There is a saying about equities investment cycles along the lines of up the stairs, down the elevator. Yesterday saw the ASX200 hit a new all-time high. It took almost 12 years to surpass the last high seen before the GFC in 2007 before the index more than halved during the financial crisis. 12 years to get back to where you started if you bought near that top. 12 years of kicking yourself if you didn’t sell near that top. It has certainly been a long walk up those stairs. Those who bought gold saw their money double during that same crisis.
So here we are again at record high share prices but let’s remember Mr Buffets famous saying “Price is what you pay, value is what you get”. So are values saying we have further price gains ahead as one might expect after only just surpassing the previous high? Knowing full well that whatever Wall St does, ours will surely follow, let’s look at some excellent charts courtesy of Crescat Capital’s latest quarterly investor letter. Firstly their macro model is screaming alarm bells…
The table below looks at no less than 8 different valuation metrics and where they sit statistically on the bell curve. As you can see they are all at extreme levels (i.e. rarely surpassed).
Amid growing data that economic conditions are weakening and therefore so should earnings looking forward, the following chart highlights how badly that could quickly escalate.
We hear time and again that these valuations are fine because of low interest rates. Crescat debunk this factually:
“Tackling the second bull argument that low interest rates justify today’s high valuations, the flaw in this thinking is just as pronounced. The reality is that stocks have never been this expensive for how low the 10-year Treasury yield is today. It’s true that all else equal, low interest rates justify higher valuations. However, the lowest interest rates historically haven’t corresponded to the highest P/E markets because extremely depressed yields also signal fundamental problems in the economy. Ultra-low rate environments are often marked by highly leveraged economies where future growth is likely to be weak. Growth must also be discounted in the valuation formula.”
Yeah, but jobs are so strong so the economy must be awesome….?
“As we previously said, the unemployment rate has been one the most reliable contrarian indicators throughout history. It reaches a cyclical low prior to every recession since the 1970s. The year-over-year change, however, is what tends to confirm the turning points in the economy. Most of the times this rate shifted to positive, a market downturn followed. In this business cycle, the YoY change likely bottomed in late 2014 and it has now been flirting with the positive camp since then. However, other labor market indicators are already showing signs of weakening economic conditions. The Conference Board’s Jobs Hard to Get Index is one of them. It has recently spiked and is yet another classic late-cycle development in the economy.”
And the ‘everything’s awesome’ trade is coming off precipitously, as before each recession:
And arguably one of the most accurate predictors, the yield curve:
“As show below, the US 30-year yield dropped below the upper bound of the federal funds rate (FFR) for the first time since the global financial crisis. It’s one more bearish signal that adds to Crescat’s fire hose of cycle-ending macro data. The same warning occurred ahead of the GFC, tech bust, Asian crisis, S&L crisis, and 1980’s double dip recessions. The only false signal was in 1986, but one could argue that it did ultimately lead to the 1987 crash. Above all, as of July 2nd, we had the entire US Treasury curve below the Fed overnight rate. Perhaps the bond market is trying to tell us something.”
But if the Fed does indeed cut rates by 50bp next Wednesday that will just juice this market up even more won’t it? Not according to history. Cutting into a ‘strong’ market sends a clear signal that all is not well rather than cutting in a weak market to help it recover.
Where does this leave gold, silver and platinum?
“Precious metals are one of the few pockets of this market offering tremendous value to hedge against extreme monetary policies, bursting asset bubbles, and record global leverage. We see this opportunity playing out across gold, silver and related mining stocks. Gold is the ultimate form of money with a long history of storing value for investors and outperforming risk assets during market downturns. In our view, a new wave of global fiat currency debasement polices is now in its early stages. Gold should become a core asset for those who believe in this macro development, but it is still widely under-owned today.
With the Fed shifting back to easing mode as the global economy is faltering, new fuel has ignited a precious metals fire. It is still very early in the game in our analysis. Rate cuts point to a new trend of declining real yields to drive precious metals higher even before inflation returns. Below we show seven-year trends in real rates and gold that have just reversed.”
Crescat’s hedge funds have substantially outperformed the S&P500 and the MSCI World index during this unprecedented ‘unconventional monetary policy’ environment since the GFC. They are certainly worth listening to… Their conclusion:
“The US market is fundamentally and technically overvalued to an extreme. But, how much should we expect it to be down in a coming bear market? Just to get to mean historical valuations, it could be a 50% plunge. The problem is, a 50% decline would equate to the highest ever valuation at the depth of a bear market and recession in the US, so it could be a best-case scenario. That is how over-valued the US equity market is today!”
If the market drops 50% you need to make 100% gains on what’s left just to get back to even. As we started, that just took 12 years in Australia…