BeyondProxy linked to this rare footage of Cundill speaking of his investment philosophy (Value) and approach to capturing the value premium. Peter, a Canadian, found that no matter what was happening in the home market, there was usually a market in which one could find plenty of beaten up stocks. He made it his mission to spend several months each year in the country that had stocks that had been beaten up the most in the prior year. Hence, There is Always Something To Do, which can be found in the bookstore above.

Peter suffered from a neurological condition, which was diagnosed soon after he gave this lecture, and he died in 2011.

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The author of that post suggests that the CAPE is useless for comparisons since FAS 157 changed accounting for fair value. A review of other posts recently made by the author indicate that he is fairly bullish on not just the market, but also the economy.

I am a rational optimist and I would like to be as optimistic as “valueplays”, but he is wrong to assume that the reason for the concern about market valuation is merely because of the level of the CAPE. As I have written in more detail before, and even indicated in that last post, it is the other statistics that consistently corroborate the CAPE that indicate there is not something fundamentally different about this period compared with prior periods.

Consider, for example, Tobin’s Q ratio, which measures the market’s price relative to the replacement cost of the assets for all of the companies in the market. It is higher than at any time in history bar the dot com bubble when investor psyche went overboard on “it’s different this time” thinking.

Notice that Tobin’s Q is not a straight measure of corporate book value, for which it is possible that one component–retained earnings–could be distorted by FAS 157. Tobin’s Q is an estimate of the cost to replace the assets that are already in productive use. It may not be perfect, but it corroborates the implications of the CAPE.

Consider, also,  Warren Buffett’s favorite indicator of market valuation known as Buffett’s P/E given by the following ratio:

(Market capitalization) / (Nominal GDP)

Notice FAS 157 would have little influence on nominal GDP. Buffett’s P/E is more than two standard deviations higher than it’s average since 1950. Again, the only time it has been higher was during the ridiculous dot com bubble.

I have also written that the recovery has been weak based on my favorite employment statistic. But, earlier this month ”valueplays” saw “Positive Signs Everywhere“. I certainly hope he is correct, but this market looks to me like it is one misstep away from a long fall based on the above statistics and:

1. Total debt is higher than at any time in history (there was no de-leveraging);
2. Interest rates are lower and the Federal Reserve Balance Sheet is higher than any time in history. The Fed is practically out of bullets; and
3. Corporate profits–the most mean-reverting statistic in finance according to Jeremy Grantham at GMO–are as high as they have been in history;

Invest accordingly.

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We still have some way to go before asset prices normalize for the S&P 500 index, which makes up about 90% of US stock market capitalization. The CAPE and all price-to-fundamental ratios like it (e.g. Tobin’s Q, Buffett’s PE, etc.) are still high and they are all higher than their long-run averages by about the same percentage. That consistency reinforces the notion that it’s the market’s price that is the issue and not that there is something fundamentally different this time with respect to earnings, free cash flow or the replacement cost of business assets.

The CAPE is 24.90 after (last week’s) drop in the S&P 500 to 1970.89. Even if we generously assumed that real S&P earnings for the most recently available month (March 2015’s $100.57) was the proper figure to use in the denominator (as opposed to the lower real $79.13 S&P earnings over the last ten years), the S&P 500 index could still fall another 15% before the CAPE reached its long-term average (16.63). Unfortunately, no one knows when it will regress back to that level. It is impossible to predict it.

In addition, few consider that maybe the current CAPE average is too high. Both the numerator and denominator in the CAPE are adjusted for CPI inflation, so it reduces the ratio to long-run fundamental market and business activity. The CAPE averaged 14.78 from January 1881 through December 1994, which is 11% less than today’s CAPE average since 1881, largely because today’s CAPE average includes the greatest bubble in the market’s history (the dot com bubble). That suggests the S&P could fall 25% from 1970.89 even with the generous earnings figure used for the denominator.

PAR does not care about the market as a whole when it invests client funds in its Separate Account Value Investing (SAVI) strategies, so PAR is not investing as if the market were going to drop another 25%. PAR is still looking from the bottom up for SAVI  clients because that is the way to uncover opportunities that have an MOS, but there should be no surprise that there are far fewer opportunities when the CAPE is 24.9, like today, than when the CAPE is 13.3 as it was in March of 2009.

March 2009  was the last time PAR became fully invested. Most of those new positions in which PAR invested in 4Q08 and 1Q09 to become fully invested were gradually liquidated over the subsequent twelve- to eighteen-months and have largely sat in cash  since. PAR’s SAVI strategies are only a small part of PAR’s clients’ portfolios.

PAR Wealth Management also offers traditional wealth management services as a fee-only fiduciary. PAR Wealth Management is a goals-based financial adviser. Once a client’s goals are quantified and prioritized, PAR Wealth Management allocates that client’s capital to investments with qualities that match those specific goals and how a client feels about risk. Capital for short- and intermediate-term goals are generally allocated to safer, more-liquid investments. For a large percentage of a client’s long-term goal allocation, PAR Wealth Management generally chooses external managers who demonstrate an ability to capture factor premia.

Update 8-24-15: I do not want to leave the impression that the only way for the CAPE to normalize is for the S&P 500 to drop precipitously. The other way is for the denominator–earnings–to rise considerably. But, the denominator will not rise without growth in value-creating economic activity in the private sector, and that takes time. Value-creation has been stagnant since 2008 and there is little on the horizon to suggest that the private sector will turn robust. In any case, the numerator (the level of the S&P 500) would have to rise much slower than the denominator. So, either way, whether it is a numerator that falls or a denominator that rises or some combination, it portends low stock market returns over the next decade. As I have written before, invest accordingly.

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The first statistic is a macroeconomic indicator called the Employment-to-Population Ratio (E/Pop, to distinguish it from E/P or earnings yield). I prefer E/Pop to all other employment-health indicators because, unlike the unemployment and labor force participation rates, it takes the least amount of manipulation to calculate it.

E/Pop is simply the number of adults (16+ YO) employed in the US divided by the number of people 16+ living in the US who are not in institutions (jail, mental health facilities, etc.) or in the military. No one has to guess whether these people are “looking” for work or really “participating”. It measures the  number of people truly working relative to the number of us relying on those who are working to pay our collective bills. After all, the money that pays our bills can only come from people who produce; it is not created from thin air.

If there is a weakness in this indicator, it is that it overestimates economic strength by including in the numerator those who work part time, especially now when the proportion of part time workers is elevated.

http://www.advisorperspectives.com/dshort/updates/Full-Time-vs-Part-Time-Employment.php

Robust economic conditions are indicated by relatively high E/Pop ratios and weak conditions by relatively low E/Pop ratios.

The E/Pop has indicated that the economy is weak and that this “recovery” since 2007 could easily be labeled “stagnation”. The E/Pop plummeted in the housing crisis and despite unprecedented fiscal and monetary stimulus, it has barely gotten off the mat since. May’s reading announced today is 59.4%. The last time (before the current stagnation) that it was this low was in April 1984 when the economy was still digesting Paul Volcker’s attempt to choke off the inflation debacle of the late 1970s.

The second statistic–one that continues to worry me about the stock market–is Robert Shiller’s Cyclically Adjusted PE (CAPE) ratio. The latest reading shows that the stock market’s price equals 27.38 times its trailing ten-year earnings. The last time it was this high was July 2007, almost to the day that the housing crisis began and about one year before the stock market plummeted in response. It was higher only twice before in history, just before two of history’s most terrifying market crashes.

I write about these “macro” themes because, as Howard Marks says, it’s important for “intelligent investors” to know where the economy and market stand as they go about their business of evaluating businesses one-by-one and determining whether they can purchase those businesses at prices that deliver a Margin of Safety. Since 2011, the level of the CAPE helps explains why investors have found so few opportunities that possess a Margin of Safety. Invest appropriately.

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http://ngam.natixis.com/docs/265/1012/2015%20Individual%20Investor%20Survey%20white%20paper_FINAL,0.pdf

Many of the findings show that individuals are unrealistic and confused. Individual investors say they need 9.7% returns above inflation to meet their goals, which is higher than last year, although 84% said they would choose safety over performance, also higher than last year.

Among respondents, 57% said they had NO financial goals, 67% have NO financial plans, and 77% rely on gut instincts to make investment decisions. Despite this admitted lack of planning, 66% of respondents claimed strong knowledge of the income they would need in retirement: namely, 63% of pre-retirement income, which is less than the 75% to 80% that many advisers recommend.

Friends, if you would have answered the same way on any of these questions, call or email me. We can help you plan for the future. If costs are an issue, these findings show that the only thing more expensive than a financial adviser is the lack of a financial adviser.

It is no wonder that Natixis draws one clear conclusion from the survey:

One thing is clear: Now is the time to help investors set clear goals and plans, while also enhancing their knowledge and understanding of markets, investments and strategies to help them meet their goals.

ray@parwealth.com

PAR Wealth Management employs goals-based planning and asset allocation to help you define and reach your goals. PAR Wealth Management offers you access to Money Guide Pro, the top goals-based planning software for advisers and their clients, and Yodlee, a leading account aggregation tool, so that you can see all of your assets and real-time progress toward your goals with one login (marketable securities are updated real time across all accounts no matter where the assets are held).

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“Every day you’re not selling an asset that’s in your portfolio, you’re choosing to buy it.”

The idea is that managers have to look at everything fresh every day in light of all new information, so that holding a position is no different from buying it, especially if there are no tax implications for selling (e.g. positions in retirement accounts, endowments, etc.). That perspective helps prevent managers from falling in love with their positions. It’s akin to Sir Arthur Quiller-Couch’s admonition for writers to “Murder your darlings.”

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“At the quarter-century mark of 1925, the great bull market was under way, and Graham, then 31, had enjoyed impressive success as an investor in the challenging years since 1915. During an early-1929 conversation with business associate Bernard Baruch, both agreed that the market had advanced to ‘inordinate heights, that the speculators had gone crazy, that respected investment bankers were indulging in inexcusable high jinx, and that the whole thing would have to end up one day in a major crash.’ Years later Graham lamented, ‘What seems really strange now is that I could make a prediction of that kind in all seriousness, yet not have the sense to realize the dangers to which I continued to subject the Account’s capital [money he managed for clients, family and friends],’ which, by 1932, had shrunk to 15% of its 1929 value. Graham’s prodigious intellect was not defense enough against what he later described as a ‘bad case of hubris.’”

Surely Graham was not alone in having at least a vague notion in the mid- to late-20s that things would end so badly in the summer of 1932. What he and others lacked was not so much the conviction, but the moral courage and the temerity to say ‘No’ when everyone else was saying ‘Yes.’”

It is not enough to use reason and diligent analysis to draw a conclusion that is different from the consensus.  One must also act on that conclusion. That is the most difficult part for even the smartest of investors. Investment success in this case is not a question of intelligence, but the ability to stand alone, which researchers have shown causes emotional pain akin to being ostracized by your tribe.

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Among my clients’ ten corporate exposures is a gambling-related company (and it’s also a spinoff) and a defense-related company (a spinoff)–the “bets and bombs” components of the “butts, booze, bets and bombs”. PAR previously invested in the butts (UVV) and booze (TAP) and other bomb (NOC) components. It is much easier to find a Margin of Safety in these areas. Enjoy:

http://blogs.wsj.com/moneybeat/2015/02/13/sin-vestors-can-reap-smoking-hot-returns/?mod=djintinvestor_t

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The S&P 500 Index delivered a 13.69% return in 2014 as the market continued to reach new highs after reaching new highs in 2013. This year, for the first time, I have highlighted the years corresponding with the inflation and bursting of the DotCom bubble (grey) in addition to the Great Depression (yellow) and the Housing bubble (blue).

Clearly, there were more extremes and more years of extreme results during the Great Depression than the two most recent crises. In eight of the years from 1928 through 1938, the market either lost or gained more than 30%. In contrast, in each of the DotCom and the Housing bubble periods, the market had just one year of such an extreme.

There were obviously more extremes and more years of extreme outcomes during the Great Depression than the two most recent crises. Over the eight years from 1928 to 1938, generic cialis sales grew by 40% and you can read more about these successes on the main page of our website.

In half of all years since 1825, the market delivered a return between -10% and +10%. So, if we narrow the definition of extreme to losses or gains of more than 10%, the Great Depression experienced nine such years, the DotCom bubble five, and the Housing bubble five.

Many argue that the Federal Reserve is getting better at managing crises, and the above data would seem to agree. The Great Depression was the first crisis that the Fed experienced and many recent policy makers, including Ben Bernanke, went to school on Great Depression policy. On the other hand, others argue that the mere awareness of a Federal Reserve “put” is creating crises that future Fed policy will be unable to fix. I guess we will know who is right soon enough.

The return mode is still 0% to 10%. In a large majority (71%) of years, the market is positive. And, the market experiences declines of 10% (20%) or more in a mere 13.7% (4.9%) of years. So, an outsider’s perspective indicates that investing in the broad market is clearly in your favor, in part because of natural inflationary increases, and in part because of real increases in productivity and earnings due to technological and human capital advances.

The insider’s perspective is a different story. As of January 19, 2015, Shiller’s CAPE sits at 26.7, which is 61% above the average CAPE of 16.6 since January, 1881. The only periods in which the CAPE was higher than today were 1929 – 1930, immediately before the Great Depression; late 1996 – 2002, immediately before and after the DotCom bubble burst; and from late 2004 – late 2007, immediately before the bursting of the housing bubble. So, the CAPE is not a great short-term timing mechanism because recent extremes were able to persist for long periods, but it is an excellent indicator that the piper has to be paid eventually.

Other market indicators including Tobin’s Q and Buffett’s PE confirm the implications of Shiller’s CAPE. Investors who were cautious in periods like this had dry powder to exploit market declines. Investors who chased returns in periods like this rode the market without a brake (a hedge) and often only got off the ride by jumping off at market lows.

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