Imagine that you are speeding down one of those long and lonesome stretches of highway that seems to fall off the edge of the horizon. As the painted white lines become a blur, you notice a sign that says “Warning.” You look ahead for what seems to be miles of endless highway, but see nothing. You assume the sign must be old therefore you disregard it, slipping back into complacency.
The elevated market multiple is even more apparent when viewed on a median basis. At 16.8x, the current multiple is at the high end of its historical distribution.
The multiple expansion cycle provides another lens through which we view equity valuation. There have been nine multiple expansion cycles during the past 30 years. The P/E troughed at a median value of 10.5x and peaked at a median value of 15.0x, an increase of roughly 50%. The current expansion cycle began in September 2011 when the market traded at 10.6x forward EPS and it currently trades at 15.9x, an expansion of 50%. However, during most (7 of the 9) of the cycles the backdrop included falling bond yields and declining inflation. In contrast, bond yields are now increasing and inflation is low but expected to rise.
Incorporating inflation into our valuation analysis suggests S&P 500 is slightly overvalued. When real interest rates have been in the 1%-2% band, the P/E has averaged 15.0x. Nominal rates of 3%-4% have been associated with P/E multiples averaging 14.2x, nearly two points below today. As noted earlier, S&P 500 is overvalued on both an aggregate and median basis on many classic metrics, including EV/EBITDA, FCF, and P/B.”
Exhibit #3: Selling Of Company Stock By Senior Managers
Excerpt from a recent article by Mark Hulbert
“Prof. Seyhun – who is one of the leading experts on interpreting the behavior of corporate insiders – has found that when the transactions of the largest shareholders are stripped out, insiders do have impressive forecasting abilities. In the summer of 2007, for example, his adjusted insider sell-to-buy ratio was more bearish than at any time since 1990, which is how far back his analyses extended.
Ominously, that degree of bearish sentiment is where the insider ratio stands today, Prof. Seyhun said in an interview.
Note carefully that even if the insiders turn out to be right and the bull market is coming to an end, this doesn’t have to mean that the U.S. market averages are about to fall as much as they did in 2008 and early 2009. The one other time since that bear market when Prof. Seyhun’s adjusted sell-buy ratio sunk as low as it was in 2007 and is today, the market subsequently fell by ‘just’ 20%.
That other occasion was in early 2011. Stocks’ drop at that time did satisfy the unofficial definition of a bear market, and the insiders’ pessimism was vindicated.”
Exhibit #4: Investor’s Confidence
Exhibit #5: Ownership Of Stocks As % Total Financial Assets
The point my money managing friend wishes to make is simply that the “”warning signs” are all there. However, since the road ahead seems clear, it is human nature that we keep our foot pressed on the accelerator.
As the Federal Reserve extracts liquidity from the markets, the “Bernanke Put” is being removed which leaves the markets vulnerable to a “mean reverting event” at some point in the future. The mistake that many investors are currently making is believing that since it hasn’t happened yet, it won’t. This time is only “different” from the perspective of the “why” and “when” the next major event occurs.
Of course, despite the repeated warning signs, the next correction will leave investors devastated looking to point blame at everyone other than themselves. The question will simply be “why no one saw it coming?”