Isn't it time to sell?

"Next, people talk about the S&P hitting new highs as if that was something dangerous. " - Saul

It’s not dangerous for S&P 500 to hit new highs. It’s normal! What is dangerous is when it the P/E hits new all time highs, and folks remain complacent. This is what I see on this thread. 100% of the people here disagree with the premise that S&P 500 is expensive because valuations are at a peak. I even see reasons they give themselves to justify the complacency. The responses here were tremendously helpful. It helps me understand what causes a bubble to grow larger!

Regarding the GAAP argument, how much have the GAAP changes impacted today’s earnings? Does anyone have any idea and have studied the impact? Is it 10%, 15% or 20%? If it is 10%, then you can adjust 25.26 down by 10%. Even around 22.5, P/E is high relative to the past 100 year history.

Regarding a company like AMZN dominating the index, hence skewing the P/E, have you tried excluding AMZN and re-calculating S&P 500 P/E? (I have tried this. It changes the P/E by 0.35. So using the method that multpl.com used, if they currently show 25.25 with AMZN, they would show 24.90 without AMZN)

Why is that?
Just for illustration, if S&P had only two companies (market cap weighted), AAPL with 589B market cap and 46B Net Income (12.5 PE) and AMZN with 358B market cap (188 PE) and 1.9B net income, then the average PE is NOT 100.25 ((12.5 + 188)/2 = 100.25). Average PE is 19.77 in this instance. If anyone followed this example, then they would be able to understand why AMZN in the index makes negligible difference to the index P/E even though AMZN IS the 6th largest company in the index!

BTW, top 5 companies in the S&P500 index currently have $2.3 trillion in market cap and about $118 billion in earnings, giving it a 19.53 PE. IF you include the AMZN (6th) to get the top 6 companies, that shows a market cap of $2.65 trillion, and P/E of 22.2. Total market cap of all companies in the S&P500 is about $20 trillion.

We even have S&P 400 and S&P 600 indices. These are mid-cap and small-cap indices. In terms of market cap, they don’t amount to much (compared to the S&P 500)

11 Likes

The point was made earlier, and it is worth repeating. The P/E of an index cannot be considered independent of the return on a risk free investment (the 10 year Treasury is a good example). When we look at the P/E of an index relative to the P/E of a risk free bond in the context of history, we can get a range of fair valuations for a P/E and the S&P is not really out of line of these fair valuations.

http://www.financialwisdomforum.org/gummy-stuff/PE-BondRates…

5 Likes

few things are as bullish as new highs. Because by definition ultimate market peaks are reached by a series of new highs. It’s that last new high that you have to watch out for.

Denny I like the knowledge vs atoms bit. But atoms are easier to figure out. A compromise is companies with both, TSLA ISRG,etc.
I’m impressed with that long list of companies to buy if the price is right. Me, I am out of my broad based index ETF and have cut back on individual stocks.

I am willing to wait until they go on sale before buying more. Lacking Saul’s ability to sniff out when to sell, my Saul type stocks have not been outstanding performers.

3 Likes

tprooney3, sure, if you can more or less guarantee that the 10-Year US treasury bond will continue to yield around 1.50% or lower forever, then sure you can justify the current (or even higher) multiple in the S&P500. But what-if, the yield starts to rise and resumes to historic averages? I don’t know what is the historic average on the 10-year, but I imagine it’s not less than 3-4%.

And if you believe this is a new world where 1.5% on the 10-year bond will be the norm, then I don’t have any argument for that kind of thinking.

1 Like

Here’s how I see it. Are stocks worth more today than they were 20 yeas ago? Do I think they are going to be worth more 20 years from now? Since I answer yes to both these questions, it feels like a win-win scenario to remain fully invested no matter what.

When you try to time the market based off P/E valuations and what not, you risk losing. Most would call timing the market 50-50, but let’s say since you’re not really timing it (just saying that due to P/E it has to crash sometime within a year or something) and that you feel really confident that 70% of the time you win and 30% of the time you lose.

Even if you stand to make more money than me if the 70% decision works out, I’m perfectly fine sitting and waiting and winning as well. Also due to capital gains taxes and what not, your increased gain in wealth short term probably won’t even result in that big of a difference long term.

There will definitely be a major market crash in the next 20 years, probably more than one. But if you listen to everything on the internet, people with valid reasons backed up by data will tell you at 20 different times that the market is ready to crash. Fear is the most powerful emotion. Don’t let yourself fall victim to it.

4 Likes

Denny I like the knowledge vs atoms bit. But atoms are easier to figure out. A compromise is companies with both, TSLA ISRG,etc.

Being Digital (copyright 1995) by Nicholas Negroponte started me thinking along those lines.

https://www.amazon.com/Being-Digital-Nicholas-Negroponte/dp/…

I’m impressed with that long list of companies to buy if the price is right.

The only qualification for inclusion in the list is fast growth over a long period of time (no 90 day wonders). There are lots of reasons for exclusion including credit risk, excessive debt, poison pills, discriminatory voting rights, hard to understand business model, commodity type products, and many more.

A stock can’t grow at 20% per year for 20 years for no good reason. That’s the conclusion I draw from Graham’s “voting machine, weighing machine” metaphor.

Denny Schlesinger

1 Like

We have had this discussion over and over again, periodically, since I’ve been on the Fool, and probably way before then.

Yes, sometimes stocks fall, and dramatically. At the beginning of this year the news was near panic, and yet now recovered. Brexit took the market for a few days. If you read the news it was the end of the world, catastrophic. Jokes abounded as “Britain, what have you done to us!”

Anyone even consider Brexit in anything but their vacation plans now (as trips to Britain are less expensive now than they were).

There are real crashed, based on real economic circumstances. Asian contagion of 1998, Internet bubble crash, housing crash of 2008/2009 (that in many respects we are still recovering from - but surprisingly in areas other than the housing market (as that has fully recovered and then some)), and in-between many panics and micro-crashes.

There will be others. Some could lead to a wealth destruction catastrophe with no recovery, such as the Great Depression. No doubt about that. If that is what you fear, then get out of the market. There are no stocks that will save you.

Absent this, the markets may have gone up and down, the markets may stagnate over periods of time as may be arbitrarily chosen, but great companies move on.

Thus my continue advice, great companies, all the time. I prefer new such companies.

If you are older, cannot stand a hit in the portfolio, then act accordingly. Hits will come. If you are younger, and a longer term perspective, based on history, just don’t look for awhile. Understand what you hold and why, and at some point continue investing again.

That is the strategy that has produced not just the best results, but enormous economic results for investors since the late 1940s.

Things may be changing as bits consume more and more of atoms. As stores like Best Buy become less relevant, as we stay in more in our home theatres. I know I spend less and less now. Just less that I want and need to buy. I suppose vacations are something I need to spend more on (and that probably will be a continuing trend). Things are changing, but with change also comes opportunity.

Well, I’ve gone on too long. Just putting into work my now $45 Logitech ultra thin keyboard for iPad Air 2. And dang, if it don’t work great (dump the iPad Pro, with the $150 keyboard case - what a load of marketing B.S. by Apple. The Air 2, with ultrathin keyboard, unless you want the pencil and drawing capability (and that is awesome for those who do) is as much a portable computer as the much more expensive Pro.

I’ve decided to actually use this set up as my portable option to the otherwise quite stealth MacBook Pro.

With the cloud, does almost everything the MBP and Windows 10 does (on an ultraportable basis), but not a complete replacement, no.

I certainly hope for all our sakes that another world catastrophe does not take place so as to tear down the market in a Great Depression manner. The world is presently full of precursors to such potential unlike anything we’ve seen since before W.W. II I think. But it does not mean they will blow wide open.

Energy is at historically low levels, new technologies are transforming the world even more than before, third world countries are becoming consuming nations, space is on the verge of being opened up, advances in medicines…it is all there, all in place again, as long as we don’t screw it all up by doing stupid things…and history is ripe with the stupid.

So hold on!

Tinker

17 Likes

Just for illustration, if S&P had only two companies (market cap weighted), AAPL with 589B market cap and 46B Net Income (12.5 PE) and AMZN with 358B market cap (188 PE) and 1.9B net income

This example might be deceptive since Shiller CAPE is computed based of 10 year average earnings. So, if the index is composed primarily of old solid companies who make a similar amount per year with limited growth, then the current price over the 10 year average earnings will not be dramatically different than the current price over the last year’s earnings. But, if one is dealing with rapidly growing companies, as is often the case with the high tech leaders of the S&P today, one gets a very different picture.

For example, imaging two companies with a 500B market cap and earnings of 50B in the last year. Both will have a 1 year P/E of 10. But, if one grew at 10% a year and the other grew at 30%, the CAPE would be 15.4 versus 26.9 respectively.

This doesn’t mean that there is a time to sell, even great companies, but not on the basis of the S&P.

Tinker

Oh for an edit button!

Just for illustration, if S&P had only two companies (market cap weighted), AAPL with 589B market cap and 46B Net Income (12.5 PE) and AMZN with 358B market cap (188 PE) and 1.9B net income

This example might be deceptive since Shiller CAPE is computed based of 10 year average earnings. So, if the index is composed primarily of old solid companies who make a similar amount per year with limited growth, then the current price over the 10 year average earnings will not be dramatically different than the current price over the last year’s earnings. But, if one is dealing with rapidly growing companies, as is often the case with the high tech leaders of the S&P today, one gets a very different picture.

For example, imaging two companies with a 500B market cap and earnings of 50B in the last year. Both will have a 1 year P/E of 10. But, if one grew at 10% a year and the other grew at 30%, the CAPE would be 15.4 versus 26.9 respectively.

You’ve forced me into it. I’ll tell you all the “secret” to investing …

For the wary…

Norton Connect:
Malicious website blocked!
www. retro. ms11. net

Would really surprise me if the market tanked before the election. Even the FED is resisting any interest rate hikes until after.

What I will say as regards to the higher PE, when folks start to “justify” it, they are often using tortured logic. These stocks are worth what others are willing to pay for it. The higher the PE (irrespective of effect of accounting changes)the more pressure on every quarter’s earnings…one miss and look outer below.

Mauser:

What are your indicators flashing?

Duma, most of my indicators are well into the Bull territory.
The decline that came early this year turned out to be a correction not the start of a bear market. But nothing much was lost by following the indicators since they got me back in about where I left.
My reasons for limiting equity exposure have a lot to do with my age. I can’t wait a decade to recover from losses.

There is only one good time to buy almost every stock cheap and that is near the bottom after a prolonged bear market, though the bottom of a correction is good too. But I can only recognize the former not the latter. At least while it is happening.

So this is a Bull Market.
Until it isn’t.
And very few will be able to pick the top except in retrospect.

One long term point- the stock market P/E should be higher than the past if there is less risk than the past. The external risks to the US are less than when Hitler was in power or during the Cold War.
The risks to the economy and to the stock market today are more internal than external.

15 Likes

The external risks to the US are less than when Hitler was in power or during the Cold War.

• disputed islands in the South China Sea
• the imminent Ukraine invasion
• meltdown in Turkey
• uncontrolled immigration (Europe/U.S.)
• North Korea war-mongering
• Iran’s incineration of Israel
• Putin’s ascendancy
• the nuclear-armed terrorist

Yep… business as usual. Not.

2 Likes

Go back and check the stock market decline the day after Pearl Harbor.

The only significant risk to the stock market are economic. As you have more and more people getting jobs and adding to their 401k s you will get more and more demand for equities.

While there extreme, to the point of destabilizing unemployment in Southern Europe, there is a growing middle class in India and other Asian countries.

As the price of equities is set by supply and demand, I would expect demand to continue to rise.

Cheers
Qazulight

13 Likes

There was an interesting story a few days ago, I don’t know the methodology nor veracity of the report, but assuming it was accurate, the report specified that the stock market has reached new highs despite the fact that retail investors are largely staying out of the market.

The conclusion was, with this being the case, if some confidence can be built, if retail investors head back into the market, then we may have quite a ways to go still.

This reminds me of what may be the best sense of the end of bull markets, and that is when the cab driver is talking about his stocks. At that point in time all retail investors have bought in as well, and smart money begins to exit thereafter.

This report would indicate that we are a long way away from cab drivers coming back into the market.

See Haywool’s highly recommended post and link on this thread.

All I know is, that except for great companies in a bubble (like QCOM at $300 billion) for every crash, the great companies made new highs again within a few years. Look for real bubbles, transparent FUD opportunities, reverse FUD traps, and disruptive technologies and business models (not to mention market saturation and Gorilla battles). Otherwise…as I have stated previously.

This of course only applies to the younger of us ilk, and not those on the verge of or in retirement.

Tinker

7 Likes

Huddaman,

There was a question raised by Danny Schlessinger early in the thread that needs to be addressed. For the most part (AMZN being the only exception) people on this board don’t discuss S&P 500 companies. Not out of grudge but they simply do not correspond with Saul’s criteria.

So what are you proposing we sell? Is it only AMZN? Or is it something else from Saul’s portfolio as well?

Stan

1 Like

Stan,

I was referring to the market as a a whole being potentially frothy. I am certainly not advocating you sell AMZN or any particular stock. The idea behind the original post is to advocate caution. When there is a pullback, as I mentioned earlier, the baby gets thrown out with the bathwater. I realize that investors cannot stay invested if they continuously worry about a pullback. Morgan Housel has illustrated with his study of the stock market history that pullbacks are inevitable and part and parcel of the game. I personally and honestly believe that there have been very few instances in history when stocks have traded at a higher multiple than today. I ignore periods when P/E expanded due to collapse in earnings. Some of the recent increase in P/E has infact happened because S&P earnings peaked in Sep-2014. Since then I believe the drop in earnings has been due to strengthening US$ and drop in oil prices. Even after you adjust for the drop in earnings i.e use peak earnings from Sep-2014, the lower P/E is still at the top end of the range and the only time in history when I found this range was exceeded was between Jun-1997 and Mar-2002 (out of a total of 62 years I looked at independently of the multpl.com )

I understand that most of the folks here rejected my suggestion. You posted a direct question at me which is why I was compelled to respond. Having said that, I got out what I was looking from this thread. I got the pulse of the participants. I hope some of you benefited a little from my post here.

Thanks

Huddaman

5 Likes

When there is a pullback, as I mentioned earlier, the baby gets thrown out with the bathwater.

That depends on what kind of pullback that is. We have our investment thesis for these companies. If there is a pullback that would impact their bottom lines (i.e. the banking system imploding) then it might be prudent to pull out. Are you expecting this kind of event?

If on there is on the other hand no impact on our investment thesis (just a “correction of stock prices”) then there is no good reason to sell:

  1. You cannot know whether this correction will come in a month or in a year and you will miss out a good portion of the ride up
  2. When the “correction” happens and the company keeps on posting good results, the stock price will go up again in a reasonable amount of time.

Since then I believe the drop in earnings has been due to strengthening US$ and drop in oil prices. Even after you adjust for the drop in earnings i.e use peak earnings from Sep-2014, the lower P/E is still at the top end of the range and the only time in history when I found this range was exceeded was between Jun-1997 and Mar-2002 (out of a total of 62 years I looked at independently of the multpl.com )

Well, I did some calculating myself and found the source of the high P/E of the S&P 500 are two sectors - Energy (terrible earnings) and Internet services (high growth calculated into stock price). See my post about it here:

http://discussion.fool.com/with-the-sampp-500-trading-at-172-tim…

So if I summarize possible scenarios, this is what I see:

  • a general correction is comming and it will throw all stock prices down long term (we still don’t know when)
  • a general correction is comming but the healthy companies will pick up again quickly
  • a correction will only come in (one of) the two sectors mentioned above (or generally only in companies with a high P/E)
  • the market expectations turn out reasonable and the Energy sector picks up again and the Internet services double their earnings in the comming years - the P/E would then drop without any corrections necessary.
  • no correction or other adjustment is comming and the high P/E is the new normal

If you get out of stock now it may save you some money only in one of the 5 scenarios and only if it comes within a short time frame. You will lose in all the other scenarios.

If you want to build a credible case for the first scenario, it needs to be more thorough then just pointing out that the P/E of the S&P is high.

14 Likes

This reminds me of what may be the best sense of the end of bull markets, and that is when your cab driver is talking about his stocks.…We are a long way away from cab drivers coming back into the market.

Nice, Tinker!

Well, I did some calculating myself and found the source of the high P/E of the S&P 500 are two sectors - Energy (terrible earnings and hence high PE’s) and Internet services (high growth calculated into stock price)… So if I summarize possible scenarios, this is what I see:

- A general correction is coming and it will throw all stock prices down long term …
- A general correction is coming but the healthy companies will pick up again quickly
- A correction will only come in (one of) the two sectors mentioned above (or generally only in companies with a high P/E)
- The market expectations turn out reasonable and the Energy sector picks up again and the Internet services double their earnings in the coming years - the P/E would then drop without any corrections necessary.
- No correction or other adjustment is coming and the high P/E is the new normal

If you get out of stocks now it may save you some money only in one of the 5 scenarios, and only if it comes within a short time frame. You will lose in all the other scenarios.

If you want to build a credible case for the first scenario, it needs to be more thorough than just pointing out that the P/E of the S&P is high.

Interesting analysis, Stencils!

Thanks

Saul