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IBD MEETUP/NORTHRIDGE. LET’S MEETUP AND DISCUSS STRATEGY FOR Q2-2014 AND REVISE OUR WATCHLIST. 04/13/2014. DISCLAIMER. During the course of this meeting we will review stocks that should be considered as additions to your watch list.
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IBD MEETUP/NORTHRIDGE LET’S MEETUP AND DISCUSS STRATEGY FOR Q2-2014 AND REVISE OUR WATCHLIST 04/13/2014
DISCLAIMER • During the course of this meeting we will review stocks that should be considered as additions to your watch list. • These are not trade recommendations. These are candidate trades. Do your own research, keep position sizes modest, and stay diversified. • Also past performance is no indication of future stock trends.
WHAT ABOUT THE USUAL SUSPECTS? • THE DEBT CLIFF • THE BUDGET SHUTDOWN • THE TAPER • OBAMACARE • THE CONGRESS • OUR ECONOMY • THE OFFSHORE ECONOMY • INTERNATIONAL CONFLICTS
A LOOK BACK AT Q1-2014 • The backdrop has shifted over the past three months, and if we could use one phrase to describe what’s happened, it would probably be “topsy-turvy,” • The best-performing assets of 2013 underperformed, while the 2013 losers flourished. • In the biggest surprise, bond yields fell as prices rose. • Japan—last year’s market darling—found itself at the bottom of stock market performers for the quarter.
EXPECTATIONS • Expect slow growth in 2014, say 1.7% to 2.4%, since economic data has been mixed. • True weather has had an impact particularly on retail, manufacturing and housing. • But this is dissipating; and • Could also be due to • Buildup in Inventory; and/or • Still soft Labor Market; and/or • Anemic real wage growth
STICK WITH STOCKS FOR NOW • Bull Market has completed it’s fifth year • Can stocks go higher; Yes • While stocks are not cheap they are a better option than cash or bonds • Low inflation and interest rates are attractive for stocks • A gradually improving economy also benefits stocks • But expect Market gains to be relatively modest • Risk adverse investors should lock in profits; or • Shy away from small cap stocks and consumer-related sectors • Consider international sectors which have been underweighted by U.S. investors
WHERE ARE WE WITH MARKET VALUATIONS? The Stock Market is Significantly Overvalued. Based on historical ratio of total market cap over GDP (currently at 116.8%), it is likely to return 1.7% a year from this level of valuation. This page is updated daily with the market.
WHAT RETURNS CAN WE EXPECT FROM THE STOCK MARKET? • As of today, the Total Market Index is at $ 19962.1 billion, which is about 116.8% of the last reported GDP. The US stock market is positioned for an average annualized return of1.7%, estimated from the historical valuations of the stock market. • This includes the returns from the dividends, currently yielding at 2%. • As pointed by Warren Buffett, the percentage of total market cap (TMC) relative to the US GNP is “probably the best single measure of where valuations stand at any given moment.”
FACTORS DETERMINING RETURNS • Interest Rate - Interest rates “act on financial valuations the way gravity acts on matter: The higher the rate, the greater the downward pull. So if the government rate rises, the prices of all other investments must adjust downward, to a level that brings their expected rates of return into line. • Long Term Growth of Corporate Profitability - Over the long term, corporate profitability reverts to its long term-trend, which is around 6%. During recessions, corporate profit margins shrink, and during economic growth periods, corporate profit margins expand. The size of the US economy is measured by Gross National Product (GNP).
FACTORS CONTINUED • Market Valuations - Over the long run, stock market valuation reverts to its mean. A higher current valuation certainly correlates with lower long-term returns in the future. The total market valuation is measured by the ratio of total market cap (TMC) to GNP Based on these historical valuations, we have divided market valuation into five zones:
GNP VS GDP • GDP is “the total market value of goods and services produced within the borders of a country.” GNP is “is the total market value of goods and services produced by the residents of a country, even if they’re living abroad. the actual difference between GNP and GDP is minimal
SOURCES OF INVESTMENT RETURNS • Business Growth - If we look at a particular business, the value of the business is determined by how much money this business can make. The growth in the value of the business comes from the growth of the earnings of the business growth. This growth in the business value is reflected as the price appreciation of the company stock if the market recognizes the value, which it does, eventually. If we look at the overall economy, the growth in the value of the entire stock market comes from the growth of corporate earnings. As we discussed above, over the long term, corporate earnings grow as fast as the economy itself.
SOURCES CONTINUED • Dividends - Dividends come from the cash earning of a business. Everything equal, a higher dividend payout ratio, in principle, should result in a lower growth rate. Therefore, if a company pays out dividends while still growing earnings, the dividend is an additional return for the shareholders besides the appreciation of the business value. • Change in Market Valuation - Although the value of a business does not change overnight, its stock price often does. • The market valuation is usually measured by the well-known ratios such as P/E, P/S, P/B etc. • These ratios can be applied to individual businesses, as well as the overall market. • The ratio Warren Buffett uses for market valuation, TMC/GNP, is equivalent to the P/S ratio of the economy.
RETURNS THE MARKET IS LIKELY TO DELIVER Putting all the three factors together, the return of an investment can be estimated by the following formula: Investment Return (%) = Dividend Yield (%)+ Business Growth (%)+ Change of Valuation (%) The third item can be calculated if we know the beginning and the ending market ratios of the time period (T) considered. If we assumed the beginning ratio is Rb, and the ending ratio is Re, then the contribution in the change of the valuation can be calculated from this: (Re/Rb)(1/T)-1 As of 04/09/2014, the stock market is likely to return 1.7% a year in the next 8 years.
THE CURRENT BULL MARKET IN HISTORICAL PERSPECTIVE • The current bull market is now five years old. The sixth year is under way. • As of December 2013, the S&P 500 stock price index had risen by 139% from the through of March 2009 to stand at an all-time high. • The index, however, is only 17% and 22% above the previous pre-bear market peaks of October 2007 and August 2000. Adjusted for inflation, the current level of the S&P 500 index is hardly above the pre-bear market peak of October 2007 but below the pre-bear market peak of August 2000 by approximately 10%. • Table 1 reports all the periods of bull market for the S&P 500 price index since the end of World War II along with their respective percentage increase (from through to peak) and duration (in months).
FORECASTING THE MARKET • A simple formula rather than a crystal ball incorporating things like unemployment and quantitative easing. • The formula simply states that stock market returns have three components - dividends, earnings and P/E expansion/contraction. • This third factor, P/E expansion/contraction, is the wild card, driven by investor behavior.
AVERAGE LONG TERM SITUATION • Corporate profitability trend is 6% • If PE is 15 • The loss would be -16%
The size of each wedge represents the sector's relative percentage of the U.S. Equity market. The color represents weighting recommendations from independent third-party research firms. See the table below for details.
