Who Determines Market Valuation?

When it comes to market valuation, most traders and investors are watching the wrong sources.

There are familiar names in the blogosphere who are highlighted nearly every week.  Their assertions are so pervasive, so oft-repeated, that they become the conventional wisdom.  Even our best sources (e.g., Abnormal Returns and Advisor Perspectives) can only cite what they see in the blogosphere.

What are we all missing?  Only the biggest and most important players.

Two Examples

Suppose you are the manager of a large pension fund.  There is no reason for you to write a commentary pontificating about market valuation.  You might consider a public appearance to discuss shareholder rights, for example, but why discuss your portfolio strategy?

Or what about the big private wealth managers?  They do not get new clients from appearances on CNBC, and you will not see their opinions on Seeking Alpha.  They are very quiet and very dignified.

These managers control the marginal investment dollars, and the marginal dollars determine prices.  In general, the pension manager has an asset allocation decision.  While there are many choices, the expected return from stocks is compared to the expected return from corporate bonds.  The manager does not care what the Shiller ratio is or what earnings were in 2008 any more than he cares what bond rates were in 2008.  This is why the upward march of the market has matched the growth in forward earnings.

An Unusual Glimpse of the Big Time

My guess is that most people paid little attention to the CNBC interview segment with Robert Weissenstein of Credit Suisse Private Banking Americas.  He is CIO for a group managing $300 billion.  He has no need to be loud or argumentative or arrogant.  He simply explained why they had increased their allocation to large cap US equities.  You should watch the entire interview, but I know that most will not.  He thinks that stocks are very cheap, earnings are growing, revenues are growing and beating expectations, and employment is getting better.  He sees the S&P 500 at 1450-1500 at year end.

Based upon this they have raised the US equity large cap allocation from 20% to 22%, which he notes is a 10% increase.  Look at the whole story to see the asset allocation, including over 20% to fixed income.

 

Investment Conclusion

CNBC could add to our entertainment with a rating system for guests that reflected their importance based upon actual investment dollars deployed at the margin. A guest like Weissenstein is really not selling anything nor trying to impress anyone.  He reflects the decisions of many quiet but important managers who are not part of the fray.

These managers have much more impact on markets than the usual collection of your Pento's, Rosenberg's and Kass's.  You just don't hear from them as often.  Unless you were watching CNBC you would have missed this interview, and I doubt that anyone else will highlight it.  Most people who watched were probably not impressed by this quiet yet substantive interview.

Their mistake, your opportunity.

Comments

[PEX Don]

Maybe he thinks they'll go down after their tremendous run and there will be better buying opportunities

[notorious]

A quick anecdote - I spent several years working for a guy much like Weissenstein. He is CIO for equity strategies at a large asset manager (401k's, institutional money, pension funds, etc.) He makes visits to CNBC once a month or so. He was appointed to his position in 2000. Two obvious questions:
1) Could he have possibly been appointed to this position in 2000 without having been a relentless bull for his entire career? (which began in the early to mid 70s)
2) Do you think he was always talking his true investment beliefs on CNBC, or do you think he was saying what would drive him the most/best business? These guys are highly motivated to drive/grow their AUM, and while much of that comes from investment performance, a GREAT DEAL comes from new investments - sales. If your company mostly offers long-only funds - talking a long-only book is the best way to tell your current clients that they're in the right thing, and to drive new sales. Traditional big asset managers (as opposed to hedge funds) are compensated by fees, not often by performance incentives.

Just my $0.02.

[DE]

Hussman focuses on normalized earnings because that is what has predictive power. Simply following the fed model has not worked if you expand your data set pre 1980. So should I still with what is predictive (albeit over the longer term time periods) or just go with the crowd and play the momentum?

[Ken]

People need to chill. The writer is not trying to tell you that based on these pension managers' decisions now is a time to buy and hold and make money over a ten-year-period. He is saying now is a great time to buy because big money is voting the market up. It's really a momentum call. Like all momentum calls, I think it's good until it's not. Also, note that the interview is not with a pension fund guy in any event (bit of confusingly laid out in the post), he's a private high-net-worth banking guy. The only thing that surprised me was how low the allocation to emerging markets was -- 9%, especially given his comments that people are underexposed. I'd love to hear any thoughts on that. I saw something recently about how the market P/Es of various emerging markets, relative to their expected growth (even assuming the interest rates and inflation stuff) at least, look pretty darn reasonable. Maybe he thinks they'll go down after their tremendous run and there will be better buying opportunities.

[Paul in KC]

jon; this is what might be called "thoughtful".

[jon hela]

I actually couldn't care less about the conclusion. I am in 100% cash, and do not fear opportunity cost. Stocks could go up 10% over the next three months, or down 10%, and I would be happy as a clam either way.

What I detest more than anything is hypocrisy, especially from pedantics.

[oldprof]

Jon - I do not "follow" these funds and if you look carefully you'll see that I did not suggest that you do.

My point is pretty simple. These large investors determine the marginal price moves in many stocks. Also commercial real estate and other things. Most of the discussion about markets on the Internet and on financial TV emphasizes traders and hedge fund types. Meanwhile, this guy's two percent shift is pretty big.

I think they are tracking the corporate bond yield pretty closely, and I find that a good backdrop for forming my own opinions about the market.

I hope that many readers find it useful when I bring up an idea that few people talk about, and I'm sorry you don't like this one.

I do try to teach people things, and that is sometimes hard to do without being pedantic. I reject the hypocrisy accusation :)

Thanks for sharing your thoughts, but I have a sense that you just don't like the conclusion.

Jeff

[TosTrader]

Amen Brother! I found myself thinking the same thing as I read this article.

[jon hela]

Your hypocrisy is unbounded at times.

You constantly and pedantically harp on the fact that "others" make opinions without backing them up by objective facts, instead basing them on twisted versions of what they want to hear.

This article, by you, is a perfect example of such.

Follow the pension funds, you say, because they are the big money. And it's clear you also, then, consider them the smart money. We should listen to the interview, because this is big money and he knows what he's talking about.

But try as I might, I see nowhere in your article explaining that pension fund allocations to equities was at an all-time high in March 1972, right before a major bear market. Then it dropped to a multi-decade low in September 1974, right before a major bull market. Then, again, a multi-decade high right before the '87 crash. A multi-decade low in September 1990. Allocations were at their highest ever - 76% - in September 2007, then dropped to a 15-year low in March 2009.

Please explain why that is the kind of example we should be following.