Pricy stock market can get pricier
Stocktake: The Trump factor, presidential tweets and Madoff’s hot chocolate monopoly
Bernie Madoff: “He stole more money than anyone in history, and to other thieves, this makes him a hero.” Photograph: Shannon Stapleton/Reuters
Donald Trump doubters are not the only ones sceptical about the sustainability of the ongoing bull market. Stocks are expensive: can they get even pricier or are we witnessing the latter stages of this eight-year bull market?
The Leuthold Group recently used six important metrics to compare current valuations to those seen during the 1990s bull market that finally climaxed in March 2000.
Stocks appear least overvalued if one looks at their five-year normalised price-earnings ratio; during the 1990s, the S&P 500 first reached today’s levels in 1995, almost five years before the bull market ended.
Today’s price-sales ratio looks elevated, compared with levels first seen in November 1998. Taking a median of the six valuation measures, Leuthold said today’s valuations equated to those first seen in August 1997.
The S&P 500 gained another 70 per cent over the following 2½ years. Leuthold is not forecasting a late-cycle market melt-up of that magnitude, but stats suggest “there’s still room for that to occur”.
A different but related point is made by Merrill Lynch, which argues that a “great rotation” from bonds to stocks is under way. Bond fund inflows totalled $1.5 trillion (€1.4 billion) over the last decade, while equity fund inflows were flat. The bursting of the bond bubble means the ongoing rotation will be “violent, extreme and ultimately overshoot”.
Stocks will not hit 1999-type valuations – that bull market was unprecedented – but bears should be cautious: pricy markets can get pricier.
Knowing Trump impact is not enough
Whether you share market optimism regarding Donald Trump’s presidency depends on one factor more than any other: earnings. Will Trump slash corporate taxes? Is a sizable fiscal stimulus really on the way? Will Trump indulge his protectionist instincts? What will this mean for US earnings?
Anyone who says they know what’s in store is, as Oaktree’s Howard Marks says in his latest memo, “talking through his hat”. Still, let’s pretend you have perfect foresight and know exactly where earnings are headed, would you make a bundle?
Ritholtz Wealth Management’s Michael Batnick crunched the numbers, analysing the S&P’s starting point in every year since 1988. Assuming investors’ moods would stay roughly constant, he took the index’s average price-earnings ratio over the previous 12 months and multiplied this figure by the following year’s earnings. Seeing as you know exactly where earnings are headed, the resulting figure is where the index should end the year, assuming investors’ mood stayed broadly unchanged.
That’s the theory. In reality, the relationship between stock prices and earnings is complicated, Batnick noting that stocks gained 26 per cent in 1991 even though profits fell 25 per cent. Over the 29 years, his end-of-year estimates – which were, remember, based on perfect earnings foresight – differed from actual year-end figures by an average of 11 per cent.
Knowing the path of earnings is difficult enough, but price forecasts are also dependent on consistently predicting Mr Market’s changing mood. Good luck with that.
Trading on those presidential tweets
Now that Donald Trump is president, traders are wondering if he will he continue to shoot from the hip on Twitter. Iconic bond manager Bill Gross isn’t impressed by Trump’s tweets, saying his threatening of corporations is reminiscent of Mussolini-era Italy. Others just want to make money; one app, Trigger, sends users alerts when Trump tweets about certain stocks.
Punters looking to trade off Trump’s tweets should be careful, however. First, they will be too slow to capitalise on any movements: high-speed quantitative traders using sophisticated computer algorithms will jump on Trump’s tweets within milliseconds.
Second, the market-moving impact of Trump’s tweets is exaggerated. Share prices in companies such as Toyota, General Motors, Lockheed Martin and Boeing all tumbled following critical Trump tweets, but the impact is typically short-lived.
It’s best not to bother trading on Trump’s tweets. However, if you’re going to do it, the evidence suggests you shouldn’t follow in Trump’s footsteps when he slams some stock or another – take a contrarian approach and buy.
Madoff corners hot chocolate market
Bernie Madoff may be serving a 150-year prison sentence but he hasn’t lost his entrepreneurial instincts.
“Bernie really was a successful businessman with quite original insights into the market, and he’s continued applying his business instincts in prison,” said Steve Fishman, host of a new audio series, Ponzi Supernova, that profiles the disgraced fraudster.
In a Marketwatch interview, Fishman reported how Madoff “cornered the hot chocolate market”, buying up every package of Swiss Miss from the commissary and selling it for a profit in the prison yard.
“He monopolised hot chocolate,” said Fishman. “He made it so that, if you wanted any, you had to go through Bernie.”
It seems his fellow prisoners didn’t mind. “He’s a star in prison. He stole more money than anyone in history, and to other thieves, this makes him a hero.”