Stocktake

Shiller knows best on S&P valuation

Wed, Aug 21, 2013, 11:56

The S&P 500 is up 150 per cent since March 2009, 55 per cent since October 2011 and 20 per cent in 2013, but it’s not expensive, according to Merrill Lynch quant Savita Subramanian.

Relative to history, 14 of 15 valuation metrics analysed found the index to be fair to undervalued, she said. Only one – the Shiller PE ratio, which averages earnings over a 10-year period – indicates overvaluation.

Subramanian dismisses this, saying the 2008 earnings collapse distorts the picture.

We disagree. Studies confirm the Shiller PE, with over a century of data behind it, is one of the only valuation metrics to have had any predictive value historically. Most other metrics chosen by Subramanian go back only a few decades, during which time US markets have looked historically pricey.

Besides, other metrics not analysed – the well-regarded Tobin Q measure, or the total market capitalisation relative to GDP indicator used by Warren Buffett – confirm the negative outlook. The median PE ratio for US large-cap value stocks is 13 to 25 per cent above its long-term norm, according to the value-oriented Leuthold Group, while value managers such as GMO’s Jeremy Grantham predict mediocre seven-year returns.

And it’s not as if there’s not better value out there – the Euro Stoxx 50 trades on 1.3 times companies’ assets, compared to a book value of 2.5 for the S&P 500.

Icahn tweet whets appetite for Apple
Apple shares hit $500 last week after billionaire Carl Icahn tweeted he had a “large position” in the “extremely undervalued” stock. Icahn told Apple chief executive Tim Cook a larger share buyback was needed, saying they “plan to speak again shortly”.

Apple under Steve Jobs famously focused on products over shareholders’ peeves. Cook is friendlier, but unlikely to bow to Icahn. Apple has already boosted its dividend by 15 per cent this year as well as increasing its share buyback to $60 billion.

Anyway, Icahn may not stick around. Last October, hedge fund billionaire Julian Robertson said Apple, then $600, was “great value”, before later dumping the stock. In February, Doug Kass tweeted rumours of an Apple stock split, causing shares to jump. Kass sold Apple shares on the same day, later describing the rumour as “baseless”. Billionaire Daniel Loeb described Herbalife as a “compelling long-term investment” in Jan- uary; by March he had sold up.

Icahn’s tweet was perfectly timed. An iPhone 5S is expected to be announced next month, an event that typically sees a share price run-up. Improving sentiment had seen the stock break through its 200-day moving average for the first time in 2013. Icahn’s talk of a $700 share price and buybacks only added to the momentum.

Apple is already up almost 30 per cent since July; further gains may well tempt Icahn to exit.

The truth behind ‘passive investing Taliban’ remark
Market strategist and high-profile blogger Josh Brown (thereformedbroker.com) attracted attention last week after dissing what he called the “passive investing Taliban”.

Passive investors “don’t need to beat everyone else over the head” with their beliefs, he said, before later pulling the post and apologising for his “insulting” metaphor.

Ironically, Brown’s original post essentially made the case for passive investing.

Data showed markets could not be timed consistently, he said; the top stock pickers in one year rarely repeat their performance; when it comes to fund selection, the only metric to have any predictive value is that the lower the cost, the better; and both Warren Buffett (above) and Ben Graham, two of the best ever stock-pickers, both advocated passive investing.

“The actual facts in this debate are almost completely one-sided,” admitted Brown, who went on to argue that many choose active investing simply for entertainment value, to “live vicariously through the ups and downs, the triumphs and defeats”.

In essence, passive investing is more rational, but less craic.

Investors steering clear of emerging markets
Short-term contrarians should be betting on emerging markets, gold and bonds but weary of US equities, the dollar and banks, according to Bank of America Merrill Lynch’s Michael Hartnett.

Merrill’s latest global fund manager survey found the consensus is “bullish on global growth, bearish on bonds and hates emerging markets”, said Hartnett, with investor exposure to emerging markets at a 12-year low. In contrast, exposure to the UK is at a 10-year high while the percentage of investors overweight the US is the third-highest in a decade. Optimism towards Europe has also surged, with confidence regarding company earnings returning to pre-crisis levels. Merrill’s call is a short-term one, saying the summer decline in emerging markets, bonds and gold was the first but not last “QE crash”. For now though, they are too unloved, while other sectors are over-owned.