While we wonder whether the market has completely lost its mind, or is merely temporarily insane, we look to some of our favorite quantitative indicators for some degree of comfort.
One word of caution, as always: nothing, even the best-looking numbers ever, can tell us when the malaise in the market will end. These should merely reflect just how much has been lost, and therefore, how much can be gained on the other side of the valley.
First, the classic “Fed Model.” In the long-term, stock prices and bond prices are highly correlated. So when stock prices are rising, bond prices are normally rising, and thus interest rates falling. The long-term correlation is very, very significantly high. But there are times when the relationship breaks down, namely bubbles and panics. The chart below indicates that this is close to being a candidate for the mother of all panics. While we’ve seen a lot of corrections and 5 bear markets in the last 27 years, the difference between the S&P 500’s earnings yield (E/P, or the inverse of P/E, which is currently 9.5%) and the 30-year Treasury bond is virtually unprecedented. Normally, the T-bond yield is higher than the earnings yield, until the last 3 years. Now the earnings yield is 5.7% higher than the T-bond yield:
Next, a series of charts from Strategas. Click here to view the Adobe .pdf file. The first 2 pages show, in table and chart form, valuations compared to history. The table shows that today’s valuations are even lower than the worst day of two really bad bear markets: 1974 and 1982. Page 3 shows why mutual fund investors make far less money than the market: they put the most money in at the peak of the market and take the most out at the bottom. Hard to argue that we’re far from the bottom based on these withdrawal numbers. Page 4 holds 2 technical charts. First, the RSI of the S&P 500 is now (9 days after this chart was published) the most oversold market ever, even worse than 1932 and 1974. Page 5 refutes the common belief today that P/E multiples commonly go into the single digits. In the last half-century, this happened only during the bear market troughs of 1974 and 1982, when inflation and interest rates were very high (recall the Fed Model: when interest rates are high, P/Es are usually low), and in 1932. We saved the best for last: 10-year returns on large-cap stocks going back to 1808. We are now in worst-ever territory, including the Depression.
That chart tells the same story as our “Worst Decade Ever” chart. We’ve recently considered retiring the chart because we jokingly asked in a newsletter when it was introduced 3 years ago: “Does this feel like the Depression to you?” At the time, the 2000’s would have placed 5th among the all-time worst 10-year periods ever. These 10-year periods begin every year, like 1929-38, 1930-39, 1931-40, etc. We have ranked the period since the beginning of 2000, even though it’s just shy of 9 years long, against these 10-year periods simply because the market peaked near that time. Well, now this decade’s total return is 20% worse than the worst ever 10-year period, 1929-38, which encompassed the Crash of 1929 (which Joe Biden watched on TV) and nearly all of the Great Depression:
So far in this tome we’ve mostly ignored the economy. There is no doubt the economy is ugly right now, and its ugliness is directly related to the credit freeze. The sooner the freeze thaws, the less damage will be done to the economy. But it should be acknowledged that the economy peaked in the 3rd quarter of 2007, more than a year ago, and corporate earnings peaked 1 quarter before that. As the picture below shows, stocks normally start to move back up 2 quarters before GDP growth turns positive, and more than a year before earnings growth turns positive. The dashed line in each of the 3 charts is the average of each of the last 7 recessions—the average for stock performance, GDP growth, and earnings growth. The solid line is this cycle, with dates shown on the bottom axis. As the top chart shows, the drop in stocks this time around seems to be discounting a recession that is nothing like the average recession.
We keep waiting for the great “melt-up” to happen, and we often wonder if we’re waiting with Linus for the Great Pumpkin. There is a lot in the economy to be concerned about, but we are very strongly convinced that thousands of companies are virtually unaffected by these problems, and their valuations are completely irrational. If they were double their current prices, that would be a good start, but not quite fair value. What will get the ball rolling? When companies come out from their financial hibernation and start to take action, like buying companies on the cheap. There is no shortage of stocks at fire-sale prices; companies just need to make the move. So far, we’ve seen large deals done only by Warren Buffett and a few banks buying other banks. But you have to believe there are a lot of CEOs looking at the stock prices of their rivals and just salivating….