I Don’t Get It: Market Valuation, ETFs, Monetary Policy (Kopernik Perspective)

Smart Money

Kopernik Perspective, August 2017

  • Approaching ten years of accommodating monetary policy around the world. At this point, we can agree that the central banks have been brilliant in convincing the average citizen it is a positive to increase credit and keep our economy from crashing
  • Today, the US Fed owns $4.5 trillion in assets including over 20% of all US treasuries and 11% of all US mortgages
    • Japanese ownership of bonds and stocks is approaching $4.5 trillion, which is ~40% of all Japanese government bonds
    • Europe Central Bank is approaching $4.5 trillion in assets and growing
    • Switzerland is approaching $900 billion in assets which is well over 100% of their annual GDP and they are now the 8th largest holder of US stocks
  • While we know the Fed in the US and equivalent central banks around the world are all experimenting with different forms of QE with no practical regard for the unintended consequences, the realities have long been known
  • In Europe, where individual countries don’t have ability to “manage” their own currency (other than Germany), they have much worse debt profiles than the US
    • But their weakest public companies (junk rated) now have debt trading at lower yields than the US federal debt yields
    • Over 60% of European BB rated bonds yield less than similar-maturity UST
  • It is still amazing to see people pouring money so quickly into a price insensitive product such as indexes and ETFs:
    • John Deere’s annual sales peaked in 2013 at $38Bn with net income at $3.6Bn. Revenues are expected to decline 33% and net income expected to decline 45% in 2017 since then. Over that time period, stock price is up 42%
    • Caterpillar’s revenue peaked at 2012 at over $65Bn with net income at $5.7Bn. For 2017, expected to have under $41Bn in revenue and net income of roughly $2.5Bn (37% and 55% declines). Over that time period, stock price up 30%
    • Apple’s revenue peaked in 2015 at $234Bn and net income of $54Bn. Expected 2017 revenue of $226Bn and net income of $47Bn but the stock price is up 42% during this time frame
    • Oil peaked at $115 in June 2014. Exxon’s revenue in Q2 2014 was $98Bn and in Q2 2016 was $58Bn; EPS fell from $2.05 to $0.41 and their payout ratio for dividends has gone from 41% to 183% (debt from $19.4Bn to $44.5Bn). Over this period, stock is up 4% while most small cap oil companies are down big
  • Clearly passive money has created the current scenario where fundamentals matter less to an individual stock’s valuation than the money flows, which creates valuation perversions that ultimately can’t last
  • Index universe has become a big momentum trade. It seems to be one of the most crowded trades in the history of investing
  • Amazon is the darling, having gone up 250% since early 2015. It trades at 190+ P/E. Do most investors remember that the stock went down 94% between late 1999 and late 2001 (sales were up 90% in that time period) and were down 60% from late 2007 to late 2008 (sales were up 29% in that period)? EV to Sales has gone up from 1.5 in 2015 to almost 3.5 today – so yes, company is growing quickly but the valuation is growing much faster
  • Microsoft is thought of very positively for their cloud platform and Windows and Office franchises. Stock is up 175% since end of 2012 while revenues are up 22% and net income is down 13%. It trades at 29 P/E. Do most investors remember that between late ’99 and late ’00, stock was down 63% (sales were up 20% in that period) and was down 60% from late ’07 to early ’09 (sales were up 20% during that time period)?
  • While many people say today’s market is not near as expensive as it was in 2000, the answer is it depends
    • In 2000, top decile of expensive stocks were outrageously expensive while the rest of the market was high but not outrageously so
    • Today, top decile is really high but not nearly as bad as 2000 but virtually all of the rest is very expensive as well
  • Stein’s Law by the economist Herbert Stein: “If something cannot go on forever, it will stop.” More specifically, if a trend cannot go on forever, there is no need for action or a program to make it stop, much less to make it stop immediately; it will stop of its own accord
    • It is so obvious it seems stupid
    • There are times where it is helpful to step back from the noise or narrative everyone is talking about and think about fundamentals and value

Image Source: BAML Research, Using HEAD Index and G0Q0 Indices, Bloomberg, Kopernik