VALUATION UPDATE
CNBC recently ran a story stating that ‘Investors have put more money into stocks in the last 5 months than the previous 12 years combined’.
Wall Street’s belief is that this infusion of capital is grounded in solid fundamentals based upon ‘expected economic activity’. The article quotes Chief Market Strategist Art Hogan “There’s a certain amount of logic to markets right now. It is less about irrational exuberance in the overall market, less about the 1999-2000 levels, and more about what is the driver. The driver is clearly an explosion in economic activity that likely will have some earnings growth in its wake.”
Wall Street is likely getting ahead of itself. The Federal Reserve of St Louis notes, in the following chart, that we are close to 2019 GDP levels. GDP's growth rate seems to have returned to its’ pre-pandemic levels but it might take another year before we are back to break even. (chart source: Federal Reserve Economic Data)
From an employment perspective we used to have a couple million Americans in need of unemployment assistance, currently we have about 20,000,000 Americans drawing unemployment assistance. In my opinion this runs counter to Art Hogan’s “explosion in economic activity” statement. An exploding economy should have largely hired back unemployed Americans., at the minimum we shouldn’t be at the same level we were at 6 months ago. (chart source: DoubleLine)
The CNBC article does not tell us the source of fund flow, it is certainly a combination of individual and institutional purchases. A good guess is that purchases lean heavily towards the institutional camp.
When the Federal Reserve wants to stimulate the economy there is a mechanism whereby the Fed can move money (yes, it just prints it) into the banking system and it is expected that banks will lend the money to business large and small, who will then invest in growth and hire more people. Historically large companies have benefited from this exercise, but medium and small sized business typically have not.
As it relates to the stock markets hedge funds borrow from banks and invest the proceeds, in a leveraged manner.
FRED’s chart below, illustrating M1 Money Stock, shows how the Federal Reserve and the Congress has pushed trillions into the economy. M1 Money Stock is essentially all the US Dollars running through the global economy. (source Federal Reserve, weekly not seasonally adjusted)
Yes, you are looking at $14,000,000,000,000 in additional debt that your children and grandchildren will attempt to pay off. (chart source Federal Reserve Economic Data)
The surge of money flow into stocks could have more to do with money printing than true economic activity.
This attitude of risk taking is supported by an overall sense of euphoria. Citi Research maintains a Panic/Euphoria index and we are currently at unprecedented levels. Looks euphoric. (chart source Citi Research)
Stock trading on the OTC Market is another gauge of euphoria. Typically referred to as Penny Stocks or the Pink Sheets, the OTC Market is commonly made up of U.S. corporations that are barely making it. In 2000 and 2009 we saw large spikes in the prices of these stocks as investors bought in the hopes that their $1 stock will move quickly to a $2 price. Current price appreciation is double those levels. (chart source Portfolio123)
Call option purchases can be an indication of excess. Call options can produce exceptional returns but can also expire worthless, due to their risk they are typically only purchased by traders who specialize in this arena. When markets get euphoric retail investors start buying options. The chart below outlines the four-week rolling sum of call option contracts (most contracts are 1 month in duration) and the total has sky-rocketed from a few billion to a high of roughly 40 billion (10 to 20 times the multi-decade average). (chart source Sundial Capital Research)
Finally State Street Global Advisors publishes a valuation table monthly, currently valuations globally are extended. For example, the S&P 500’s Price/Earnings Ratio, Price/Book Ratio, and Price/Sales Ratio is in the 100% percentile (i.e., the highest percentile ever). (chart source State Street Global Advisors and FactSet)
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DEFINITIONS
Call Option - Call options are financial contracts that give the option buyer the right, but not the obligation, to buy a stock, bond, commodity or other asset or instrument at a specified price within a specific time period. The stock, bond, or commodity is called the underlying asset. A call buyer profits when the underlying asset increases in price. A call option may be contrasted with a put, which gives the holder the right to sell the underlying asset at a specified price on or before expiration. Either can expire worthless.
Citi Panic/Euphoria Model – The Panic/Euphoria involves nine different trackers that are weighted equally. The math incorporates put/call ratios, short interest, retail money market funds, margin debt, the average of American Association of Individual Investors and Investors
Intelligence bullishness, gasoline prices, NASD trading volume relative to NYSE volume, the CRB commodity price index, and the premiums paid for puts and calls. The various inputs are adjusted using techniques including rolling averages, smoothing and detrending and these specific details constitute its proprietary nature, but the outcomes are quite crucial.
Factset – FactSet provides financial information and analytical applications to global buy and sell-side professionals, including portfolio managers, market research and performance analysts, risk managers, sell-side equity researchers, investment bankers, and fixed income professionals. FactSet's software platform, also called FactSet, includes real-time news and quotes, company and portfolio analysis, multi-company comparisons, industry analysis, company screening, portfolio optimization and simulation, predictive risk measurements, alpha testing and tools to value and analyze fixed income securities and portfolios.
FRED: Federal Reserve Economic Data – a database maintained by the Research division of the Federal Reserve Bank of St. Louis that has more than 500,000 economic time series from 87 sources. The data can be viewed in graphical and text form or downloaded for import to a database or spreadsheet and viewed on mobile devices. They cover banking, business/fiscal, consumer price indexes, employment and population, exchange rates, gross domestic product, interest rates, monetary aggregates, producer price indexes, reserves and monetary base, U.S. trade and international transactions, and U.S. financial data. The time series are compiled by the Federal Reserve and many are collected from government agencies such as the U.S. Census and the Bureau of Labor Statistics.
FRED Gross Domestic Product - Gross domestic product (GDP), the featured measure of U.S. output, is the market value of the goods and services produced by labor and property located in the United States.
FRED M1 Money Stock - weekly, not seasonally adjusted - Beginning May 2020, M1 consists of (1) currency outside the U.S. Treasury, Federal Reserve Banks, and the vaults of depository institutions; (2) demand deposits at commercial banks (excluding those amounts held by depository institutions, the U.S. government, and foreign banks and official institutions) less cash items in the process of collection and Federal Reserve float; and (3) other liquid deposits, consisting of OCDs and savings deposits (including money market deposit accounts). Seasonally adjusted M1 is constructed by summing currency, demand deposits, and OCDs (before May 2020) or other liquid deposits (beginning May 2020), each seasonally adjusted separately.
Over the Counter Market - An over-the-counter (OTC) market is a decentralized market in which market participants trade stocks, commodities, currencies, or other instruments directly between two parties and without a central exchange or broker. Over-the-counter markets do not have physical locations; instead, trading is conducted electronically. This is quite different from an auction market system. In an OTC market, dealers act as market-makers by quoting prices at which they will buy and sell a security, currency, or other financial products. A trade can be executed between two participants in an OTC market without others being aware of the price at which the transaction was completed. In general, OTC markets are typically less transparent than exchanges and are also subject to fewer regulations. Because of this, liquidity in the OTC market may come at a premium.
Price-to-Book Ratio: An asset's book value is equal to its carrying value on the balance sheet, and companies calculate it netting the asset against its accumulated depreciation. Book value is also the net asset value of a company calculated as total assets minus intangible assets (patents, goodwill) and liabilities.
Price-to-Earnings Ratio: The price-to-earnings ratio (P/E ratio) is the ratio for valuing a company that measures its current share price relative to its per-share earnings (EPS). The price-to-earnings ratio is also sometimes known as the price multiple or the earnings multiple.
Price-to-Sales Ratio: The price-to-sales (P/S) ratio is a valuation ratio that compares a company’s stock price to its revenues. It is an indicator of the value placed on each dollar of a company’s sales or revenues. The ratio can be calculated by dividing the company’s market capitalization by its total sales or on a per-share basis by dividing the stock price by sales per share.
S&P 500 Index: The modern design of the S&P 500 stock index was first launched in 1957. Performance back to 1950 incorporates the performance of predecessor index, the S&P 90. The index is a capitalization weighted index of the 500 large companies listed on various stock exchanges (such as the NYSE or NASDAQ). The S&P 500 was developed and continues to be maintained by S&P Dow Jones Indices, a joint venture majority-owned by S&P Global. The S&P 500 differs from the Dow Jones Industrial Average and the NASDAQ Composite index, because of its diverse constituency and weighting methodology. It is one of the most followed equity indices, and many consider it one of the best representations of the U.S. stock market.
Z-Score - Simply put, a z-score (also called a standard score) gives you an idea of how far from the mean a data point is. But more technically it is a measure of how many standard deviations below or above the population mean a raw score is. A z-score can be placed on a normal distribution curve. Z-scores range from -3 standard deviations (which would fall to the far left of the normal distribution curve) up to +3 standard deviations (which would fall to the far right of the normal distribution curve). To use a z-score, you need to know the mean μ and also the population standard deviation σ. Z-scores are a way to compare results to a “normal” population.
IMPORTANT DISCLOSURES
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual security. This memorandum is being made available for educational purposes only and should not be used for any other purpose.
The information contained herein does not constitute and should not be construed as representation or solicitation for the purchase or sale of any security or related financial instruments in any jurisdiction. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing.
Investing involves risks including possible loss of principal. Past performance does not guarantee future results. Any investment or investment strategy outlined herein are not suitable for all investors, readers should conduct their own review and exercise judgment prior to investing. Wherever there is the potential for profit there is also the possibility of loss. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments.
International investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors.
This report expresses the opinions and views of the author as of the date indicated and are based on the author's interpretation of the concepts therein and may be subject to change without notice. Neither Highcroft, Inc., Gerald Asplund, nor LPL Financial, has no duty or obligation to update the information contained herein.
To the extent you are receiving investment advice from a separately registered independent investment advisor or broker, please note that Highcroft, Inc., Gerald Asplund, and LPL Financial are not an affiliate of and makes no representation with respect to such entity.
Certain information contained herein concerning economic trends, Fundamentals, and/or Technical analysis, and performance is based on or derived from information provided by independent third-party sources. The economic forecasts set forth in this material may not develop as predicted.
Technical analysis is generally based on the study of price movement, volume, sentiment, and trading flows to identify and project price trends. Technical analysis does not consider the fundamentals of the underlying corporate issuer.
The sources from which information has been obtained is assumed to be reliable; the accuracy of such information is not guaranteed, and the accuracy and completeness of such information has not been independently verified.
All indexes are unmanaged and cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment. All performance referenced is historical and is no guarantee of future results. Investing in the index would require investors purchase an investment product, which would involve fees and expenses.
The fast price swings in commodities and currencies can result in significant volatility within an investor's holdings.
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