the years immediately ahead is the expansion of what is being called “smart beta” index funds and the addition of more and more actively managed funds. We’ll also see tactical strategies like ours packaged inside of a single ETF structure. The diverse set of liquid investment tools available for you to build better portfolios is expanding.
I found Dr. Siegel to be surprisingly entertaining. There is a skill to presenting and it was evident he has mastered that skill. On leadership, Pat Riley, current President and former head coach of the Miami Heat, told the story of how he was able to bring LeBron James to the Heat. He promised hard work (he would play for the most fit team in the league) and emphasized team work. All the other coaches trying to recruit LeBron promised fame and money. Riley stressed that no one player can win a championship – the team comes first. Simple, of course, but how do you imbed that into your culture. He was able to sign three of the most talented players in NBA history by sharing a vision that was bigger than any one individual. I left inspired.
All of the major industry players attended. The Blackrock, State Street and Vanguard’s. The manufacturers and product innovators were there as well. I also enjoyed listening to Vanguard’s CIO, Tim Buckly, and Nouriel Roubini share their perspective on the global economic outlook and some takeaways they had from Davos. A bit more upbeat but they reminded the crowd that an awareness of unusual risks associated with QE is mandatory.
Leadership is a major theme around CMG as I’m sure it is in your business as well. Whenever I get really stuck, I turn to my mentor, Jim Ruff. Jim was the mastermind behind Oppenheimer Funds incredible growth. He makes the seemingly complex look so simple. I remember him telling me three years ago, “You just don’t know what you don’t know. I’ve made hundreds of the mistakes you are likely to make. I can help you.” He has opened my eyes and today I see what I didn’t know; of course, there is so much more to learn.
We recently attended a meeting on sales. I’ve asked Michael Sciortino, CMG’s Head of Distribution, to shape a webinar around what he learned. The speaker was phenomenal. I’m also going to ask Jim if he’d present his views on management and leadership. Hopefully, we’ll be able to share them with you soon.
Speaking of Jim, I am, along with my senior management team, heading to Bend, Oregon late next week to huddle up and learn from Jim.
The overall objective is to be incredibly clear with what we’re trying to do, how we’re going to get there and the outcomes we want from the team. How do we cascade the goals down through the organization so that the front-line people know exactly where we’re going.
Importantly, we have built in some down time to ski nearby Mt. Bachelor, Jim’s home mountain. I’m really looking forward to that. Hopefully, we’ll get lucky with some fresh powder snow.
Wishing you a great weekend!
With warm regards,
Steve
Stephen B. Blumenthal
Founder & CEO
CMG Capital Management Group, Inc.
Philadelphia – King of Prussia, PA
steve@cmgwealth.com
610-989-9090 Phone
610-989-9092 Fax
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