Years ago, I’d subway down to Chinatown in the Big Apple AAPL +0.88% to play tic-tac-toe, paired against a chicken encased in a glass box. The chicken got first move so you couldn’t ever beat her, just tie. She was trained with birdseed dishes at the corners, so this chick went for corners straight out.
The market dwells in negative ground excepting Russell Growth, the NASDAQ Composite and NASDAQ 100. If playing in the S&P 500 space or Russell Value, you’re playing tic-tac-toe against my nemesis, Chinatown’s programmed bird. Can’t win for losing, no matter the quarters inserted into the change slot.
The gap still widens in the growth vs. value game. Try over 900 basis points between Russell Growth versus Russell Value. Variance between the value index and NASDAQ is even greater, 10 percentage points. Value dwells in negative territory while NASDAQ remains positive.
Historically, the value index edges out growth – so this 10 percentage point gap favoring growth happens just a couple of times over say 30 years. Past 15 years, only in 2009, with the huge market recovery from the financial world’s meltdown growth outperformed value by 1,000 basis points.
I remember buying Walt Disney DIS -0.99% in the teens, spring of 2009, and Bank of America BAC +0.00% for a 5 dollar bill.
JPMorgan Chase JPM +0.00% swallowed Bear Stearns and Bank of America took over Merrill Lynch. Airline debentures sold for a song.Continental Airlines ticked at 50 cents on the dollar, maturing in 3 years, for a yield to maturity of 41%.
I left out one other metric – high yield bonds and preferred stocks this year easily earn their coupon and dividends. Preferred stocks yield 6% while 5-year duration Baa bonds give you around 5% – competitive even with NASDAQ 100.
What says our financial markets? With the exception of some utility stocks, the typical big capitalization industrial, whether United Technologies, Union Pacific or Caterpillar Tractor, carries losses year-to-date ranging up to 25%. Energy properties like Chevron and Conoco Phillips, negative by 30%. Contrast this with positive patterns traced by Amazon, Facebook, Google and Starbucks, up from 20% to 70% for Amazon.
Ironies run deep. Amazon and Facebook are not readily analyzable. Yes, balance sheets are strong and there’s some free cash flow. But, reportable earnings ring conjectural because management initiatives for reinvestment can easily erase current earnings. At the slightest smell of fish these stocks can self destruct.
Alibaba, for example, was cut in half, but now looks actionable to me at 19 times next year’s earnings power. Netflix after its 25% correction still sells as 65 times enterprise value to EBITDA
And yet, the conceptual case for growth stocks is powerful but valuation metrics seem formidable. Stocks like Salesforce.com, MasterCard, Priceline Group, Starbucks and Adobe Systems sell at big premiums to the market on next year’s projections.
There are issues, too, of wide disparity between GAAP and non-GAAP reported earnings, as much as 40%. This applies to Google, Facebook and Alibaba as well, where stock grants are sizably dilutive.
Start with the valuation of the market relative to GDP. Currently, we’re at parity or 100%, stocks vs. GDP. Aside from the 2008 – ‘09 meltdown, this relationship has lasted since 2000.
For most of the postwar period the ratio of stock valuation was closer to 50% of GDP. The pivotal core metric is probably much lower inflation in the country since the sixties and seventies when the UAW and Teamsters flexed their muscles.
Paul Volcker ridded the country of its inflationary bias during 1982. Price-earnings ratios then stepped up to the mid-teens, pretty much where we trade today, actually slightly higher. The dot com bubble in 2000 was the exception when P/E ratios spiked and probably precipitated the 2001 – ‘02 recession.
My case for stagnation of industrial earnings power embraces major macros that start with the likelihood of slower GDP momentum for several more years, 2% to 3%. The Fed’s no-action decision was based on this high probability and it’s why stocks sold off, sympathetically.
Big picture metrics like flat capital spending and capacity utilization for industry suggest operating profit margins for our major industrials have peaked. Recessionary conditions in most emerging markets are a factor because that’s where most of incremental growth came from these past years.
Exports go nowhere with Euroland and China sloughing off. Even with low interest rates prevailing for years, the dollar should wax stronger because of our comparatively higher growth rate. In a low inflation, slow growth scenario valuation will count for less than a stock’s growth trajectory.
My gnawing problem today is whether it’s like yearend 1972, on the eve of the gut wrenching recession of 1973-74. Then, Nifty Fifty growth stocks like Polaroid and Xerox got destroyed, just as U. S. Steel and First National City Bank succumbed. Earnings for everyone proved cyclical, not secular.
Price-earnings ratios got halved. Nothing sold at 40 times earnings for years afterward. Twenty times was deemed full valuation.
Before its recent weeks’ correction of 25%, Netflix sold at 75 times enterprise value to EBITDA. A Goldman Sachs technology team then raised its 12-month price target to $140, based on 85 times its projection for 2016. Gimme a break. Each cycle we deal with our self-formulated kind of valuation insanity.
How will Facebook, Amazon and Alibaba fare in a worldwide recession that impacts personal consumption spending? Don’t ask! Do money managers overlook the scary variance between GAAP and non-GAAP earnings? Don’t ask!
Believe as I do that the operating profit margin for our heartland has topped out, but recession ain’t around the corner. You gotta play in the growth sector. Interest rates could hold at their abnormally low level for years to come. So far, Kinder Morgan’s 6% yield entices me,
but it acts more like an energy property, a pipeline conglomerate saddled with too much CO2 production, difficult to hedge today.
If recession is around the corner, I’d echo the 1974 words of Morgan Guaranty Trust’s chief investment officer: “Geez! I shoulda seen it coming.”
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