My Photo
Note: Jeff does not accept guest blog posts on A Dash of Insight.

For inquiries regarding advertising and republication, contact main@newarc.com

Follow Jeff on Twitter!

Enter your email address:

Delivered by FeedBurner

Certifications

  • Seeking Alpha
    Seeking Alpha Certified
  • AllTopSites
    Alltop, all the top stories
  • iStockAnalyst
Talk Markets
Forexpros Contributor
Disclaimer
Copyright 2005-2014
All Rights Reserved

« Reviewing John Mauldin on Employment and the Economy | Main | Book Review: Bailout Nation »

July 08, 2010

TrackBack

TrackBack URL for this entry:
http://www.typepad.com/services/trackback/6a00d83451ddb269e20134854ec01e970c

Listed below are links to weblogs that reference Revisiting the List of Worries:

Comments

James

As far as Europe, you are jumping the gun with your conclusions. Actually, more and more of economists realize that EU breakup is the best solution to the structural problems that the EU experiment created.

Euro Area Breakup Would Boost Region's Economies
http://www.bloomberg.com/news/2010-07-10/euro-area-breakup-may-boost-economies-from-greece-to-germany-report-says.html


Also, problems for the US are much greater than most realize (except Dagong that has just downgraded US credit rating)

"Dagong said it rated Washington below China and 11 other countries such as Switzerland and Australia due to high debt and slow growth. It warned the U.S. is among countries that might face rising borrowing costs and risks of default."
http://www.google.com/hostednews/ap/article/ALeqM5hoClThrviIt1Jf_nVbVtdc6qQkxgD9GSNHN86

Ram

I like the theme of this post very much. A few bearish points

Re: auto sales
1) Looking at a longer time scale, we are still at absolute sales level reached in the late 1960's!
http://calculatedriskimages.blogspot.com/2010/07/light-vehicle-sales-long-june-2010.html

Re: Personal spending
2) Shouldn't you look at "real" spending which by eye-balling may not have exceeded prior highs?
3) Isn't personal income less transfer payments a better measure of spending sustainability?http://calculatedriskimages.blogspot.com/2010/07/recession-measure-personal-income-may.html


Re: mortgage rates
4) Well, folks were expecting the mortgage spread with treasuries to go up by 25-100 basis points. So far, the spread has indeed gone up by 45bps (or 20bps, accounting for risk aversion): not massive but still up as predicted.
http://www.housingwire.com/2010/06/17/mortgage-spreads-stay-low-after-fed-mbs-exit-pmi-economist
5) What is more surprising is the plunge in purchase index to 1997 levels coinciding with the plunge in mortgage rates
http://calculatedriskimages.blogspot.com/2010/06/mba-purchase-index-june-30-2010.html

Thanks for a refreshing blog that is data-focused and, dare I say, fair and balanced :-) I got to know through Maudlin -- so John helps play a connecting role as well.

oldprof

Elliot -- Thanks for the link. You have some interesting ideas. More importantly, we should all be trying to think about events (both positive and negative) that are not already in the news.

You illustrate this very well.

Jeff

oldprof

Mike C - Coming up with long-term growth rates is a tricky question, especially for an index where the makeup changes. I work on it for individual stocks (where I have many attractive candidates and holdings) but not for an index.

Just for the sake of your thesis, let's say that we take some long-term average in nominal terms. Everyone would still argue about whether we were starting from a point below the trend, etc.

I agree that current prices reflect extremely low growth expectations, which is why I call these valuation measures long-term sentiment indicators.

Jeff

Elliot

Jeff:

I really like your perspective and ideas. As you have been saying, it's so much harder to think about what can go right than what can go wrong--it's easy to point out flaws. With that in mind, I put together a post about 3 Black Swan ideas that could go "terribly right" for the economy over the next few years.

http://wallstcheatsheet.com/breaking-news/economy/say-hell-no-to-a-black-swan-free-world/?p=14068/

Regards, and keep up the good work!

Elliot

Mike C

Mike C - As I have often noted, I do not want to turn every article into a debate about valuation in the comments. My position is well-known and I try to update it periodically.

Jeff,

You repeatedly make the point that too many such as Shiller, Hussman excessively focus on past earnings.

You know what, you have ***convinced*** me that is at least partially true, and mind you I'm not persuaded easily. So your arguments have been effective in getting me to reconsider and modify my views.

That said, the clear implication of the part I quoted is that you believe current forward multiples are probably too low.

Without getting into the MBA level finance mathematics in this comment, obviously a "fair multiple" is a function of the growth rate. If company XYZ is going to grow earnings 50% a year for the next 5-10 years, then a trailing P/E of 50 is actually dirt cheap. In fact, a P/E of 100 might be too cheap if you know with absolute certainty that is how the future earnings will play out.

So if the position is that forward multiples are too low then the corollary to that is one must have some opinion on future earnings growth rate.

I honestly have no opinion on overall valuation here because I have no good opinion on earnings growth prospects, and my question was to try to get you to expound on that point which really is the key variable. If you think earnings can grow at 10% annually, then I'd like to know why, because you could have a very good argument I'm not familiar with.

I'll play along for one thought. This would be a good question if the stock return currently equaled a corporate bond return. Then we might talk about growth.

Suppose there was 0% growth. Where do you think stocks should trade?

Valuation is always a function of future growth (Buffett has said exactly this a great number of times). The corporate bond return might impact the discount rate one uses to calculate the present value of those future earnings.

A short-hand methodology is basically Ben Graham's formula of P/E=8.5 + 2*growth rate*4.4(AAA yield). With a 0% growth rate, that gets you to basically 8.5, and let's just say 9-10. A 10% growth rate gets you to a P/E around 20, so today's price clearly is discounting some pretty low future growth rates. Again, I have no strong opinion at all because there are so many cross-currents as you highlight about things to be worried about.

I don't follow your last statement about "flip side". Of course earnings matter, they always did, they always will. EVERYTHING ELSE just makes for fun conversation. Where will SPX earnings be in 2015? $70, $100, or $180. If it $180, then stocks are RIDICULOUSLY CHEAP and I should be borrowing every last dime I can to buy as much as I possibly can. Bottom line, I was interested in your opinion on why future earnings growth might surprise to the upside of what is the PIMCO "New Normal" view.

oldprof

Mike C - As I have often noted, I do not want to turn every article into a debate about valuation in the comments. My position is well-known and I try to update it periodically.

This article is about the ever-changing reasons that you can find to hate the market. The data changes, the opinions do not.

I'll play along for one thought. This would be a good question if the stock return currently equaled a corporate bond return. Then we might talk about growth.

Suppose there was 0% growth. Where do you think stocks should trade?

Prediction: As PIMCO gets more into stocks, the definition of the "new normal" will change. Meanwhile, this argument sounds like the flip side of those in 2000 who said that earnings did not matter!

Jeff

Mike C

Many who believe that the low earnings multiple is justified either focus only on past earnings, expect an economic decline, or believe that we are in a new regime where stocks will never again achieve historic P/E ratios.

What is your rough estimate for SPX earnings growth over the next 3-5 years starting from today's base of trailing 4 quarters? Over the next 3-5 years, will we see closer to 0% earnings growth annualized, 5% annualized, or 10% annualized?

The comments to this entry are closed.