The deviation in performance has reached historic extremes.

The last time that “value” underperformed “growth” by such a large degree was heading into the “dot.com” crisis. At that time Warren Buffett was being ridiculed for underperforming the S&P 500 by such a large degree.

He was vindicated for his “value” approach shortly thereafter.

 

 

 

 

Of course, a major reason for that underperformance is the $128 Billion in CASH that Buffett is holding on his balance sheet. Of course, for a value investor like Buffett, it is hard to invest cash into a market where there is little to no value, and forward 10-year returns are expected to be low.

 

 

 

 

In other words, when the media starts dismissing Warren Buffett, maybe its time to start considering the “why” he is sitting on so much cash.

 

The Federal Reserve Injections of Capital into the Markets

Going back to 2016, as the world faced a “Brexit” crisis, the Fed, ECB, and the BOE all joined forces to provide liquidity to the markets. Then, just before the 2016 election, as the world was concerned a “Trump Election” would crash the market, the Fed provided a huge boost of liquidity. All along the way, each dip in the market was met by liquidity support.

Currently, we are being told there is “nothing to worry about” with respect to the financial system. Maybe, but the amount of liquidity being injected dwarfs all previous injections by massive proportions.

 

 

 

 

So, despite commentary to the contrary, there are only two conclusions to draw from the data:

  1. There is something functionally “broken” in the financial system which is requiring massive injections of liquidity to try and rectify, and;
  2. The surge in liquidity, whether you want to call it a “duck,” or not, is finding its way into the equity markets.

The Fed’s bad choices have compounded to the point where all the options are bad.

I see almost zero chance the Fed will end the repo program after the six months it presently plans, because I see zero chance the federal deficit will shrink.

 

 

 

Sentiment (Fear vs Greed in the Markets)

Currently, “exuberance” has returned with a vengeance.

Last December we had a 20% correction and the CNN Greed and Fear index went to 1.

 

 

 

 

But it isn’t just sentiment which has gotten extraordinarily extended, but also investor positioning on many levels both individual and professional.

 

 

 

 

Slow Economic Recovery

 

 

 

 

This is why the differential between GAAP earnings and corporate profits is going to be a major challenge for investors going forward.

As such, stocks will likely once again be reliant on both multiple expansion and share buybacks for further gains in 2020. However, there are limits to just how many shares a company can repurchase given balance sheet constraints of both liquid cash and debt levels.

The bullish case does remain as both fiscal and monetary stimulus remains excessively abundant. Given the recent passage of another $1.4 trillion continue resolution to increase spending without the constraint of a “debt ceiling,” and the Fed continuing with monetary interventions, the amount of money sloshing around the system has to go somewhere.

 

 

 

 

Iran

Iran’s oil exports declined substantially last year.

 

 

 

 

Here is Iran’s GDP growth.

 

 

 

 

US Imports From China Have Changed

 

 

 

 

Negative Interest Rates

Sweden’s Riksbank decided in late 2019 to exit from negative interest rates. Economist Daniel Lacalle explains why it was right to do so and others that haven’t, like the Bank of Japan and European Central Bank, aren’t helping their economies.

Key Points:

  • Negative interest rates spring from a wrong diagnosis: that growth falters because people and businesses save too much and therefore saving must be penalized to stimulate the economy.
  • In fact, low growth is due to excessive debt, artificially induced overcapacity and subsidies to unproductive businesses.
  • An investment that is profitable with rates at -0.5% but unviable with 1% rates is hard to imagine, but any that exist are time bombs waiting to explode.
  • Negative rates are a huge transfer of wealth from savers and workers to borrowers and the government – essentially a tax on caution.
  • Sweden reversed policy after it observed negative rates failed to stimulate investment and consumption.

Bottom Line: Like other monetary policies, negative rates give governments an excuse to delay beneficial reforms that politically powerful groups wish to avoid. They don’t solve the underlying problems and may even aggravate those problems. We haven’t seen negative rates in the US yet, but with the president tweeting he likes the idea, it could happen.

“I believe the benefits of negative rates have become overwhelmed by the costs and risks, and I believe that we are going to look back on this period of negative rates as being problematic to the functioning of a market-based economy.” – Mohamed El-Erian, chief economic adviser at Allianz and former chief executive at Pimco, believes the United States is riding a “liquidity wave” that can’t last forever.

 

Current Market Valuation

The chart is from Ed Easterling, founder of Crestmont Research.  The Crestmont P/E of 34.5 is 135% above its average (arithmetic mean) and at the 100th percentile of this 14-plus decade series. The prior P/E10 high was in 2000 at 33.7. Note the other peaks and troughs in the lower section of the chart.

A much better entry point is highlighted in green. That will be a move back towards the long-term P/E10 growth trend line (red).

 

 

 

 

Warren Buffet’s Favorite Chart for Market Valuation

“We have long felt that the only value of stock forecasters is to make fortune-tellers look good. Even now, Charlie (Munger) and I continue to believe that short-term market forecasts are poison and should be kept locked up in a safe place, away from children and also from grown-ups who behave in the market like children.” – Warren Buffett

Total Stock Market Capitalization as a Percentage of Gross Domestic Product (a.k.a. Warren Buffett’s Favorite Chart)

Here’s how to read the chart:

  • Simply focus on the blue line. It tracks the total value of the U.S. common stocks (NDR Estimate). As of December 31, 2019, the stock market is valued at $33.31 trillion and US Gross Domestic Income (nominal means before inflation) is $21.54 trillion.
  • The Total Stock Market Capitalization as a Percentage of Gross Domestic Product is 154.6%. To put that into perspective, it is the second highest in history looking at data back to 1924.
  • Other high periods are identified in red: 1929, 1973, 2000 and 2007.
  • Think of the entire US market as one singular business. What is our revenue relative to the value of our business? Ours is a big business and we can only grow our business so fast. Prior to 2000, we grew our GDP north of 3% per year. Since 2000, we’ve been growing at 2% per year. Note too how over time the blue line moves above and below its long term up trending line (black dotted line). Better value will present, like it did in 1980, 2003 and 2009 at or below the long-term growth line.
  • Bottom line: By this measure, the stock market sits at the second most overvalued level in history. More defense than offense. No wonder Warren Buffet has accumulated so much Cash, $128B!

 

 

 

 

I also like Price-to-Sales, Price-to-Book, Price-to-Cash Flow, and others to properly value the stock market. Pretty much no matter how you slice it, the market is “Extremely Overvalued.” Here’s a look at various other metrics. Red is bad, green is good.

 

 

 

 

Market Cash Levels

NDR Total Stock Market Value vs. Money Market Funds

Here’s how to read the chart:

  • As of December 31, 2019, the top section shows the Total Stock Market Value equals $33313 billion.
  • As of December 31, 2019, the middle section shows the Total Money Market Fund Assets: $3.6 trillion.
  • As of December 31, 2019, the bottom section shows that Total Money Market Fund Assets are 10.8% relative the $33.3 trillion Total Stock Market Value. It’s as if you have $1 million in the stock market and you have $110,800 in your money market account.
  • The idea here is just how much money do you have sitting on the sidelines that might be used to buy stocks. Keeping in mind we all need some cash available for certain spending needs or emergencies. Thus, the balance rarely gets too low.
  • The red arrows show when investors are aggressively invested in stocks (little money in reserve to buy and bid prices up). Note the dates and think about Sir John’s advice. This chart shows what investors are actually doing with their money.
  • The green arrows are the big buying opportunities. Again, note the dates. This chart is a good statistical visual of investors doing the wrong things at the wrong times. Look at all the cash in 2009. No wonder it was such a great buying opportunity.
  • Finally, the red/yellow circle shows what the stock market performance when cash is “Below lower bracket” vs. “Between brackets” and when cash levels were highest “Above upper bracket.”

 

 

 

 

Nifty Fifty of the 1970’s vs FAANG Now

Do you recall the “Nifty Fifty” craze in the 1970’s? I do. It was the bubble of the day. John Hussman shared this in his piece:

“The Nifty Fifty appeared to rise up from the ocean; it was as though all of the U.S. but Nebraska had sunk into the sea. The two-tier market really consisted of one tier and a lot of rubble down below. What held the Nifty Fifty up? The same thing that held up tulip-bulb prices long ago in Holland – popular delusions and the madness of crowds. The delusion was that these companies were so good that it didn’t matter what you paid for them; their inexorable growth would bail you out.” (Forbes Magazine, 1977, “The Nifty Fifty Revisited”)

John then shares what happened next:

Blue Chip Performance: 1973-1974
Du Pont -58.4%
Eastman Kodak -62.1%
Exxon -46.9%
Ford Motor -64.8%
General Electric -60.5%
General Motors -71.2%
Goodyear -63.0%
IBM -58.8%
McDonalds -72.4%
Mobil -59.8%
Motorola -54.3%
PepsiCo -67.0%
Philip Morris -50.3%
Polaroid -90.2%
Sears -66.2%
Sony -80.9%
Westinghouse -83.1%

He added, “We forget.”

And he then takes us through 2000-2002.

Blue Chip Performance: 2000-2002
Cisco Systems -89.3%
Microsoft -65.2%
JP Morgan -76.5%
Intel -82.3%
McDonalds -74.4%
EMC -96.2%
Disney -68.4%
Oracle -84.2%
Merck -58.8%
Boeing -58.6%
IBM -58.8%
Amgen -66.9%
Apple -81.1%

He added, “We forget.”

Along the way, John shows valuation data and compares today’s valuations to times past and shows what that means in terms of risk.

Blue Chip Performance: 2007-2009
Google -65.3%
Bank of America -94.0%
Microsoft -50.3%
Merck -65.5%
Coca Cola -42.3%
JP Morgan -68.5%
Intel -56.8%
AT&T -49.3%
Cisco Systems -60.0%
Boeing -72.6%
Apple -60.9%
Citigroup -98.1%

Is this going to happen again? We don’t know. But what is clear is that, as John puts it, “A passive (Buy and Hold) stock-bond portfolio mix currently faces the lowest prospective returns in history.”

Everyone is overweight passive indices, funds and ETFs. The 60/30/10 S&P 500, Treasury Bond and T-Bill mix fell to just 0.30% annually over the coming 12 years. “The lowest level in history, breaching even the dismal prospects observed at the August 1929 pre-crash peak.”

 

 

 

 

US and Worldwide Manufacturing Weakness

The Institute for Supply Management’s (ISM) Manufacturing Index fell to 47.2% in December. A reading below 50% indicates the manufacturing sector is contracting. The December reading is the lowest since June 2009.

 

 

 

 

Meanwhile, ISM’s new orders index—which measures demand—fell to its lowest reading since April 2009 when the US economy was mired in The Great Recession. “Global trade remains the most significant cross-industry issue, but there are signs that several industry sectors will improve as a result of the phase-one trade agreement between the US and China,” Timothy R. Fiore, chair of the Institute for Supply Management Manufacturing Business Survey Committee, said in a statement.

Market Data
  • The latest survey of manufacturing purchasing managers showed further deterioration, the kind we usually only see during recessions. This ends the longest streak since 1950 of “not bad” readings.
  • The 12-month trailing weighted earnings in the S&P 500 plateaued a year ago and have failed to rise meaningfully. They are now down more than 2% from the peak, even as the price of the S&P 500 itself has kept rising.
  • The Baltic Dry Index of shipping costs has plunged over the past several months, now down nearly 70% from the peak in September.
  • Even though prices have risen consistently, it’s not due to better earnings. Within the Russell 3000 universe of stocks, there are now the most money-losing companies in at least 15 years. There is also a near-record number of money-losing IPOs, thanks in part to a record high in venture capital-backed issues.

 

All content is in the opinion of Brian Decker