Just 2 days back I penned down my thoughts for the month of May (read here).
Well, I am going to write some more.
Before I continue, I would like to point out that I tend to focus more on the companies and their fundamentals/earnings/dividend, prospect rather than the overall market or trend. However, what we are going through now is kind of unprecedented and there is just too many news about the market values and forecasts (bombarded daily). Guess I need to sort out some of my thoughts.
We often tend to read or hear what we believe is right. This is even more so during this unusual period of the Covid-19 crisis. The markets have been up for the month of April 2020. And that to many people, is a surprise since technically we are not really out of the woods yet. Even the billionaire investor Howard Marks in his recent memo ‘The world is more than 15% screwed up’: dated 21 April 2020 (read here) warned the recent stock rally doesn’t reflect reality. To quote: “We’re only down 15% from the all-time high of February 19,” the investor said, referring to the S&P 500. “It seems to me the world is more than 15% screwed up.”
Many attribute the rise in prices due to (A) the unprecedented monetary policies, (B) fiscal policies and that (C) there are early signs that the U.S. Covid-19 case and death counts may be levelling off, as the growth of new cases and deaths plateaus. These 3 factors I think are the major factors.
- The economy is in free fall. So why isn’t the stock market? (read here)
Not many have taken advantage of the lows in March 2020 (or more specifically 23 March 2020). I have been reading a lot of articles from both sides, each has differing views (eg. some think 23 March 2020 is the bottom, while others saying we will go lower).
Nevertheless, US stocks in general, are not particularly cheap from a value point of view (even if we take the prices on 23 March 2020). Typically people use these two ratios: Shiller Cape PE (aka Shiller PE ratio for the S&P 500) and Buffet Indicator, to determine if the overall US stock market is over or undervalued.
Shiller P/E, or P/E 10 ratio, is a valuation measure usually applied to the US S&P 500 equity market. It is defined as price divided by the average of ten years of earnings, adjusted for inflation.
Buffett Indicator is the sum total of the market capitalization of all U.S. stocks relative to the nation’s gross domestic product.
- Warren Buffett’s favorite stock-market indicator hits record high, signaling a crash could be coming (read here)
In the above article dated 30 April 2020, to quote: “The Buffett indicator now sits at a historic high of 179%, reflecting the US stock market’s rapid rebound since the coronavirus sell-off, and the 4.8% slump in annualized GDP last quarter. Its current level is well above the average reading of 107% over the past 20 years.”
From both graphs, we can clearly see that US stocks, in general, are not under-valued.
So that begs the question, should I even be invested or investing my hard-earned money now. For the pure blue-blooded value investors, it might seem obvious (eg. should not invest when stocks are over-valued).
However, when looking at the chart, a few thoughts came to my mind. Irregardless of the ~30% market crash which we had just witnessed, stocks have been over-valued for a long time (a very long time).
Let’s look at the Shiller Cape PE chart. The mean and median PE is 16.7 and 15.77. So technically I would be looking at a PE of less than 15.77 for stocks to be undervalued. That did happen briefly in 2009 (around the time of the 2008-2009 GFC)…. probably less than a year. And we all know that it is super hard to time the bottom and psychologically it is hard to buy near the bottom. So hypothetically, if we missed this period (probably hoping for the Shiller PE ratio to dive lower, but it went up instead)… what would one do? Stop investing for the next 10 years?
Similarly for the S&P/Case-Shiller index of property values (read here), if you are a property investor in the US, you would have been waiting very long for prices to be undervalued.
The Shiller Cape PE ratio was invented by American economist Robert Shiller.
When I watched videos on interviews on Nobel Laureate Robert Shiller, he highlighted that these days markets are more driven by psychology.
So yes in very simple terms – we are living in an overpriced period.
To quote the article below:
“All assets are overpriced, according to American economist Robert Shiller. The U.S. as a whole is a market where stock, real estate, and long-term bonds are overpriced, he said in a recent interview with Calcalist. “It is a period of abundance. The economy is strong, but strong is not the same as healthy.”
“He (Robert Shiller) promotes an economic field called narrative economics, the gist of which is that economists need to look beyond hard data and formulas to the stories that affect people’s behavior and decision making. According to Shiller, viral narratives, whether true or false, influence economic events like momentums, recession, or bubbles. This school of thought goes against many more traditional economic paradigms. “
- This Is a Period of Abundance, But a Strong Economy Is not the Same as Healthy, Says Economist (read here)
From what Shiller mentioned, looking purely at hard data (which I reckon includes the Shiller PE) is insufficient, the other key is this ‘narrative economics.
Moving on to Buffett Indicator. Like the Shiller PE chart, it has been in an overvalued position for a long time. Some time since early 2013 till now. It was below 100% from late 2007 to early 2013. Even with the 30% crash in the US markets we just witness in March 2020, the value is still firmly above 100%.
In the Gurufocus website, it states that as of 3 May 2020, the Total Market Index is at $ 28500.6 billion, which is about 132.3% of the last reported GDP. Its current level is well above the average reading of 107% over the past 20 years.
Again, if you are a true blood value investor and a firm believer of the Buffett Indicator, you would have stayed at the sidelines since early 2013. More than 7 years.
While listening to the Annual Shareholder meeting of Berkshire Hathaway, one interesting question popped up:
- Warren Buffett discusses why Berkshire didn’t repurchase shares when their prices sank recently (watch here)
Despite the market crash, Berkshire is a net seller of stocks (as they could not find any companies at an attractive value enough). There are many other factors. For example, Berkshire given the size of the warchest, there are looking to buy companies outright at the US$10 to US$40 billion range (unlike us small time retail investors), and the swift actions by the Fed has no far cushioned many would be ‘in dire straits’ companies from the fall (hence – so far no urgent need for Berkshire’s elephant gun), eg. Buffett’s phone just started ringing prior to Fed’s swift actions (then stopped ringing).
However, it is interesting as to how Warren replied when someone asked him why he did not repurchase Berkshire shares in March 2020 (when they dropped to a price that was 30% lower than the price when he repurchased them in Jan & Feb 2020.
Warren’s first reply was that the crash was a very very short period. Then he added that he did not think that Berkshire shares at current value is not at a significant discount (than in Jan or Feb 2020). He also do not feel that it is more compelling to buy Berkshire shares now (to step up in a big way), and also given situation nows (eg. his decision to purchase airline shares was a mistake).
Actually, if you have been investing for long, you would have noticed that over the years / decades, crashes have became faster and steeper (I guess it is due to all the automated short sellers, margin calls etc, think May 6, 2010 flash crash). The pace of the sell-off is certainly alarming from a historical perspective.
He may just missed it. From a very long term perspective, it probably did not matter much.
- US stock market falling faster than during the Wall Street Crash (read here)
I think many factors affect Buffett’s buying decision. But basically, I feel that generally, Buffett does not think stocks are at an attractive price now. When it comes to Berkshire own stocks, it is also the components (not just the price)… like his mistakes in airline stocks. That is my general feeling.
So yes, it is not a straight forward answer.
So in any way, looking at both the charts, (US) stocks are in general, overvalued for a long time.
Would I then keep all my cash at the sideline and wait for it to be undervalued? Probably not.
For one I would be missing out on all the dividend payout and the rise in earnings of the individual companies. The amount may be small relatively – but if we multiple it by years.. that is a significant amount. 10 years of dividend payout beats bond interest payout or money market fund payout hands down.
- Warren Buffett compares buying stocks to being a farmer (watch here)
Secondly, I feel we need to look beyond just stock prices. Yes, it is an important component. Investing at a time of high stock prices is detrimental to the overall portfolio value, but I am sure many of us would have read articles about the importance in staying invested in the long run. The difference between investing at the right time vs staying invested in the long run (eg. via DCA, Dollar Cost Averaging) is not much.
Even Warren Buffett in the recent Annual Shareholder meeting acknowledged that the stock market “can do anything”…
And I think it is more important to review individual companies individually unless we are index investing.
- Time, Not Timing, Is What Matters (read here)
FYI I do enjoy Peter Lynch quotes very much…
“I am invested all the time. It is the best feeling ever, getting caught with pants up.” Peter Lynch
“In fact, you can argue that if you’re not willing to react with equanimity to a market price decline of 50% two or three times a century you’re not fit to be a common shareholder, and you deserve the mediocre result you’re going to get compared to the people who do have the temperament, who can be more philosophical about these market fluctuations.” Charlie Munger
Thirdly, I think there are now many factors at play here. Personally although I do not really believe that the Fed can prevent a recession or a major market crash. However, looking at the Shiller PE ration during the 2008-2009 Great Financial Crisis, it did not really crash as much as what many has expected (as compared to previous great crisis). Only dropped to 15.
I reckon in a large part the Quantitative Easing (QE) and monetary policies (and fiscal policies) do have a large part to play. If we go way back to the great depression, or even the 1980s, the part that the Federal Reserve played then was relatively small.
Today the Fed seem to learned from the GFC and quickly deployed unlimited QE and unlimited Bond-Buying Plans to cushion the fall. Sure it will not make people go out and spend / restart the economy as a whole… but it sort of change the playbook from the past.
- The Fed Goes All In With Unlimited Bond-Buying Plan (read here)
And yes, we are still having super-low interest rates… for more than a decade.
“Capitalism without bankruptcy is like Catholicism without hell.” Howard Marks
So back to my month of May plan.
I reckon instead of investing, given my relatively low war-chest (only approx. 10%). I think my current priority is to build up my warchest instead. Yes I will still stay invested, but my near term priority is to set aside my salary and dividend towards my warchest.
I need to have more ‘rainy weather” funds and funds I can deploy when stocks do become “undervalued:.
Deploy some when the US growth stocks (price) dropped significantly.