is the S&P expensive?

I’ve been reading a lot of commentary recently that maintains stocks are generally expensive.  Sometimes the commentators even recommend selling, although in true Wall Street strategist style, they’re not very specific about how much to sell or how deep they think the downside risk is.

The standard argument is that if you compare the PE ratio of the S&P today with its past, the current number, just about 25x, is unusually high.

That’s correct.

What I haven’t see anyone do, however, is consider the price of stocks against the price of alternative liquid investments–cash and bonds.  That would tell you what to do with the money if you sell stocks.  It would also tell you that bonds are much more expensive than stocks.

The yield on the 10-year Treasury is currently 2.23%.  That’s the equivalent of a PE of about 44x.  The return on cash is worse.  Cash, however, protects principal from capital loss, except in the most dire circumstances–ones where you’re thinking you should have bought canned goods and a cabin in the woods..

In addition, I think the most likely course for interest rates in the US is for them to rise.  When this has happened in the past, bond prices have fallen while stocks have gone basically sideways.  There’s no guarantee this will happen with stocks again.  But rising rates are always bad news for bonds.

What is surprising to me about current market movements is that stocks continue to be so strong during a time of typical seasonal weakness.





how important is the Trump economic agenda for stocks?

Personally, I’m not a big Donald Trump fan.

In this post, however, I’m taking off my hat as a human being and putting on my hat as a portfolio manager to give my thoughts on how the Trump economic agenda may affect stocks over the coming months.

How I read events so far:

through 1/31/17

–the S&P 500 rose by 10% from the surprise Trump presidential victory through yearend.  Leading sectors were Materials, Industrials and Energy.  The three were all potential beneficiaries of the Trump platform–infrastructure spending, developing domestic energy sources and promoting domestic manufacturing

–the dollar rose by about 7% against the euro.  This came from a combination of hope for accelerating economic growth, and belief that greater fiscal stimulus would allow the Fed to raise short-term interest rates at a faster-than-consensus pace

–promise to reform corporate taxes, to reduce the top tax rate from the present 35% to perhaps 20%, while eliminating loopholes.  Why?  The rate is unusually high in world terms and a key reason for US corporations shifting operations abroad.  My back-of-the-envelope calculation is that tax reform could boost the profits of the S&P 500 by around 10%.  I think it’s reasonable to assume that a large portion of this potential gain was being baked into stock prices prior to the inauguration


during 2017

–stock gains, sector rotation.  the S&P 500 has risen by a further 10% since January 1st.  However, the 4Q16 leaders have ceased outperforming.  The big winners have been IT, Healthcare and Consumer Discretionary–all beneficiaries of an expanding, but not red-hot economy, and the first two with substantial non-dollar exposure

–dollar weakness.  the euro went basically sideways/slightly up from early January until April.  Since then, the euro has reversed course, gaining 10% vs the US$.  It’s now about 8% higher than it was the day before the election.  The yen is a more complicated story, because Bank of Japan policy is to weaken the currency against trading partners’.  The dollar has also strengthened against the yen during 4Q16 and has weakened since.  The yen is now about 6% weaker against the dollar than it was in early November.

my take

The poor performance of infrastructure spending beneficiaries since January suggests to me that there’s little expectation on Wall Street today that Mr. Trump will deliver on his promises in this area any time soon.  So not a worry.

The weakness in the dollar has two aspects:

—–it acts as an economic and stock market stimulus.  For a euro-oriented investor, for example, the S&P 500 has barely moved this year.  In other words, to some degree this year’s stock market rise is being triggered by the currency decline

—–it’s also a function of lowered expectations for interest rate rises in the near future.

Both indicate, I think, a tempering of 4Q16 economic expectations for the US.  The fact that the dollar has basically given up its post-election gains argues that this isn’t a worry either.

Substantial tax reform would likely mean a 10% boost to S&P 500 earnings–and therefore arguably a 10% rise in stock prices. A good chunk of this potential positive was factored into stock prices, I think, in late 2016 – early 2017.  The worry that Mr. Trump will not deliver on taxes may have already put a ceiling on stocks around where they are now.  If concrete evidence of Washington dysfunction around the tax topic emerges, that might easily clip 5% off the current S&P 500 level.

a rainy Friday in August in New York

August is the month when many senior portfolio managers are away from the office on vacation.  So big decisions on portfolio structure tend not to be made.

Friday is the day of the week when short-term traders’ thoughts turn to flattening their books so they won’t carry risk over the weekend.

It’s raining, which sparks thoughts in traders of sleeping in or leaving work early.

Add all that up, and the heavy betting should be that US stocks will likely move sideways in the morning and fade off toward the close.

That means this is a good day to stand on the sidelines and size up the tone of the market.


In pre-market trading, tech is up and bricks-and-mortar retailing (on the earnings miss by Foot Locker) is down.  …nothing new about this.  At some point there will doubtless be a fierce counter-trend rally.  But the negative earnings surprises are still provoking severe selloffs.  So I don’t think today is the day.

Pundits are speculating about the damaging effects on his political agenda of Mr. Trump’s apparent defense of neo-Nazis in Charlottesville.  …but the Trump trade has been MIA since January, with the US a laggard among world stock markets during Mr. Trump’s time in office so far.  Yes, there may be residual hope for corporate tax reform from the administration, which this latest demonstration of the president’s ineptness as a executive could arguably undermine.  My guess is, however, that he is already well understood.

Two questions for today:

–will the market perform more strongly than the season and the weather are suggesting? This would be evidence that there’s still an untapped reservoir of bullishness waiting for somewhat better prices to express itself.

–should we be buying in the afternoon if it’s weaker than I expect?  My answer is No.  I think there is a lot of untapped bullishness, but we’re in a slowly rising channel whose present ceiling is less than 2500 on the S&P 500.   That’s not enough upside for me.  I’m also content to wait for any incipient bearishness to play itself out further.

It will be interesting to see how today plays out.


…finally, internet again

I’ve been travelling in the rural Northwest the past week and have had only intermittent internet access   …until now.

Stepping back from the day-to-day, has its advantages, though.  Having little up-to-the-minute data, I’ve been forced to look at the longer-range stock market picture. 
The first two or three months after the election, the dollar and stocks both rose as investors celebrated the presidential results.  The strongest groups were Energy, Materials and Industrials–the ones that would benefit both from an acceleration in economic growth and implementation of the professed Trump agenda of tax reform and infrastructure spending.

This period ended rght around the inaguration.  It was replaced by a market that embraced secular growth areas of Technology and Healthcare.  The dollar began to drift downward, as well.  This sector/currency shift was partly, I think, a rotation from leaders to laggards that happens in every market that’s not going sideways.  Part was also concern that delivering on the Trump agenda might not be as easy as investors had supposed over the previous months.

During 2Q17, the stock market began to understand how deep the problems are that the Republican party and the adminstration are having in getting anything done.  The main direct consequence of this loss of confidence has been a sharp fall in the dollar, I think, on the idea that failure of the administration and congress to engineer fisal stimulus would translate into a slower pace of interest rate increases by the Fed.  A weaker dollar benefits multinationals, so IT continued to be a winner, along with many members of the Staples group, which also has large foreign exposure.

This last movement has also played itself out in recent weeks, I think.  The market as a whole, and major tech stocks in particular, have begun to move sideways, expressing Wall Street’s belief (mine, too) that they’ve gone up enough for now.  As I see it, action has been based chiefly on relative valuation– rotations deeper into IT via smaller stocks and back into the Trump stock winners of late 2016.  
The kind of movement described in the last paragrah doesn’t typically last long.  At some point, the market will return to the question of whether structural reform in Washington is possible.  As I see it, the underlying notion investors now have is that important change can and will happen, although people may have substantially different pictures of how this will occur.  

It seems to me that as long as investors hold this belief, the US stock market will move sideways to up, driven by earnings gains.

Uber and corporate control


The continuing troubles at Uber have placed renewed focus on the dominant form of corporate organization among internet companies in Silicon Valley:  voting control concentrated in the hands of a small number of founding principals, with the vast majority of shareholders having little or no say in corporate affairs.

The companies in question have more than one class of stock.  The shares the public holds have either no say at all or, at best, a small fraction of the voting power each of the founders’ shares have.

Tech entrepreneurs didn’t invent the idea of multiple share classes.  Companies like Hershey, the NY Times or News Corp. have had this structure for decades.  And, yes, it does create problems.  Insiders are free to ignore the concerns of outsiders, who have little recourse other than to sell their holdings.  Of course, in the case of Uber, that’s easier to say than to do.

vs. GE

I think it’s striking, however, that the other prominent corporate name in the news today is GE, a company with a long history and a wide-open corporate register.  GE’s CEO, Jeff Immelt, is being forced to retire after 17 years at the helm–during which time GE has been a chronic underperformer.

I have some sympathy for Mr. Immelt, who, as far as I can see, inherited the terrible mess that his predecessor, Jack Welch, had created at GE by the turn of the century.  Even if we say Immelt’s first half decade was spent cleaning things up, though, it took a subsequent lost decade before the board decided to make a change.  And that is arguably only because an activist began to stir the pot.

…vs. J C Penney (JCP)

Then there’s the cautionary tale of JCP, where an investor group led by Pershing Square took control of the board a number of years ago.  The newcomers carried out a number of disastrous changes in JCP’s strategy that caused the firm’s profits–and its stock price–to crater.  They then convinced the board of directors to repurchase their stock at what I judge to have been an extremely favorable (for them) price–and disappeared.

In this case, having only one class of stock, and no dominant insider, worked to ordinary shareholders’ disadvantage.

my point?

To be clear, I’m not an advocate of having several share classes.  But I don’t think that’s the Uber problem.

As I see it, early investors backing Uber made a bad mistake in their assessment of the quality of the company’s management.  And by not providing enough mentoring they allowed a toxic corporate environment to proliferate.  The fact of multiple share classes makes it harder to rein in a renegade culture.  But take the multiple classes away and Uber would still have become what it is, I think.







last Friday’s US stock movement

Last Friday the S&P 500 opened at 2436, rose to 2446, fell to 2416 and rallied at the end of the day to close little changed at 2432.  Volume was maybe 10% higher than normal.  Sounds ho-hum.

Look at Financials, Energy or Technology and the story isn’t one of a sleepy summer-like Friday.  It’s violent sector rotation instead.

According to Google Finance, the Energy sector was up by +1.4% for the day and Financials by +0.8%.  Technology fell by -2.7%.

But that understates what happened beneath the calm surface.

Oil exploration and production stocks, which have been in free fall recently, rallied by 4% or more.  Large internet-related names fell by an equal amount.  Market darling Invidia (NVDA) rose by 4% in early Friday trading, then reversed course to fall by 15%, and rallied late in the day to close “only” down by 7%+.  That came on 5x recent daily volume.

What’s going on?

Well, to state the obvious, Friday’s stock market action in the US runs counter to recent trends.  To my mind, the aggressive buying and selling are both based on relative valuation rather than any sudden change in the fundamental prospects for any of the companies whose stocks are gyrating around.  It’s an assertion by the market that no matter how grim the outlook for oil, the stocks are too cheap–and no matter how rosy the future for tech, the stocks are too expensive.

This is part and parcel of equity investing.  There’s always someone, usually with a long investment horizon, who is willing to bet against the current trend, on grounds that current price movements are being driven by too much emotion and not enough by dollars and cents.

what’s unusual

What’s unusual about last Friday, to my mind, is how sharp the division between winning and losing sub-sectors has been and how aggressively stocks have been both sold and bought.

For what it’s worth, I also think it’s odd that this should happen on a Friday. Human buyers/sellers of this size tend, in my experience, to worry about whether they can execute their plans in one day, preferring not to let the competition mull the situation over on the weekend.  But that’s a minor point.  (One could equally argue that if the buyers/sells were looking for maximum surprise, Friday would be the ideal day to act.)

If this is indeed a counter-trend rally, meaning that after a period of valuation adjustment the prior trend will reassert itself (which is what I think), the most important investment question is how long–and how severe–the pro-energy, anti-tech rotation will be.

My experience is that it’s never just one day and that a counter-trend movement can run for a month.  On the other hand, this doesn’t look like the typical work of traditional human portfolio managers.  It looks to me more like trading done by computers.  If that’s correct, I’d imagine the buying/selling will cut deep and be over relatively quickly.  But that’s just a guess.  And I know my tendency in situations like this is to act too soon.

For myself, I’ve been thinking for some time that US oil exploration companies have been battered down too much.  As for tech, I still think it will be the most important sector for this year.  So I’m happy to use this weakness to rearrange my overall holdings, nibbling at the fallen tech names and offloading a couple of REITS I own that I think are fully valued.