Too much complacency in the stock market?

jabba42

There are many metrics how you can see if a market is overbought, this time I chose the 200 moving average in relation to the s&p 500. Nothing to do with p to e.

Bernanke started this in 2009 with his QE, now he has created a monster bigger than 2008. For new investors it is probably not a good time to start your investing career.

As for the FTSE not being overvalued in relation to the US markets we all know that when the US sneezes we catch a cold.

merlingrey

bowlhead99 wrote: »

In your example, if Company A's 100k share buyback happened on day one of the financial year, the weighted average number of shares in issue over the year is only 0.9 million and the amount of earnings per share over the course of the year is legitimately £5.56 which is all available for distribution to its 0.9m investors. It is a more valuable company to be invested in, than Company B which could only return £5.00 to each of its (greater number of) shareholders.

If Company A's 100k share buyback happened on the last second of the 365th day of the financial year, the weighted average number of shares in issue is 1 million and consequently it would report £5 per share earnings, which is the same as Company B. It hasn't performed any better than Company B and would not be reported as having done so.

So, there seems to be no great scam?

Company A in my first example has made more money per share off fewer shares to generate the £5m. Having made the £5m on only 900k shares, it might choose to distribute more per share as dividends to utilise its cash. Higher dividends and higher EPS would result in it being valued higher than B. Or alternatively, A might only choose to distribute £4.5m at £5 per share as dividends and keep the balance back to give it resources for future share buybacks. Investors would see that it is not paying any more dividends than B, so might not immediately value it higher on that metric alone. But as it has higher EPS, better dividend cover, and a track record of doing share buybacks (which are tax efficient from an investor's perspective), it would be valued higher in the market, as it should be, because it is making more money per share.

Whereas Company A in the second example has made no more money per share than B over the course of the year, and would not be reported as having a higher EPS. If they have sufficient funds already set aside to do a share buyback, they could do one on day 365, and then their £5 a share dividend to shareholders on the register a couple of months after year end only costs them £4.5m of cash. But each investor still gets 100% of earnings paid out (still 1x dividend cover, like Company and the same dividend per share (£5 a share like Company , and has missed forecasts as bad as Company B (£5 EPS vs £5.50 forecast), so is going to get valued the same as Company B, all other things being equal.

What am I missing? I appreciate that share price movements are all about the market reaction, but what they react to is the data reported by the company in line with consistent accounting standards, and a lot of market participants know what these things mean. Admittedly if someone (like a journalist looking for a story or an inexperienced retail investor) does not understand what an EPS actually represents, they may jump to the wrong conclusions?

You are right an efficient market would take the view that if the earnings are the same vs common stock outstanding then it would weigh them up that way, but markets are voting machines in the short term they are only efficient longer term and that is why I bring it up.

Compared to P/E if you was to look at stock buybacks it seems the more stock buybacks there are the more likely you should be selling, see here for example:

http://www.factset.com/websitefiles/PDFs/buyback/buyback_6.19.13


As you can see buybacks reached an all time high in q3 2007

It's fair to say that companies react like ordinary participants they buy high and (if they go bust or are doing rights issues) sell low or fail to buy.

Why do bad companies do it at all though? I mean none of the bad companies should touch their own stock, by bad I mean if things look like they are going south why not hold onto the cash and wait for cheaper share price?

Although I suppose a silver lining here is that companies seemed to have halted buybacks since 2011 suggesting they have got wiser to it, for the moment.

Something else to keep an eye out next time you see higher P/E + massive stock buybacks.

bowlhead99

jabba42 wrote: »

There are many metrics how you can see if a market is overbought, this time I chose the 200 moving average in relation to the s&p 500. Nothing to do with p to e.

Seriously? You are falling for the hype in that linked article which is written as a teaser from the perspective of a guy trying to pump his 'free special reports' i.e. tip sheets.

This is not doom and gloom. This is a fact. The Fed has created an even bigger bubble than the 2007 one.
The time to prepare for this is not once the collapse begins, but NOW, while stocks are still rallying. Stocks take their time moving up, but when they crash it happens VERY quickly.
With that in mind, I’ve already urged my Private Wealth Advisory clients to start prepping. We’ve opened six targeted trades to profit from the stock bubble bursting.
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Why would you say the measure of overbought status is "nothing to do with p to e" when the various different types of p to e measures literally tells you how many times historic (or futute forecast) earnings you are paying to buy something?

Not wishing to patronise you but if you say the 200-week moving average shows it is "overbought", can you explain why that must necessarily be true? Because I don't believe it is.

Lets say we have a world war or a financial crisis or whatever which takes us down to FTSE at 3000. Then, crisis averted through co-operation, bailouts and measured QE stimulus to restore employment and normality, for 4 years the index recovers at a steady pace to 6000 or so, the fair value for companies producing the level of profits they are producing. Confidence returns and everything is fairly priced again. Ignore whether you personally feel it is or it isn't, as of today, this is just a quick review of what the moving average does.

Where is the 200 week moving average at that point, with FTSE at 6000 from 3000 around 200 weeks earlier? It is the average of everywhere the price has been over the last 4 years, ie 3000, 3100 etc up to 6000. So 200 week moving average is 4500 and the market is at 6000. Any rising market, for whatever reason (real, stimulated, fake, whatever) will lead its trailing average if the price had previously been lower for whatever reason.

And then the market stays in the 6000s for a while having finished recovering, broadly, to its fair price (perhaps the fair price is 7000 to 8000 but some nervousness remains). As the index is no longer rising at the same rate, the rate of increase of the moving average reduces. So it gets up to 4800, 4900, 5000 etc but slows as it's doing so, and this causes the MA chart to start to curve.

If you look at the PEs of the companies involved, the 6000-7000 level might be a completely normal and expected level.

But if you are a doom monger writing a tip sheet, this is where you start to scream to any sheep that will listen:

WOW LOOK THIS INDEX IS SERIOUSLY OVERBOUGHT!!. The FTSE is 20% higher than the 200 week MA. The FTSE rise has started to flatten. The MA is curving over now and REMEMBER WHAT HAPPENED WHEN the dotcoms crashed and we had Enron and 9/11 and REMEMBER WHAT HAPPENED WHEN the Credit Crunch happened. THE FTSE was in the 6000s! It was above the 4 year moving average! The moving average line was just starting to curve flatter before falling. THESE ARE FACTS. THIS IS HAPPENING AGAIN NOW. WAKE UP SHEEPLE WE ARE DOOMED! BUY THIS TIP SHEET AND SAVE YOURSELVES!!!

So while I agree there is more than one way to judge the fair value of a market, my suspicion is you are falling for the article, the entire purpose of which is to create fear to sell tip sheets. You may well feel it is overbought, and you may well be correct, but the idea to follow the most basic and flawed bits of technical analysis (i.e. based purely on "whatever goes up must go down") rather try to figure out what something is worth (earnings, assets, growth etc) is fundamentally a weak argument.

I would agree that the US market is looking pretty high, while some others are not.- UK versus previous peaks is relatively less high, for example. And the US previous peaks had even more dot-com nonsense in them than ours did and so for the US to exceed those peaks really takes some going - US stocks now are relatively more expensive than UK ones it seems. And yes when the US goes down we will share the fun and games. But to disregard fundamentals such as earnings in favour of an MA chart that simply tells you the price is higher than the average of the last 4 years, is misguided. If we have had a recovery of confidence and the price has gone up without going heavily back down, I can tell you the price will be above the MA without drawing a chart.

But if you like, I can write you a tip sheet, an tell you it's free (to you because I sell advertising on the side and am harvesting your personal details when you register). Or it will genuinely be free because it has no real solutions for you and is just a teaser for you to subscribe to Private Wealth Advisor at $299 per year. That's less than 82 cents a day! Plus, you'll get FREE bonus gifts valued at $427. And the 'value' of those gifts are as determined by me, a market expert! But honestly, they are dead good. Why not sign up now?

Reaper

My brief mention of PE has turned into a heated discussion. Merlingrey you are right it can be manipulated which is why you should not really depend on a single metric to tell you whether a single company is cheap or not. However looking at the market as a whole over a period of time and considering your useful link to historic buy backs shows they are currently only at an average rather than elevated level I think my graph is valid in suggesting there is not a bubble in the market.

However I will now undermine my own position by saying market PE levels have tended to be poor indicators of what the stock market will do next. To try to get round this people sometimes use CAPE (Cyclically Adjusted PE) instead. Supposedly it is a better predictor at to whether the market is overpriced or underpriced becuase it should always return to its natural level. In the USA it is 24 compared to a long term average of 18.7 so (if you trust it) the US is a bit over priced.

If you do believe in it then where is the best place to invest? Russia. I'm not brave enough to do that at present though!

jabba42

Sentiment drive markets Bowlhead, not P and E or Moving averages. So we can talk about how cheap and expensive thing are but complacency at the moment must be at an all time high. The thieves in wall street and going to lock you all in, set the house on fire and burn everyone alive.

I see very little benefit in getting in now unless it is short term. Also I will not be getting this guys' newsletter but I tend to agree with the sentiment.

merlingrey

jabba42 wrote: »

Sentiment drive markets Bowlhead, not P and E or Moving averages. So we can talk about how cheap and expensive thing are but complacency at the moment must be at an all time high. The thieves in wall street and going to lock you all in, set the house on fire and burn everyone alive.

I see very little benefit in getting in now unless it is short term. Also I will not be getting this guys' newsletter but I tend to agree with the sentiment.

It's about 85% sentiment.
We live in the fast Information Age and microwave generation, our society wants quick returns, in and out.

You have to be another warren Buffett type to beat the market consistently.

I'm also concerned about what this guy has to say, he has a fairly good argument to believing the future ( and growth prospects) are going to be smaller especially in a peak oil era:



https://www.youtube.com/playlist?list=PL7E8A774DA8435EEB

bowlhead99

jabba42 wrote: »

Sentiment drive markets Bowlhead, not P and E or Moving averages. So we can talk about how cheap and expensive thing are but complacency at the moment must be at an all time high. The thieves in wall street and going to lock you all in, set the house on fire and burn everyone alive.

I see very little benefit in getting in now unless it is short term. Also I will not be getting this guys' newsletter but I tend to agree with the sentiment.

I agree the existence of free cash (QE) and the lack of yield from anything historically 'safe' (bank accounts, bonds etc) has pushed equities and other asset classes up.

An "OK" p/e ratio is only OK if the earnings are really sustainable - and if they are fueled by investors getting cheap loans and mortgages and getting negative yields on savings so wanting to spend spend spend rather than save at more normal rates, then arguably the revenues are not really sustainable (in some sectors).

CAPE as mentioned by Reaper is another type of p/e, it seems more useful in some circumstances - of course anything that uses an adjusted earnings which consider 10 year averages to cyclically adjust, is going to be flawed when earnings do tend to naturally rise rather than stay flat over 10 years (the Apples and Googles were nowhere 10 years ago).

My point was that there are lots of measures available and we have to weigh up all the circumstances around politics, local and global economy and reported micro and macro results to decide on which side of the fence we sit. If you think it will go down, that's a perfectly reasonable view, but "this time I chose the 200 moving average in relation to the s&p 500" is a very poor reason because it's not generally useful for the reasons I describe.

And you have said just now that sentiment drives markets rather than p/e or moving averages, so does this mean you agree we now shouldn't read anything into the moving average you were using to try to prove your point?

Bottom line I agree with you that one should never be complacent when it comes to investing, it can lead to mistakes. Thinking a market has to go up because the price is fine and the herd will drive it up, is a bad way to invest because the herd will stop at some point and the price might not be so fine after all. However I do generally have less time for views that "the thieves in wall street are going to burn everyone alive" because it sounds a little more tabloidy that I can put up with in anything more than small doses.

Glen_Clark

Radiantsoul wrote: »

The main alternative to stock markets is interest bearing assets which are not hugely attractive either.

Certainly shares look better than cash at the moment, but how much longer can interest rates be held below inflation?

talexuser

Glen_Clark wrote: »

how much longer can interest rates be held below inflation?

As long as the large group of older voting pensioners do not realise just exactly how much money they are losing and quietly acquiesce without headline grabbing protests?

srcandas

This thread is the best read I have had here in a long time. Some of our best thinking contributors have chipped in and one can see just how difficult reading the future is. Especially with different sources of Data (in particular US and the UK).

Clearly 'chosen' figures can prove almost anything and there is still lots of room for gut feel.

For my pennies worth I feel we are on the edge of a big step forward and now is a time to invest but carefully.

That said almost half my investment is in the hands of Sebastian.

[ I know it means little but just two weeks ago I read Sebastian was buying gold and now I see its price rising. While that leaves me feeling good I appreciate Sebastian's strategy flies in the face of many others. I'm not even sure I accept his arguments but I trust the guy for some gut feel reason ]

Maybe what makes investing fascinating is the big unknown aspect. Even a minor player can beat the big boys (i'm talking about investors and not about the financial industry) every now and again.

But great stuff and much appreciated. I now know more about PE than ever I thought I might need to know