Mish's Global Economic Trend Analysis

Stocks More Overvalued Now Than 2000 and 2007 No Matter How You Look at Things
How to Uncover Hidden Economic Weakness!
Retail Sales Soft Again (Unless You Exclude Everything Weak); How to Uncover the Hidden Consumer Strength!
Federal Spending Per Full Time Workers and Related Charts

Stocks More Overvalued Now Than 2000 and 2007 No Matter How You Look at Things

Posted: 11 Dec 2015 01:18 PM PST

Overvalued No Matter How You Look

Currently, stocks are extremely overvalued by multiple methods.

The first way is by looking at Cyclically Adjusted P/E Ratios commonly known as CAPE, Shiller P/E, or P/E 10 ratio.
The second is by looking at median P/E and P/S (Price to Sales) measures

We will look at both, but here's a description of CAPE.

CAPE is a valuation measure applied to stock market indexes. It's defined as price divided by the average of ten years of earnings (Moving average), adjusted for inflation. The essential idea is earnings are mean-reverting making forward looking earnings frequently too optimistic, and current PEs too high following steep corrections.

CAPE is not without its detractors and debates have raged over its usefulness recently, just as they do at every major market peak when investors find all sorts of silly reasons to presume "It's different this time".

Stocks More Overvalued Now Than Ever

I will post a CAPE chart in a bit, but for now let's take a look at another PE measure I first saw described today.

The idea is from Ned Davis, but written up by Mark Hulbert in Opinion: Stocks are more overvalued now than at 2000 and 2007 peaks.

Median NYSE Stock's Current P/E and P/S Ratios Sparks Concern

The stock market currently is even more overvalued than it was at the bull market peaks of both March 2000 and October 2007 — according to not just one, but two, valuation measures.

That at least is the message of an analysis released earlier this week by Ned Davis Research, the quantitative research firm. What caught my eye in the firm's analysis was that, unlike virtually all others that conclude that stocks are overvalued, this one was not based on the so-called Shiller P/E — the cyclically-adjusted P/E ratio championed by Nobel laureate Robert Shiller of Yale University.

That's noteworthy, since there would be nothing new in reporting that Shiller's P/E shows stocks to be overvalued. That ratio has been giving this same message for several years now, and skeptics have found many ways of wriggling out from underneath its bearish implications.

But Ned Davis's latest report focuses on something different: the median stock's price/earnings and price/sales ratios. The median stock, of course, is the one for which exactly half have higher ratios and half have lower. By focusing on the median, Davis's findings are immune from the charge that they are being skewed by outliers — such as the terrible earnings among energy companies.

The chart at the top of this column summarizes what Davis found. Currently, according to his firm's research, the median NYSE-listed stock has a price/earnings ratio of 25.6, when calculated based on trailing 12-month earnings. At the bull market peak in October 2007, for example, the comparable ratio was below 20; at the top of the Internet bubble in March 2000, it was even lower.

In fact, according to Davis, the price/earnings ratio currently for the median NYSE stock is the highest it's ever been since his data series began in 1980 — except for the bear-market lows of October 2002 and March 2009, when earnings were depressed by recessions.

A similar story is told by the price/sales ratio. The median S&P 500 SPX stock currently has a ratio of 2.16, according to Davis, versus 1.9 in October 2007 and even lower in March 2000. The median stocks' price/sales ratio has never been higher than it's been this year.

Stocks Incredibly Expensive

To me this is a nice confirmation of what I already know: that stocks are incredibly expensive. Renown investor Jeremy Grantham at GMO feels the same way.

And GMO's Ben Inker makes a strong case that US equities do not deserve much of a PE premium as noted in Disastrous Discussion: US Corporate Profits vs. GDP: How Sustainable is Corporate Profit Trend? Do US Equities Deserve a PE Premium?

How bad can it get?

Inker suggests real (after inflation) earnings may range between -4% and +2% every year for seven years, on US large equities, depending on profit margins vs. assumptions. Yes, a 4% real loss every year for seven straight years is a possibility.

Inker does not put odds on any particular number but here is their actual current best guess.

GMO 7-Year Asset Class Real Return Forecasts

The above from latest GMO Forecast.

GMO Disclaimer

The chart represents real return forecasts for several asset classes and not for any GMO fund or strategy. These forecasts are forward‐looking statements based upon the reasonable beliefs of GMO and are not a guarantee of future performance. Forward‐looking statements speak only as of the date they are made, and GMO assumes no duty to and does not undertake to update forward‐looking statements. Forward‐looking statements are subject to numerous assumptions, risks, and uncertainties, which change over time. Actual results may differ materially from those anticipated in forward‐looking statements. U.S. inflation is assumed to mean revert to long‐term inflation of 2.2% over 15 years.

I point out that a 0% for seven years would be disastrous for pension funds expecting 8% returns or better for the same timeframe.

With that let's return to CAPE.

Shiller PE Ratio

The above chart from Shiller-PE. The chart is continually updated.

I added the dashed red lines. Stocks at or approaching the upper red line are in the warning zone. That does not mean a crash is imminent. Things can stay overvalued for years.

Stocks at or below the bottom line are cheap, but they can always get cheaper. Note that in 2000 crash stock did not even drop in the value zone. They did in the 2007-2009 crash, but never reached the point of exceptional value.

In contrast to the Ned Davis median PE valuation method which only looks at current PEs, Shiller-PEs will drop following a crash.

I see viability in both models, you just need to understand what you are looking at. And right now they are pretty much screaming the same thing, at least to me: sell.

Mike "Mish" Shedlock

How to Uncover Hidden Economic Weakness!

Posted: 11 Dec 2015 09:16 AM PST

Having just written How to Uncover the Hidden Consumer Strength!, I think it's only fair to see if there is a way to uncover hidden weakness.

Business inventories provide a method. The consensus estimate for month-over-month changes in inventories was +0.1% but the actual change was 0.0%.

To see if we can spot the weakness, let's once again start with analysis from a Bloomberg Econoday report, this time on inventories.

Businesses appear to be putting the brakes on inventories which however are still rising a bit relative to sales. Business inventories were unchanged in October with September revised down 2 tenths to plus 0.3 percent in readings that will pull down the GDP outlook slightly. Sales came in unchanged which is just enough to drive up the stock-to-sales ratio to 1.38 from 1.37. This time last year, this reading was at 1.31.

All three components show only the most minimal change in inventories, up 0.1 percent for retailers and down 0.1 percent for both manufacturers and for wholesalers. And sales tell the story, unchanged in October for both retailers and wholesalers and down 5 tenths for manufacturers.

The lack of punch in the economy, the result of weak foreign demand, continues to put upward pressure on inventories. But businesses are successfully keeping their stocks as low as possible, thereby limiting future corrections in production and employment.

Success in Pictures

I don't know about you, but I am absolutely delighted to learn "businesses are successfully keeping their stocks as low as possible, thereby limiting future corrections in production and employment."

Problem Vanishes

I thought I spotted a problem on December 9 as detailed in Wholesale Trade: Another Bad Report: What About Autos?

Inventories to Sales

The inventory-to-sales ratio is clearly in the danger zone. Over-optimism across the board is generally what causes these spikes.

Year-on-year, inventories are up 3.6 percent but sales are down 3.7 percent. Inventories contributed heavily to rather anemic GDP growth this year.

Inventory and Sales - Percent Change From Year Ago
Group Sales Inventories Sales-to-Inventory Ratio Current Sales-to-Inventory Ratio Year Ago
US. Total -3.7 3.6 1.31 1.22
Durable -2.2 2.5 1.66 1.58
Automotive 2.3 13.1 1.77 1.6
Furniture 6.4 9.9 1.63 1.58

Take a good look at autos. Sales are up 2.3 percent but inventories are up 13.1%. Across the board, inventories-to-sales seem way out of line.

Today, I learn there is no problem because inventories are as lean as they can possibly be.

So, I have to apologize. There are no weaknesses, hidden or otherwise. There are only "hidden strengths".

Please click on the link at the top to discover how Bloomberg can guide you to the proper way to unhide those hidden strengths.

Mike "Mish" Shedlock

Retail Sales Soft Again (Unless You Exclude Everything Weak); How to Uncover the Hidden Consumer Strength!

Posted: 11 Dec 2015 08:33 AM PST

Retail sales disappointed once again today. And for the second month in a row, autos led the decline.

Last month retail sales rose 0.1%. This month retail sales rose 0.2% vs. a Bloomberg Consensus Estimate of a 0.3% rise. Nonetheless, Bloomberg analysts cite hidden strength.

Hidden Strength?

Once again the headline for the retail sales report understates underlying strength. Total retail sales rose only 0.2 percent in November which is just under the Econoday consensus. But weakness here came from vehicles of all places which otherwise have been one of this year's standout component for this report. Excluding vehicles, sales rose 0.4 percent which is 1 tenth above expectations. Excluding both vehicles and gasoline, core sales rose a very solid 0.5 percent which is 2 tenths above expectations. A key discretionary category, restaurants, shows yet another very strong gain, this at 0.7 percent in the month. Also showing sizable gains are electronics & appliances, clothing & accessories, non-store retailers (once again), and the general merchandise category where, despite a deflationary pull from falling import prices, sales jumped 0.7 percent in the month.

Vehicle sales fell 0.4 percent in the month on top of October's 0.3 percent decline. These declines are a bit of a surprise given steady readings in unit sales of vehicles which have been holding firmly at 12-year highs. Whether there's a rebound ahead for vehicle sales, which had been so strong through the year, will be key to consumer spending going into the new year. Sales at gasoline stations continue to contract, at minus 0.8 percent in the month. Furniture sales, which have been strong, fell back as did sales of building materials & garden supplies, which have been soft.

Year-on-year rates show nonstore retailers out in front, at plus 7.3 percent to confirm acceleration for online sales. Restaurants are right behind at plus 6.5 percent year-on-year followed by furniture and by sporting goods, both at plus 5.4 percent. All together, core retail sales are up a moderate 3.6 percent year-on-year held down by contraction in electronics & appliances and soft readings for grocery stores and general merchandise. Outside the core, motor vehicles are still in the thick of things, at plus 4.0 percent year-on-year, with gasoline stations down 19.9 percent. Total retail sales are up only 1.4 percent but the gain goes up to 3.6 percent (the same as the core) when excluding just gas.

Taken together, rates of growth are no more than moderate but certain areas are posting eye-catching results, results that point to what must have been a successful Black Friday sales push. The consumer, boosted by a solid labor market and having more money to spend because of low gas prices, is definitely alive and spending going into the final weeks of the holiday season. In a methodology note, the November data reflect a new sample and prior levels have been revised (mostly lower).

Exclusionary Process

It amusing how much analysts go out of their way to ignore everything bad in a report. Take the case of autos. All year, autos have been one of the leading retail sales components. For the last two months they haven't. Earlier this year, analysts were cheerleading autos, today they say ignore autos.

While we are at it, let's exclude gas. If we ignore gas, retail sales are up 3.6%, but only up 1.4% including gas. That's obviously a strong case right there for ignoring gas.

Last month, on November 13, I reported Retail Sales Weaker Than Expected, Led by Autos; Car Boom Ending?

Here are my lead paragraphs from a month ago.

This month the retail sales consensus expectation was for a 0.3% rise.

The actual reading was a gain of just 0.1% for the month. In addition, last month's retail sales were revised lower to +0.0% from an initial reading of +0.1%.

This was the third consecutive weak report.

Nonetheless Bloomberg managed to put an amazing amount of lipstick on today's report.

This is how Bloomberg analysts saw things on November 13:

Bloomberg: "Retail sales slowed in October but fundamentally remain solid. Sales rose only 0.1 percent, 2 tenths under the Econoday consensus. But when excluding vehicles, which slipped back after surging in prior months, and when also excluding gasoline stations, where sales once again fell on price weakness, core sales rose a respectable 0.3 percent which hits the consensus."

What did Bloomberg say in September?

I just happen to have that answer in my September 15, report Retail Sales Rise Thanks to Autos; Industrial Production Sinks Thanks to Autos; Last Hurrah for Autos?

Bloomberg: "Turning first to strength in the August data, motor vehicles rose 0.7 percent on top of July's 1.4 percent gain. These are very solid readings for a very important component that points squarely at a healthy and confident consumer."

In September autos pointed "squarely at a healthy and confident consumer". Obviously we need to include autos in our September analysis.

What did Bloomberg say in October?

I happen to have that answer in Autos and Restaurants Positive in Overall Weak Retail Sales Report; Last Month's Sales Revised Lower.

Bloomberg: "And there are plenty of tangible positives in the data including a third straight solid gain for motor vehicles, at plus 1.7 percent in September, and a second straight outsized gain of 0.9 percent for restaurants. Both of these are discretionary categories and point to underlying consumer strength. Clothing stores are also posting strong gains, up 0.9 percent despite negative price effects from lower import prices."

Four Months of Hidden Strength

Autos don't matter now, and they won't until they will. They will the next time autos rise. Gasoline sales never matter until gas prices start to rise again, and then they will.

Uncover the Hidden Strength!

I suggest Bloomberg uncover what's hidden and produce a chart that shows the strength. All they have to do is strip out those things that sometimes matter and sometimes don't, while always removing things that never matter, until of course they do.

Then the strength will no longer be hidden and everyone will be happy.

Questions to Ponder

Is it good for GDP that people are buying junk (likely from overseas), instead of autos which are likely to be domestic?

Have autos peaked? I think so.

Mike "Mish" Shedlock

Federal Spending Per Full Time Workers and Related Charts

Posted: 11 Dec 2015 12:57 AM PST

Reader Tim Wallace sent in another series of interesting charts showing the existing trends in employment, government spending, population, and labor force. Click on any chart for a sharper image.

Federal Spending Per Full Time Worker

In 1968, the US government spent $2,734 per every full time worker. By 2015, the amount soared to $30,834. Had spending per full time worker increased at the rate of inflation, it would have been $19,390.

Full Time Employment as Percentage Population

Employment as Percentage Population

Labor Force as Percentage of Population

Work Force Data

Fewer and fewer workers are supporting more and more retires. Military spending, Medicare, Medicaid, and other entitlement costs have soared out of sight and not about to stop. In addition state pensions are a disaster area in spite of the massive stock market rally.

Millennials have now taken over as the largest demographic group but they cannot possibly pick up all the associated costs. Something has to give.

Mike "Mish" Shedlock

Economy News

11.12.15

Mish's Global Economic Trend Analysis

Mish's Global Economic Trend Analysis

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