I promised a few posts ago to have a look at market valuation indicators. So I propose to do that today and also look at some other anecdotal evidence to check on the health of the current bull run. I think this is a good time to do this because the bull run is getting on a bit at around five years now and indices being either at or close to all time highs, with share prices having nearly doubled in the UK and more elsewhere, like the US. So with out further delay I'll break these down into Anecdotal, Valuations and Worries as bull markets are said to climb a wall of worry.
1) Was the report about sales of retail funds last year, the fifth year of the bull market. This showed, wait for it, UK funds under management hit a record high in 2013, while sales of equity funds tripled from 2012. Overall, net retail sales soared 43% from £14.3 billion in 2012 to £20.4 billion in 2013 with the highest net retail sales since 2000 at £11.4 billion. There have been similar figures reported in the US. So the small investor piled back in last year in a big way, they are often late to the party.
2) Initial Public offerings or (IPO's) picking up see E-commerce revolution drives European retail IPO rush.
This was helped by last years Royal Mail privatisation and now continuing with a stampede of Venture Capitalist bringing their hyped up and geared up Theme parks, Pet and Pound shops to market. In addition to this canny entrepreneurs are also cashing in some of their chips in an echo of the dot com boom with the floats of AO and Boohoo the on line retailers in the UK and King the computer game developer behind Candy Crush Saga in the US. IPO's usually pick up when business owners see it as a good time to sell their business.
3) Stock Margin Debt Reaches Record-High,Surpassing 2007 Pre-Crash Level - this is a US centric report / measure but it also highlights insider selling exceeding buying by a 20 to 1 ratio in February 2014. To finish this section there was another report entitled 10 Warnings Signs Of Stock Market Exuberance which also touched on some of the above with observations like "Margin debt/gdp (March 2000: 2.7%, July 2007: 2.6%, Jan 2014: 2.6%) & Margin debt/market cap (March 2000: 1.8%, July 2007: 2.3%, Jan 2014: 2.0%)" It also touched on parabolic price moves in the likes of Biotech (the latest bubble perhaps) and the extreme valuation on some technology acquisitions like Facebook and What's App that I wrote about recently. It also explores various valuation metrics which I'll come onto in the next section.
4) Profit margins at record levels - these tend to mean revert eventually, so is this as good as it gets for businesses? See point 2) above on IPO's.
On this rather than reinventing the wheel I'll refer you to some others who do some good work on this starting with the chart below from Doug Short (who I've mentioned before and that's his name not his positioning). You can read his post if you want that explains each measure in greater detail, but as they say a picture is worth a thousand words. Note he says:
"the percentages on the vertical axis show the over/undervaluation as a percent above mean value, which I'm using as a surrogate for fair value."
So while it is not as extreme as the 2000 peak this combination of valuation measures is now at similar levels to those achieved just before the downturn in 2007/8. In the UK according to Stockopedia the FTSE has a median Trailing P/E of 16.9x and a mean of 20.9x with yields of 2.9% and 3.2% while the FTSE Mid 250 is trading on 19.7x and 22.4x and yields 2.3% and 2.6% on the same basis. None of which strike me as bargain basement and certainly towards the upper end of generally accepted valuation ranges, although good growth is forecast given the current recovery of a sort in economies.
This is important because the price you pay for an investment will influence the future returns. Around 14 to 15x PE is average and will likely give you the long term suggested returns of around 5% real if you buy into a market at that price. At 20x and above returns going forward tend to be poor. While at 10x or less future returns from a market priced at that level tend to be above average. Obviously for individual stocks this can vary as the growth rates, earnings and dividends reported by individual stocks can vary widely, but again the same general rules apply as highly rated growth stocks fall heavily if they disappoint and the de-rating hits returns. This tends to work in a reverse more positive fashion for value stocks if they surprise on the upside.
Since P/E10 and Q are mentioned above I'll finish off with some references to these metrics. In the UK another site / author I have mentioned recently is John Kingham of UK Value Investor who does periodic updates on the CAPE or PE10 in the UK. His last one from February can be read here and unusually this shows the CAPE as being cheaper than current trailing figures - again perhaps bearing out the fact that current values are somewhat high compared to the last 10 years.
However I also discovered a recent new blog on FT.com by Andrew Smithers who I think invented the Q ratio and also talks about CAPE in relation to the US which he thinks is overvalued but he also talks about more buyers than sellers and Quantitative easing and share prices, although I think he has been bearish for a long time. Which brings me nicely onto to talk about:
The Wall of Worries
1) Withdrawal or curtailing of Quantitative easing. This is a big worry for investors in equities as big moves up seem to coincide with the implementations of this. So it seems logical to worry about its withdrawal, but impact limited - so far.
2) China Crisis oh no sorry they were a band - I mean slow down, debt concerns mounting?
3) Ukraine Crisis - that's the one - on going.
4) I worry that I can't find much to buy that's good value and many of the stocks I own have been re-rated so much that they themselves no longer look that compelling.
So in conclusion, I'm not saying I'm outright bearish - I'm just saying we are probably overdue some sort of correction as we have not had one for quite a while now. That would probably be a healthy development and hopefully afford a few more opportunities. However as Keynes said: "the market can remain irrational for longer than you can remain solvent" - but then I'm not short the market, so if it does all well and good, but any way just be careful out there.