Valuations
First a bit of a context where valuations are now at.
Let’s start with the US Stock Markets.
S&P 500
The mean and median PE ratio for the S&P 500 is 15.82 & 14.83 respectively. On 2 Sept 2020, the PE ratio is 30.78. That is almost double the mean/median PE.
Nasdaq
Then we look at Nasdaq. Looking at Nasdaq PE Ratio range over the past 13 years, the median PE was 19.24. On 3 Sept 2020, the TTM PE ratio is 24.075. Much higher than the median PE.
Market cap to GDP ratio
Another way to look at valuation, is via the market cap to GDP ratio. This ratio compares the total market cap of all U.S. publicly traded stocks with GDP. More specifically, it calculates the total value of the outstanding shares of all U.S. domiciled, publicly traded companies (the numerator), and divides that number by total GDP.
As per the article below, the U.S. stock market, collectively, is about 77.0% overvalued.
U.S. Stock Market Hits Record 77% Overvalued (read here)
The following chart will provide more clarity. The top graph shows the market cap to GDP ratio; the middle graph is the level of the S&P 500 Index; and the graph at the bottom represents the annualized growth rate of GDP (after inflation). The bottom lists each president from Jimmy Carter to Donald Trump for quick reference. The grey-shaded, vertical areas represent recessions.
Note the top right of the graph. Currently, the degree of overvaluation is around 77.6% (177.6% – 100% = 77.6%). The previous record high was 49.3% on January 26, 2018. Prior to that, the highest reading was 49.0% overvalued in March 2000, just as the Tech Bubble burst. So yes, now it is significantly overvalued base on this chart.
Schiller PE Ratio
The cyclically-adjusted price-to-earnings (CAPE) ratio of a stock market or the Schiller PE ratio, is one of the standard metrics used to evaluate whether a market is overvalued, undervalued, or fairly-valued.
The way it works is that you take the average of the last ten years of earnings, adjust them for inflation, and divide the current index price by that adjusted earnings. This makes it so that the current price is divided by the average earnings over the latest business cycle rather than just one recent year of bad or good earnings.
The Shiller PE ratio for S&P 500 on 2 Sept 2020 is 32.89 which is much higher than the mean and median PE ratios of 16.74 and 15.80 respectively.
Singapore Stock Market
On the other hand….If you have been a long term investor of the STI Index ETF, you would have been keenly aware of the under-performance of the Singapore stock market in comparison to the US stock markets (esp. Nasdaq).
What is happening to the STI Index? (read here)
Are Investors Overlooking Singapore’s Straits Times Index? (read here)
To quote the above article: “Over the past five years, the S&P 500 index (as represented by the green line) has increased by 51% but the STI has gone the other way — to negative 19%.”
Over the past 10 years, its average PE ratio of the STI was around 12x. On 2 Sept 2020, the PE ratio of SPDR Straits Times Index ETF (ES3.SI) is 10.51, even lower than the average PE ratio.
The STI’s major components are the three banks, taking up close to 40% of the index. Other stocks that make up the top 10 companies include Singapore Telecommunications (SGX: Z74), Ascendas Real Estate Investment Trust (SGX: A17U), and Thai Beverage Public Company (SGX: Y92). Basically the ‘old industry’ stocks. Which could probably explain its underperformance to other markets such as the tech heavy Nasdaq.
Nevertheless, 30 companies of the STI provide some 44% exposure to the Asia-Pacific region, with Singapore taking up 49%. And investors get to partake in the growth in the region here.
However, Singapore being an open market, any drastic changes or crash in the US stock markets would inevitably affect the stock market here.
Will markets stay elevated?
To be frank, your guess is as good as mine. However, back to the market cap to GDP ratio chart. During this pandemic, GDP has fallen while stocks (and market cap) have risen, creating the highest level of overvaluation since the ratio began in January 1971.
There are a few factors that are commonly acknowledged for the rise in market cap.
We are aware that the markets ‘bottomed’ on 23 March 2020 (now on hindsight).
During the Federal Open Market Committee’s emergency session held in mid-March 2020, central bankers lowered interest rates to near-zero levels and eventually committing to buying more than $1 trillion in assets.
In April, Fed chair Jerome Powell made clear the U.S. central bank had no plans to raise interest rates anytime soon and expects the economy to need monetary assistance for some time. And we are all aware that Federal Reserve is doing whatever it takes to keep the economy afloat.
The Fed has set short-term interest rates near zero and is pledging to keep buying government bonds and other assets indefinitely.
Federal Reserve Doing ‘Whatever It Takes’ to Keep Economy Afloat Amid Coronavirus (read here)
Indeed with low interest rates, very few investment categories offer a good alternative to the stock market. Cash is paying next to nothing and bond yields are at historic lows. You could invest in gold and silver and some high-flying tech stocks but buying these after such an increase could prove risky. With a lack of alternatives, you might say stocks are the only game in town. Moreover, suppressing interest rates helps to “steer” investors into stocks – a technique known as financial repression.
So back to the question: Will the (US) Stock Markets stay elevated?
However, at some point, stocks will fall (or GDP will rise), and the ratio will decline. My argument is that it will be the former – stocks will fall. Why? Simply because the Fed and the US Government cannot keep the economy afloat indefinitely (despite Fed’s pledge).
As of late Aug 2020, the Fed balance sheet is close to $7 trillion.
A $10 Trillion Fed Balance Sheet Is Coming (read here)
A glance at what other notable investors are doing
Besides reading or listening to the notable investors, it might be more worthwhile to see what are their recent trades (and try to understand).
Warren Buffett
Over the years, a number of Warren Buffett’s Berkshire Hathaway’s trades contradicted with his earlier statements. From the purchase of IBM stocks in 2011 then Apple stocks to the purchase of airline stocks (and subsequent sale), and the recent purchase of stocks of a gold mining company, Barrick Gold Corp.
Buffett has in the past said he doesn’t like investing in gold. Unlike dividend-paying stocks or high-quality bonds, buying and holding the metal in an investment portfolio generates no income.
Surprisingly, Buffett opened a stake in Barrick Gold (GOLD) in the second quarter this year, while exiting Goldman Sachs (GS). Berkshire bought nearly 21 million shares of gold mining giant Barrick Gold, valued at more than $563 million.
In addition to exiting Goldman Sachs, Buffett also slashed stakes in JPMorgan Chase (JPM) by 61%, but made recent purchases of Bank of America (BAC) stock (its second biggest portfolio position). So technically, he did dump all bank stocks.
Basically, my thought is that JPM and GS have much bigger exposure to derivatives, as compared to BAC. And Buffett once famously mentioned in 2002 that he viewed derivatives as time bombs. To quote: “In my view, derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal”.
And yes, it will not end well if there is a systematic collapse of the financial system. Well, this recent move to move away from banks with big exposure to derivatives, plus the tiny stake in a gold mining company (whose earnings by the way are heavily dependent on the price of gold) – seem to point to a not so rosy near future.
Ray Dalio
Ray, who famously said that ‘cash is trash’ prior to the market crash early this year, also mentioned “a bit of gold is a diversifier”.
Cash is trash; hold some gold – billionaire investor Ray Dalio (read here)
Well, in his recent Q2 2020 13F filing, we can see that approx. 20% of his Bridgewater $5.96 billion portfolio is in gold ETF. Ray Dalio’s hedge fund poured more than $400 million into gold in the second quarter of this year. That is a very significant increase in a very short time despite his earlier comments prior to the market crash to just hold ‘a bit’ of gold in the portfolio.
Billionaire Ray Dalio’s Bridgewater fund poured almost half a billion dollars into gold in Q2 (read here)
In gist
Well, nobody knows when the market will crash, and I don’t believe in staying out of the markets totally. Nevertheless, the above are just broad valuations of the overall markets, and if you invest in individual stocks, it is more important to understand the fundamentals and narratives of the companies themselves.
Just make sure when it does, you have a war-chest ready, and perhaps now is not the time to continue chasing some of the stocks with lofty valuations.
Some people are comfortable staying fully 100% invested. For me, I would like to have some at the side (for the rainy days).
Ultimately our worst enemy is ourselves.
A Pen Quotes 