Weighing The Week Ahead: All Eyes On Earnings

Summary

• The economic calendar is very light and the week is a short one. The earnings calendar is heavy. Voila!
• The economic news has been very good and the market has responded. Technical market health is also better.
• The P/E multiple has increased, even on forward earnings. That is important to watch.
• I suggest the best factors to watch during earnings season and where to find them.
• And of course, we have stock ideas and hints on how to play the Great Rotation.

The economic calendar is one of the lightest we will see in 2020, and we have a holiday-shortened week. Economic data will not be the main story. The news will be filled with Impeachment updates, but that is not a focal point for investors. For us there are 144 earnings reports from S&P 500 stocks. It will be a case of:

All Eyes on Earnings

Last Week Recap

In my last installment of WTWA, I asked whether it was yet time to worry about inflation. It has been so tame that most do not see the risk. I said that I was probably still early in this worry, and so it was. I also failed to reach much of my audience. Despite my rationale that understanding the Fed helps your investing more than railing against the government’s inflation numbers, many remain unconvinced. At least I tried!

Personal Note

Mrs. OldProf asked me how this picture of my box of cords got in the WSJ. She believes that I could have done more weeding before our recent move. (I’m not allowed to talk about her “mystery” stuff). She doesn’t know that I have three boxes like this (I think – might be more).

The Story in One Chart

I always start my personal review of the week by looking at a great chart. This week I am featuring Jill Mislinski’s weekly update, which combines several key features in an easy-to-read picture.

The market gained 2.0% for the week. The trading range was 1.9%, on an intra-week basis. You can monitor volatility, implied volatility, and historical comparisons in my weekly Indicator Snapshot in the Quant Corner below.

Noteworthy

Statista shares the most read Wikipedia Articles of 2019. I’m sure there is a lesson in this.

The News

Each week I break down events into good and bad. For our purposes, “good” has two components. The news must be market friendly and better than expectations. I avoid using my personal preferences in evaluating news – and you should, too!

New Deal Democrat’s high frequency indicators are an important part of our regular research. This week the indications are positive in all three time frames. NDD has been watching for signs that manufacturing weakness might have spread to consumers. His conclusion is a bit more upbeat:

"As of this week, there is little sign that the weakness in the producer sector has spread out to affect consumers. The conclusion that this remains a passing slowdown vs. a recession remains most likely."

Fans of technical analysis might compare this with the improvement in market health in the Quant Corner (below).

NDD’s conclusion has some support from Bloomberg’s read on consumers.

The Good

• Mortgage applications were very strong. The start is even better than last year’s excellent performance.

• Core CPI increased only 0.1% in December versus expectations of 0.2%. As I explained in the last WTWA, low core inflation allows the Fed to remain on the sidelines. There are better indicators of economic growth.
• Core PPI increased only 0.1% in December versus expectations of 0.2%.

• Retail sales for December increased 0.3%, in line with expectations, but November was revised from 0.2% to 0.3%. The ex-auto report showed a gain of 0.7% versus an expected 0.5%. (MarketWatch).
• Initial jobless claims surprised by recording only 204K last week. This beat expectations of 217K and the prior week’s 214K.
• The JOLTS report for November confirms the expansionary labor market. The quits rate, an indication of employee confidence, was 2.3%. The ratio of unemployed workers to job openings declined slightly but remained at historically low levels under 1.0. The Beveridge Curve remains stronger than at the start of the expansion in the 2000’s. (Washington Center for Equitable Growth). The superficial treatments of this report just mention the number of job openings. The real purpose in value is the insight into labor market structure. Calculated Risk also pushes back on the common superficial interpretations.

So, for the twenty-first consecutive month, there were more job openings than people unemployed. Also note that the number of job openings has exceeded the number of hires since January 2015 (almost 5 years).

• Housing starts for December were 1608K (SAAR), far surpassing the expected 1380K and November’s (upwardly revised) 1375K. Calculated Risk provides the analysis and a possible explanation. (Emphasis in the original).

"These were blow out numbers! This was the highest level for starts since December 2006 (end of the bubble). However, the weather was very nice in December, and the weather probably had a significant impact on the seasonally adjusted housing starts number. The winter months of December and January have the largest seasonal factors, so nice weather can really have an impact. Note that Permits were more in line with expectations (still solid).

Single family starts were up 29.6% year-over-year, and multi-family starts were up 74.6% YoY."

The Bad

• NFIB small business optimism for December registered 102.7, down from the prior 104.7. It remains in a historically high range. David Templeton (HORAN) notes that it is one of the highest readings in the 46-year history of the index. There is also a decline in the number of respondents describing the “Cost of Labor” as the single most important problem. Diana Olick notes that the optimism slipped slightly but is still high.

• The NAHB Housing Market Index for January was 75. While this was a slight beat of expectations, it was lower than December’s 76. Bespoke highlights the positive.

• Industrial production in December declined 0.3% versus expectations of a 0.1% gain. November was also revised lower, from the reported 1.1% gain to 0.8%.

The Ugly

Puerto Rican rescue supplies sitting in a warehouse? For years? “Explanations” are being offered and we do not yet know if this was mismanagement or corruption. It is bad enough to suffer through these natural disasters, but those cannot be controlled. This could be. (CBS).

The Week Ahead

We would all like to know the direction of the market in advance. Good luck with that! Second best is planning what to look for and how to react.

The Calendar

The economic calendar is light and the week is holiday-shortened. The big news will come from corporate earnings reports. 88 companies in the S&P 500 have reported so far, and another 130 will do so this week.

Briefing.com has a good U.S. economic calendar for the week. Here are the main U.S. releases.

Next Week’s Theme

As always, earnings season provides validation – or refutation – of economic data and market prices. This week we have:

All eyes on earnings.

Background

Like any complex story, earnings reports present a great opportunity for pundits and for those on a mission. Everything can seem great in a report, but a few cautious words in the conference call can change everything. Even if a company’s report is spotless, a subsequent decline is interpreted as the news that was already “baked in.” It would be interesting if those who act so smart after the reports had to tell us what is “baked in” before the announcements!

What to Watch

Investors who are willing to do some work can learn a lot during earnings season. Here are some ideas that can guide your research.

Forward Earnings Lead Actual Earnings

Markets act on expectations of future outcomes, not history. Dr. Ed Yardeni has been tracking forward earnings for decades. His site provides an impressive analysis of economic series and stock prices that are strongly correlated with forward earnings. Here is one important example.

Stock Prices and Valuation

Forward P/E is an excellent measure of valuation. The valuation measures in the table below have mostly worked to keep investors out of the markets during the entire rally. The last one, EY Spread, is the earnings yield minus the lowest investment grade bond. By this measure, stocks are significantly undervalued.

Watch Sector Results Through the Earnings Season

This provides more information about the economy and underlying investment trends. This chart shows the long-term history of various sectors versus the year-by-year results.

A great source for this is John Butters at FactSet. He regularly provides updates on overall results as well as the sector analysis. I’ll start showing the charts next week when there is more data.

Look at Revenue as well as Earnings

I am not as suspicious as those on my “reliably bearish commentators” Twitter list, but we all know that some companies “manage” their earnings. Looking at revenues and cash flow provides a good check on this possibility. John Butters also provides this important data.

Watch Changes in Forward Estimates

Since forward estimates are so helpful, changes are an early warning system. For many years, Brian Gilmartin has been a leader on this subject. In this post, he explains some current revisions and a possible pattern in the first quarter of each year. Instead of trying to do some statistical analysis of a handful of data points, he takes a closer look at each year. Here is his conclusion, but read the full post to understand the method:

"My own opinion on the general bearishness of analysts regarding forward prospects is that it’s partly a hangover from 2008, the worst recession in the post WW II era, but also management’s have little incentive to be aggressive, which is the complete opposite of the late 1990s."

This may surprise those who believe that analysts are always too bullish. Since the bar is always low at the time of the report, they had to turn pessimistic at some point! Brian’s hypothesis explains why things often look weak at the start of a year and then firm up.

Read the Transcripts

Not so long ago anyone wanting to hear a company’s conference call would need to learn the number and listen to the entire presentation. If you want to feed your algorithm or trade on “breaking news” that is still necessary.

For many investor purposes, it is enough to read the transcript after the fact. Seeking Alpha’s Transcript Team publishes thousands of earnings calls in a searchable form. It is very practical to use for a wide variety of purposes. One important advantage is that you will know what was actually said instead of some knee-jerk market reaction to a phrase or two.

I’ll have some additional observations in today’s Final Thought.

Quant Corner and Risk Analysis

I have a rule for my investment clients. Think first about your risk. Only then should you consider possible rewards. I monitor many quantitative reports and highlight the best methods in this weekly update, featuring the Indicator Snapshot.

Both long-term and short-term technical indicators remain neutral, but are now improving. Last week’s trading was a tonic for nervous technical indicators.

The C-score remains in a zone which suggests that we watch for confirming data. Like others, we don’t see much of that. Most sources have lowered recession odds, and some have moved recession chances completely out of 2020. Why has the C-Score fallen? The potential for inflation. So far, so good on that front, but it is important to keep the Fed out of play while we start to enjoy reduced trade war effects.

The Featured Sources:

Bob Dieli: Business cycle analysis via the “C Score”.

Georg Vrba: Business cycle indicator and market timing tools. The most recent update of Georg’s business cycle index does not signal recession.

Brian Gilmartin: All things earnings, for the overall market as well as many individual companies.

Doug Short and Jill Mislinski: Regular updating of an array of indicators. Great charts and analysis.

Guest Sources

This is an important chart from JPMorgan’s excellent Guide to the Markets. Keep it handy for when someone tells you about the aging bull market.

Insight for Investors

Investors should understand and embrace volatility. They should join my delight in a well-documented list of worries. As the worries are addressed or even resolved, the investor who looks beyond the obvious can collect handsomely

Best of the Week

If I had to recommend a single, must-read article for this week, it would be Trent Hamm’s How to Turn What You Read into Financial Action. (HT/Abnormal Returns). We are all overwhelmed with ideas, making it a challenge to implement those that are important. This post may seem simple in principle – and it is. That does not make it less important. The author raises three questions:

1. Is there anything in this article that feels like it could actually improve my life in a way that I seriously want?
2. Is the proposed change a realistic one for my life situation?
3. What single action could you take that would start you on the right path?

He provides a number of great examples, including a frugal Valentine’s Day. (That won’t be on my list!)

Make it a point that, when you find an article that describes something really powerful and meaningful to do, you actually translate that into one single meaningful action. Do just one thing. Don’t try to do it all – that’s overwhelming. Break it down to just one step, do that one step, then ask yourself tomorrow how you feel about it.

That’s how real change begins. It doesn’t come from reading an article and forgetting about it. It doesn’t come from trying to change everything all at once. It comes from that one meaningful action.

He challenges readers to take something from his article and do it. It provides proof of concept. I might offer the same challenge to WTWA readers, since I have some very specific suggestions this week.

And as for my own challenge - where is that box of old cords?

Stock Ideas

Lyn Alden Schwartzer’s Seeking Alpha 2020 preview has been published. It is packed with facts and important strategic ideas. I recommend reading it carefully. I am answering many of the same questions, so it will be fun to compare!

Chuck Carnevale explains that Value Investing Is A Long-Term Strategy And Should Be Judged Accordingly. As always, he illustrates his analysis with great examples. Readers will, as usual, get both a lesson and some stock ideas.

Oil services? Schlumberger: A Dominant Oil Franchise says Michael A. Gayed. He mentions that earnings will be out next week. Read the full analysis carefully.

Stone Fox Capital analyzes BoAML’s call of Citigroup (C) as the “pick of the decade.” It is a good analysis of an interesting call, “an insanely cheap stock” while the “whole money center bank sector remains exceptionally cheap.”

Kirk Spano has another report from CES 2020: EVs Could Dominate New Car Sales By 2030. His article includes several key themes, including when to expect fully autonomous vehicles and which companies are poised to benefit. This discussion of sales trends and cost of ownership is especially helpful.

Pharma and biotech? Executives at the JPMorgan Healthcare Conference were not worried about the political rhetoric (Barron’s). “When asked, many pharmaceutical and biotech executives offer the same answer: Whatever happens, our company’s drugs are important enough that we’ll get paid fairly for them.”

The Great Rotation

Here is an update on the trade war impact on agricultural exports (EconoFact). Read the full article for an explanation of the retaliatory tariffs and other indirect effects. Even the modest Phase One program unwinds some of the negative effects and begins the process toward more.

Emerging Markets Could Be Poised to Outperform U.S. Stocks for a Very Long Time writes Andrew Addison. His argument is technical, illustrated by this chart:

Watch out for

• High yield debt (junk bonds). This chart shows the yield to worst (that means the soonest time the bond could be called away to your disadvantage). You are getting stock-like yields with a lot less upside.

• Excessively high REIT yields. Blinded By The Dividend-Paying Light: Beware Of Washington Prime's 'Sucker Yield' writes Brad Thomas about WPG. What about a dividend yield of 26.74%?

"Well, let me put it bluntly, it’s a sucker yield.

Frankly, there’s no excuse for it.

There are times when a dividend-paying company – particularly a REIT like Washington Prime is – can offer a 7% yield in a safe manner. There are times when a REIT can offer an 8% or even 9% yield without breaking the bank.

But I can’t think of a single example of a dividend-paying company – REIT or otherwise – that could sustain something over 20% for too long."

Final Thought

Some of the easy money in the market has been made. The multiple of forward earnings at 18.8 is much more reasonable than last year’s. It can move even higher (and often does with rates this low), but it will require continued confidence in the economy. That translates into confidence in earnings expectations.

I find backward-looking earnings analysis far less valuable than forward earnings. Oftentimes those using past earnings do so only because they do not understand how to forecast.

Sure, it is important to normalize earnings growth to reflect the business cycle. I do this in every stock I purchase, using the excellent FAST Graphs tool. What is the difference in my approach?

1. I do not use data from the nineteenth century. Or even most of the 20^th century. An adjustment should reflect the relevant factors, not using all of the data merely because you have it.
2. I consider interest rates as part of the process. I demand a much lower P/E ratio when the yield from bonds is attractive. The expected inflation rate is relevant for both.

These concepts are more widely accepted after a ten-year rally, but when I first started writing they were controversial. Many contended that the proper P/E for stocks was fixed at about 16x trailing earnings. Using forward earnings was something that “bullish analysts” did. People did not accept the fact that this was the investor’s choice. Critics continue to disparage the concept of seeking the most rewarding investment by the term “TINA.” There is no alternative. That is just a sassy way of saying what some of us pointed out a decade ago.

An idea for beating the markets is illustrated below in this mystery chart.

Great Rotation Hint of the Week

If you have been following my weekly hints, you are building a portfolio that will take advantage of the Great Rotation. I have been quite frank about my method. If you do similar homework, you’ll find some really attractive stocks. This earnings season I am looking for companies that complain about effects of the trade war. I do not care if the earnings were weak; I want to know the reason. A closer look will allow me to evaluate how much the Phase One deal will help.

For my final advice this week, I am tempted to say, “Buy low and sell high.” I do not mean to be glib, but that is the choice facing investors. It will not be enough to play along with what worked last year. I’ll have more on this theme in my Seeking Alpha Preview for 2020 – soon to be released.

[This is a time of great risk and great opportunity – a bad place to make a big mistake. Is your portfolio ready for the Great Rotation? Are you overloaded with risky, overpriced stocks? If you are unsure, write for my brief paper on Four Signs of Portfolio Trouble and also the one about Market Highs. Just send an email request to info at inclineia dot com].

Some other items on my radar

• Inflation remains a concern, despite the recent reports. Rental charges are moving up and the labor market remains tight.
• Business investment. If uncertainty was reduced, businesses could act more decisively. New equipment and plants would foster productivity and economic growth.

And then we have the “Mystery Chart.” The underlying ETN is the Barclays ETN+ Shiller CAPE ETN (CAPE), a method based on Dr. Shiller’s work. Rather than using the ratio to time the market, the managers compare the CAPE for various sectors to historical norms (not going back to 1871). They do not get out of the market. They buy the cheapest and exit when the sector becomes more expensive.

Analyst’s Disclosure: I am/we are long C, CAPE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Comments

[Brad Thomas]

@Jeff Miller Thanks for the "sucker yield" citation. WPG rated strong sell by iREIT team

[iphpweb]

good article, always a nice read, thanks @Jeff Miller
as for the great chart - I see 2 gaps and IMHO daily gaps are to be closed sometimes soon, so we might be facing some slight correction downwards, market is about to perform sideways so to say

keep writing for us))

[Jeff Miller]

@iphpweb

I was expecting someone to discuss the closing of the daily gaps! We shall see.

Jeff

[dancing diva]

Perhaps the coronavirus will be the catalyst/excuse for closing the gaps.

[NervousNeville]

Does anyone here care to critique my current asset allocation?

Age:43 Retirement target: 62

US Stock: 53%
Non-EM Foreign: 9%
EM: 9%
Bonds: 20% (mostly short/intermediate duration plus municipals which I'm tempted to dump)
Cash equivalent: 9% (Money markets with a decent yield)

thanks!

[Lake OZ boater]

@NervousNeville asked: "Does anyone here care to critique my current asset allocation?"

-I think your allocations line up well with your investment horizon.

-At age 43, you have a remaining life expectancy of 38.7 years. (i.e. your investment horizon is 38.7 years).

Source: www.ssa.gov/...

Consider a basic financial planning concept...

"If a buy-and-hold investor with no particular view about market conditions or future returns wishes to have a fairly predictable amount of wealth at some future date, that investor should hold a portfolio with a duration that is roughly equal to the investment horizon."

ETFs used for estimates of portfolio durations:

Stocks: I used some stock index ETFs to get modified duration estimates of your holdings, using a quick rule of thumb, i.e. the dividend discount model (DDM).

SPY: 55 years

VXUS: 32.6 years

VWO: 30.8 years

Bonds: I estimated a blended duration of 5 years-- considering you hold both short-terms and intermediates.

Cash: Has a duration of zero (0).

Your portfolio allocations' overall duration...

(0.53 x 55 yrs) + (0.09 x 32.6 yrs) + (0.09 x 30.8 yrs) + (0.2 x 5 yrs) + (0.09 x 0) = 35.7 years.

Your portfolio's 35.7 years is pretty close to the 38.7 years investment horizon.

See "Matching Investors to Portfolio Duration" at link.

aurumwealth.com/...

Other thoughts:

-The calculations should be done once annually.

-You probably could even have an even higher overall stock allocation (your personal risk tolerance permitting of course) by decreasing your US exposure and adding more to your international stocks allocations. The international indexes have lower equity durations.

-Your current international allocation is 18% / 71% = 25%. Given high valuations in the US market, Vanguard is recommending up to 40% in international stocks.

pressroom.vanguard.com/...

Hope this helps. Good luck in the years ahead!

[NervousNeville]

Thanks so much for your analysis and the links. I really appreciate it. I'll look into this further.

[Lake OZ boater]

@NervousNeville FYI... Rationale for increasing international equities allocation.

"In each market we examined, our analysis indicated that volatility was reduced most with an allocation to international equities of between 40% and 50%. While this observation may help investors determine the appropriate mix of domestic and international equities,
volatility reduction is not the only factor to consider."

www.vanguard.com/...

[Randall Potter]

Mr. Miller, Silverblatt's S&P 500 earnings spreadsheet showed 27 companies reporting last week-2 of which did not report. There were also 4 companies that reported in the first 2 weeks of the year. He also shows 52 companies scheduled to report for this week. So I'm curious as to where you got your numbers for this article.

[Jeff Miller]

@Randall Potter I am using Refinitiv, whose table says 44 for last week, 44 for this week, and 130 for the coming week without any dates as headers. I just started using that report, so I'll try to study it more.

Thanks for your observation.

Jeff

[User 44279746]

The news wasn't all rosy from the Jolts report. JOLTS reported job openings dropped -561k to 6,800k in November. This is the first sub 7,000k print since March 2018.

[alpine]

Does anyone know if JOLTS is seasonally adjusted?

[Jeff Miller]

@alpine Yes, and benchmarked in a way similar to the payroll employment report.

from the release -- www.bls.gov/...

Seasonal adjustment

BLS uses X-13 ARIMA to seasonally adjust several JOLTS series
utilizing moving averages as seasonal filters. A concurrent seasonal
adjustment methodology is used in which new seasonal adjustment
factors are calculated each month, using all relevant data, up to and
including current month data. JOLTS seasonal adjustment includes both
additive and multiplicative models and REGARIMA (regression with auto-
correlated errors) modeling to improve the seasonal adjustment factors
at the beginning and end of the series and to detect and adjust for
outliers in the series.

[alpine]

@Jeff Miller Many thanks, in which case, I do "worry":
- BA's travails are extending far and wide within and without its vast eco-system;
- perhaps the best of "X-13 ARIMA" seasonally adjusting model could not 'readjust' for the unseasonably warm weather in Dec?

[Bill Kort]

Jeff, I absolutely agree that the issue of a potential resurgence of inflation is under-appreciated. In my opinion it will be a result of the reversal of the globalization trend that’s been in place for the past two or three decades. Cheap global labor (as well as technology) has kept our labor costs and prices in check. In the process we have created huge consumer markets in China, India and elsewhere and societies in those countries that will continue to demand upward mobility. They will demand resources and higher wages that will push prices up all around the world. Of course, we have printed oodles of dollars, yen, yuan and euros to propel this demand. Of course, this will not happen overnight and in the beginning it will be very positive for incomes in this country as well as the ability of corporations to raise prices. Pricing over the past 2 or 3 decades has not been easy. As such, it has taken one of the arrows out of the corporate quiver that used to be used to increase profitability and earnings. When this takes effect it will eventually show up in interest rates, eventually leading to maybe much higher interest rates, higher rates the Fed will not be able to control ... the return of the bond market vigilantes.

I wrote about this in kortsessions a couple of posts ago: www.kortsessions.com/...

As usual, my crystal ball remains very foggy. I’m not sure when the tipping point comes. But I think it will be a positive before it becomes a negative. Anyway, it’s just my two cents. I appreciate the work that you do weekly and look forward future posts.

bk

[PNW Total Return Investor]

Awesome reply to a great WTWA. I try to factor in that we are in an extremely low interest-rate environment and while there doesn't seem to be a floor to how low they can go, I regard it as a Pascal's Wager. I, therefore, have allocated portfolios that I manage that way. That means a lower allocation to long-term bonds and high allocation to short-term treasuries.

I guess I am just uncomfortable with using bonds as a price appreciation tool and rather increase my equity allocation if I want price appreciation.

[Fishn4profits]

Jeff, Thanks again for a great read. Love the box of cables - I have quite a few (boxes/drawers/wads of) cables around myself and they have saved me from time to time. The cables only go in the trash when they are defective or become truly obsolete (for example the mouse and keyboard cables with circular connectors). This is just the price of living in a technological society...

In the 90's I would argue that the forward PEs on tech stocks were meaningless because they were the result of wishful thinking, not estimates based somewhat on reality. These days the forward PEs are more reasonable in most cases, so I use them (of course when there is an economic shock or recession, they will again be meaningless...). Another reader mentioned they are wary of earnings growth projections based on a shrinking share count due to buybacks - to counter that I look at the 5 year earnings and profit history (not per share) before I invest, to make sure there is no monkey business.

[Donny McNeil]

To counter that, real profits are declining now over to 20% in the 1st quarter, it ain't gonna get any better. tariff stocking probably saved real profits from a larger decline faster.

Real earnings are basically at the cycle bottom. If they go any farther, they go below the trend set in 2010.

[Donny McNeil]

Mortgage applications weren't very strong. My guess when they fall this week, your nostril will flare. Understand hedonics.

[mikesuntok]

Jeff, an ETN is as good as its issuer. In recommending an ETN, wouldn't a read out on Barcly's liquidity necessary?

[Jeff Miller]

@mikesuntok

Absolutely! Like everything in WTWA, you do your own research before you act. I just find it amusing that a Shiller-named product does so much better than the "standard" use of CAPE.

Good point -- and thanks.

Jeff

[Lake OZ boater]

Really liked the closing on the mystery chart and the Shiller P/Es by S & P 500 sectors !

FYIs...

1. Gurufocus.com tracks the Shiller P/E by sector. (not back to the 1800s!)

www.gurufocus.com/...

Caveats: CAPE 10 is not the ideal metric to apply to financials nor REITs though.

2. Retirement planning expert Michael Kitces has found the CAPE 10 has the highest correlation (0.65-0.7) with the "real" (after inflation) return at an 18-20 year time horizon.

CAPE 10 has a very low correlation to "mean reversion."

See "Shiller CAPE Market Valuation: Terrible For Market Timing, But Valuable For Long-Term Retirement Planning"

www.kitces.com/...

3. Kitces has also concluded that CAPE 10 is predictive enough of future returns, that a conservative retirement investor, or pre-retiree, might consider a valuation-based approach for "tactical" stock allocation.

www.kitces.com/...

-I prefer using the 50-year average of CAPE 10, channeling the advice of Ben Graham.

-The last 50 years includes oft-mentioned CAPE 10 objections about changes to technology, finance, and accounting practices.

-Ben Graham often reminded his students that objective conclusions require very long samples of large amounts of data, and he used no less than 50 year periods to analyze historical data.

-By shifting the starting or ending date for data samples, he demonstrated that the results change dramatically.

-Graham advocated analyzing data as many different ways as possible, across as many time frames as possible, to provide insights that are more likely to be more durable over time, and include out- of- sample.

A valuation-based approach to stock allocation...

50-year average CAPE 10= 20.5. (much higher than the long-term mean of 16.7).

www.multpl.com/...

2/3* times the 50 yr ave. of CAPE 10 = 13.7

4/3* times the 50 yr ave CAPE 10 = 26.6

CAPE 10 Ranges------------------------Stock allocations

26.6 and higher------------------------30%

13.8 to 26.5----------------------------45%

13.7 and lower-------------------------60%

------------------------------------------------
*thresholds found in the Kitces article.

GLTA in 2020!

[Dialectical Materialist]

Of course investments should be forward looking.

But there is a simple problem with using forward PE: It is only as good as your earnings estimates.

A decade ago some folks were saying AAPL was undervalued. They were corrected by others who, using forward earnings estimates, said it was fully valued. Then the year would come and go and Apple would crush the earnings projections. Bulls would repeat the notion that AAPL was undervalued and again be told by folks using what proved to be ridiculously conservative earnings projections that AAPL was fully valued.

And it works in the reverse too. TSLA's forward PE has been positive for years. Yet each year they fail to generate any earnings at all. Who is right? The investor who points out that the company hasn't made any money or the one who is certain there are gobs of profit coming any day now?

That's why some folks give weight to past earnings performance. It may be past, but at least it's factual. Forward earnings projections are only as accurate as your assumptions.

It's easy for companies (or analysts) to make rosy predictions about future earnings. And investing IS about the future. But with stocks, as with people, it's important to compare promises about the future with performance of the past.

[gutcheck]

strange that within couple of weeks 19 pe is now acceptable and for last few decades and century it would be considered overvalued.

[Chaffey]

Oh yes but ...everything is new...the new paradigm ...just like in 1999.
www.youtube.com/...

[FredDorfman]

I think Japanese equities peaked at a hundred p/e back in the 80s on the "blue chip Nikkei." Where there isn't in fact negative rates there is the demand for said such "stimulus" and indeed an order for such a thing. Interesting market corner in palladium tho. No one calls it that of course tho..

[chicagotim1]

....if I remember correctly:
In the 80's, the capital gains tax rate on personal real estate in Japan was ~90%, but the capital gains tax on equity transactions was somewhere around 20%.

People never sold their homes, but had all sorts of equity in the residence. So, borrow against the house, and put the proceeds in the stock market.

Ouch. Not saying 'everyone' did this, but I'd met people from Japan who'd make reference to the phenomena.

The meaning of 'bubble'.

[Illinois Bob]

Thanks for the read Jeff...

I've been looking to try to diversify my portfolio and will do more research in the coming week.

Also trying to help my wife make a move of her 401K which she transferred out (still in process due to goof @ holding company). She would freak out when her stock portfolio would go down... from month to month, but she is looking to re-invest it... may want to change mix...

Hope all have a great day and don't get to upset with market closure on Monday...

[UncleEddie]

@Jeff Miller

I have a couple of those boxes! They are mostly the result of upgrading my various electronic technologies.

[gelstretch]

@Jeff Miller

The depiction of the above identified "box of electronics" is justified .... I refer to mine as a "strategic electronic resource reserve" and it now is has relevance as something of value.

[FredDorfman]

natural gas price collapse appears to be the kick off to yet another "Greenspan Put"(on orders via Twitter by President Donald J. Trump.) The impeachment of President Trump is "hyper bullish" for equities and I expect the massive move higher in healthcare and biotech to greatly accelerate. Long $UNH United Healthcare

Strong buy

[danwatson888]

Jeff - very much enjoy your articles/links/charts and thanks for the Barrons link on Biotech/Pharma = www.barrons.com/...
However, as I am 100% invested in Biotech/Pharma/Medtech stocks I remain very concerned should certain Democratic candidates gain in the polls and/or the potential of a Democratic majority of both houses of congress increases. For me the comment "preparing for a rocky 2020" in the article is where I think most in the biotech/pharma sector are at. We shall see.
"Despite the sanguine outlook, it’s clear that some in the sector are preparing for a rocky 2020."
Perhaps Lilly's aggressive statement for 2020 may counter some of the politic.
GLTA in 2020, long ($LLY) and many other biotech's
best
Dan
seekingalpha.com/...

[alpine]

Re:"Both long-term and short-term technical indicators remain neutral, but are now improving."

I was struck at your quick change of direction, i.e. to revert to 'improving' vs just last week's WTWA!

I feel the main thrust of why US markets keep going up could simply be just the sheer volume of cheap money coming into the "system", i.e. from a supply point of view to purchase all these equities, either in the form of shares, but also, increasingly, ETFs. It seems to me Wall Street and even multinational organisations like OECD, BIS, IMF, etc have not analysed deeply enough the amount of 'searching-to-be-invested' cash that is coming out of not just US individuals, but pension funds, insurance companies, etc but also from non-US individuals and instituions like those named earlier. This may be the singular reason that stocks keep going up to ridiculous levels, and I fear, they may continue to go up.

If there is one indicator that I see as a sign of this 'crazed' environment, it is simply the number of advertisements that have started appearing in my local newspaper, distributed free, asking people to sell their 'used' jewelry of any kind, be it gold, silver, platinum, even copper!

There is no sign of any of these reversing, simply because most of the cash supply seems to be coming from 'surplus' that neither the individual (and in some cases, instituions) will need to 'spend' over the next 10, maybe even 20 years, e.g. insurance companies.

[Jeff Miller]

@alpine

I was also surprised at the rapid change in direction of technical market health. These are not subjective calls, but based upon market data. Our modeling guru, Vince, commented to me, "What a difference a week makes."

Thanks for raising this.

Jeff

[Ian Farbrother]

Hi Jeff. Along those lines, I was particularly surprised this week to see the 'technical health' indicators (particularly short-term) in Quant Corner still stuck at 3.

Very curious as to why they haven't gone up this week.

Cheers, Ian

[Bohan2012]

What justifies looking at only 25 years worth of valuation data? Others use data running back over a hundred years or how about at least back to WWII. Compared to the longer time frames the last 25 years have had much ricer market valuations. Price to revenue and price to market cap are also missing.

[Former CFA]

Because 50-75-100 years ago the market was dominated by capital intensive, hyper-cyclical and relatively low ROC businesses.

In general, the companies making up today's stock market are much less capital intensive, have higher profit margins/better ROCs, are less cyclical, etc.

Thus when long-term market valuation measures compare these eras (and when "reliably bearish" pundits use them to "prove" the stock market is overvalued), they are not comparing apples to apples. It's not unreasonable to pay a higher P/E for the types of companies making up today's stock market than you'd pay for the companies making up the stock market of 1910 or 1949.

[dancing diva]

CFA is correct, but I think the more important reason for the higher p/e's are the many changes to the tax code since Reagan. Reductions in marginal tax rates have given more disposable income - which at least partially lands in stocks. The fact dividend income is given preferential treatment over interest income (around 2003) helps shift money from cd's and bonds into stocks.
I wrote Schiller several years ago and he acknowledged changes to the tax code has had an effect on CAPE.

[eldora1]

When we get through this attempt to unseat a duly elected President, the market will be fine, along with the many promising things that can develop as the World shows some signs of calming down.

[TeachEnglish]

He has attempted to unseat himself through his lawlessness.

[Ptstanford]

Lawlessness? What crime has he committed?

[User 44279746]

Lawlessness? Where are the actual crimes in the impeachment order? A couple of made up crimes, unlike the 11 actual crimes committed by President Clinton. Oh, and even 31 Democrats in the House voted for his impeachment inquiry, and 10 Republicans in the Senate voted not to convict on the perjury charge. Let's see how many Democrats in the Senate vote not to convict Trump.

[Kirk Spano]

One thing I think folks ought to keep in mind is the data underlying what Jeff is doing. Following and UNDERSTANDING the data is vital. It always amazes me how many others cite data exactly opposite of what it really means. Jeff is spot on almost every time.

Quantitative data for investing is also important. I have moved largely toward a quant approach on trading as well. It's the only defense against the machines in my opinion. The combination of value, a smart forward outlook and quant trading are the only ways to mitigate risk and still catch upside.

[Jeff Miller]

@Kirk Spano

Thanks, Kirk. Using data provides a solid foundation, helping to avoid confirmation bias.

Jeff

[Kirk Spano]

Data?!?!?!? Who woulda thought!?!?!?!