OK, so this is a continuation of the scary chart series (not really intended to be a series, and not really intending to be so actively posting!).
Whenever I see these big charts showing how the markets are overvalued and whatnot, I usually just go back to looking under the hood on what’s really going on. Sometimes the P/E charts look crazy (like it did in 2000 and now), stock market to GDP is off the charts etc.
But at the end of the day, most of us here are not S&P 500 index futures traders; we are investors. And we at least pretend to be owners in businesses and not shufflers of pieces of paper. In that sense, all of these macro forecasting charts should be totally irrelevant. OK, so maybe we should be aware of some of this stuff. But as far as what to do about it, unless you have strong odds of something happening, it shouldn’t really drive any action on the part of business owners.
Odds
Speaking of odds, odds are often misused (or unused) in finance. I can’t claim to not misuse them either. But here’s what I mean. So often you hear people say the market is overvalued so they are going to short the market.
One thing that struck me is that every time Joel Greenblatt is on TV, he tends to tell us what percentile of valuation we are in and what the year-forward expected return for the market from that valuation level is. Now, that has problems too as you can argue that all of that data is based on a bull market period when interest rates were going down. But as flawed as it is, it is still much better, I think, than just shorting the market because it is overvalued and therefore thinking it must go down. If the market is overvalued, then the expected return going forward is going to be low, but not necessarily negative (over time).
Plus, for those calling a turn in interest rates, look at the long term chart of interest rates that go back 100 years or more, and you can see that these major turns don’t happen very often. So basically, the odds of calling the turn in any given year is not very high.
Anway, what you never hear from the “I’m short cuz the market is expensive” is something like that; from these levels, the probability of a crash or bear market within the next year is xx%”.
What you do hear is that when markets are this expensive, things don’t end well. And they are often right. Things often don’t end well. But then again, it all depends on what your definition of “end” is.
It was a certainty that things wouldn’t end well in the late 1990’s and 2000. And many geared up for it. Of those folks who actually caught the crash back then or got out in time, how many got back in? What is their total return through all the cycles since then?
For reference, BRK grew BPS 9.4%/year from 2000 through 2015. BRK stock price rose 7.1%/year since then. If you were smart enough to own MKL, they grew BPS +12%/year and the stock price rose +11%/year in that time period. The S&P 500 index total return was 5%/year.
The same was a certainty back in the late 1980’s; it was a certainty that things wouldn’t end well. The above figures would be even more dramatic than the 2000-2015 figures. This is not to say that we will have high returns like that going forward!
Back to the Trees
OK, so getting back to the issue. As I said, one thing I do when I see scary charts is to go back and look at my holdings to make sure none of them are bubbled up. To see what’s in store for the market overall, I will look at some major components as a sanity check to see how bubbled up the market is.
One of the first places I look is Berkshire Hathaway’s (BRK) holdings. Buffett is the greatest stockpicker ever with a live portfolio we get to see in real time. If the market is bubbled up, there might be risk built into BRK too, which we may want to be aware of.
I like to look at current P/E because ttm P/E often has a lot of noise, write-offs etc. Of course we can’t ignore those ‘one-offs’ as they often are not, but I like to look at companies based on a normalized earnings basis, and for that, current P/E often reflects a little bit more of a normalized picture (as analysts estimates often exclude charges).
Forward P/E is for the year 2017, so may be too far ahead for some. Anyway, we are more than half way through 2016, so the numbers should be decent estimates.
Here is the BRK portfolio; I only include companies listed in the annual report. CHTR and KHC are not here as there are no earnings estimates available. I added AAPL. The list includes non-Buffett names, but since it’s in the annual report top-holdings list, might as well leave them in.
| CurrPE | FwdPE | |
| AAPL | 13.10 | 12.15 |
| AXP | 11.88 | 11.79 |
| KO | 22.91 | 21.77 |
| DVA | 18.38 | 16.51 |
| DE | 20.15 | 21.72 |
| GS | 11.44 | 9.54 |
| IBM | 12.01 | 11.49 |
| MCO | 22.54 | 20.12 |
| PSX | 23.98 | 13.95 |
| PG | 22.41 | 20.71 |
| SNY | 12.96 | 13.17 |
| USB | 13.08 | 12.47 |
| USG | 15.83 | 12.48 |
| WMT | 17.34 | 16.75 |
| WFC | 11.91 | 11.43 |
| average | 16.66 | 15.07 |
| median | 15.83 | 13.17 |
So, looking at this, I think to myself, “where is the bubble?”. OK, the FANG stocks and many others are really expensive, but who cares, really, if you don’t own them. Right? OK, if those guys collapse and cause a correction or bear market, many stocks will go down. But from a valuation perspective, I don’t see a big problem here.
Let’s take a look at something more representative. The S&P 500 index is too unwieldy to look at individual names, so let’s just look at the Dow. It has a high historical correlation with the S&P 500 index so it can tell us something about the market.
Here is the same table as the above with the Dow 30 stocks:
| CurrPE | FwdPE | |
| AAPL | 13.11 | 12.15 |
| AXP | 11.91 | 11.82 |
| BA | 21.17 | 13.85 |
| CAT | 23.65 | 23.38 |
| CSCO | 13.28 | 12.68 |
| CVX | 81.87 | 21.55 |
| DD | 21.54 | 18.62 |
| DIS | 16.83 | 16.00 |
| GE | 20.86 | 18.19 |
| GS | 11.52 | 9.60 |
| HD | 21.72 | 19.14 |
| IBM | 12.10 | 11.59 |
| INTC | 13.85 | 12.68 |
| JNJ | 18.50 | 17.41 |
| JPM | 11.57 | 10.49 |
| KO | 22.91 | 21.77 |
| MCD | 21.47 | 19.44 |
| MMM | 22.05 | 20.48 |
| MRK | 17.01 | 16.61 |
| MSFT | 20.06 | 18.00 |
| NKE | 23.64 | 20.55 |
| PFE | 14.29 | 13.26 |
| PG | 22.41 | 20.70 |
| TRV | 12.47 | 12.04 |
| UNH | 18.03 | 15.74 |
| UTX | 16.59 | 15.82 |
| V | 28.62 | 24.05 |
| VZ | 13.83 | 13.35 |
| WMT | 17.32 | 16.73 |
| XOM | 36.75 | 19.84 |
| average | 20.70 | 16.59 |
| median | 18.27 | 16.67 |
The Dow is trading at around 20.7x P/E, and 16.6x 2017 estimates. Well, actually, that’s the simple average P/E of the Dow stocks. Yes, on the high side historically. But again, I don’t really see anything bubblish. The high P/Es of XOM, CAT, CVX are due to depressed earnings, not speculative frenzy. Some of the other high P/E names seem to be trading at where they have traded in the past. Maybe some a little higher, but for the most part, they seem consistent with what I would expect them to be trading at in ‘normal’ times. Nothing really screaming out at me that it has to crash.
I think we need to be careful when we say that buffett is the greatest stock picker…he's the greatest investor! Like many people, I follow him closely, aside from PTR, he really hasn't made a great stock picks since KO/AXP. He lost a good amount of money on COP. BNI- he bought out, so that doesn't count. WFC- he bought the largest slug of his stake in 2005 (bad timing). IBM we all know the story so far with that. KHC- he has a huge gain, sure, but he also took it over. He has great patience. He can evaluate businesses and people. I agree with the point of your post however. The best thing he could have done for shareholders is repurchase shares in 2011 instead of buying IBM, but nobody's perfect!
Do you know what Buffet's pure investing track record would have been on an deleveraged basis (i.e., as if there had been no insurance float so not caring about Berkshire's book value)?
No, but I've seen that sort of analysis done in the past so if you google it you can probably find something.
As for being careful about calling Buffett the greatest stock picker, well, OK. But keep in mind that he is operating under huge contraint; he only has a small pool of stocks to choose from at this size. If he wanted to, I'm sure he can create a small portfolio and beat anyone out there today. But he chooses not to do that as growing the IV of BRK is his main goal… (why run a $100 million and return 50%/year and earn $50 million when he can just increase BRK 5-6%/year and make way more? etc…)
Oh yeah, and yes, he is an investor in businesses, private and public. People have been critical of his stock-picking in recent years but many picks are, as far as I'm concerned, still pretty new. Also,some criticize his performance as having been based on leverage, but when you can get leverage like BRK can and maintain their credit rating, that is praise-worthy on it's own. If you would have bought the S&P 500 index and levered up, you would probably not be able to simulate the stable high growht thta BRK has achieved in the past.
Anyway, BRK is so big now that Buffett is dealing with a whole different set of issues; they are playing a different game. So I wouldn't conclude, from recent trends, that Buffett has suddenly become a bad investor compared to the past… He's probably just as good as ever (but can't really sohw it too much now).
I think there's a bifurcation in the market generally (US and abroad). When I look at the things I want to own in my retirement account (I'm mid 20's, so I have a super long run-way) some of them are at nose-bleed valuations. It's like there's pockets of insanity and pockets of value. Personally, I'd rather plant new seeds when the weather is a bit more clement.
Inverting – prior to which major market correction would looking at the PEs of the Dow and Buffett's holdings have been a good indicator? I mean, maybe 99, although one might have talked themselves into liking financials' valuations then? Other than 99, this exercise would rarely have done any good. Certainly not in the early 90s or in 07.
Aside, everyone is benchmarking off of the 99 mania these days. "Oh, it's not equal to the most insane bubble in a century…" of course it isn't!
Yep, the market may not be ready for a short but remains unexciting (at best for a value investor). It is true that there were periods in the past (such as the late 1990s) in which value as a style was out of fashion.So what do you do then? Unless having cash is an option, you have to look for relative defensive stocks and decent dividends. No one knows how long the current government- and Central Banks-driven bubble in bonds and financial assets will last. That said, the bifurcation between inflated financial assets and unexciting growth in the real economy will become increasingly evident and stretched. That's one of the factors to keep a close eye on.
Yep, the market may not be ready for a short but remains unexciting (at best for a value investor). It is true that there were periods in the past (such as the late 1990s) in which value as a style was out of fashion.So what do you do then? Unless having cash is an option, you have to look for relative defensive stocks and decent dividends. No one knows how long the current government- and Central Banks-driven bubble in bonds and financial assets will last. That said, the bifurcation between inflated financial assets and unexciting growth in the real economy will become increasingly evident and stretched. That's one of the factors to keep a close eye on.
Great stuff as always. I am finding, like your analysis, that there is a great deal of value in a very bifurcated market (either very cheap or very expensive). Question, how/where did you compile this data? I have been looking to do similar analysis but (without bloomberg access) not sure the easiest/quickest way to do so. Any help would be appreciated!
Hi, thanks. I got this data from Yahoo Finance; I scraped the data using Python so you have to know how to code in Python to do it. Otherwise, if you are not a programmer, you can probably do something similar by using a spreadsheet; just google downloading yahoo finance data into spreadsheet or something like that…
Thank you very much for the help! Will try that.