The Boy Who Cried Wolf

Bloomberg interview with Jeremy Grantham yesterday:
He’s still crying wolf.
https://www.youtube.com/watch?v=JlEGU2ypr1Q

An interesting snip from that:
"I think the peak of crazy behaviour is behind us. I think we’re now in the buy-the-dip mode,
which the super bubbles specialize in. You don’t have two years of buying frenzy dying overnight, typically"

Consistent with that, I just read that small US retail accounts were net buyers of both US equities and equity ETFs every trading day so far this year.
And all but two of those days were at higher dollar rates of buying than the 2021 average.

I’ve always liked this graph.
I’m sure much of it is dangerous oversimplification, but it’s easy to see bits of truth in it.
https://en.wikipedia.org/wiki/Jean-Paul_Rodrigue#/media/File…
In effect, the comment above suggests that the retail hordes are getting lined up for the bull trap.

Jim

21 Likes

Bloomberg interview with Jeremy Grantham yesterday:
He’s still crying wolf.
https://www.youtube.com/watch?v=JlEGU2ypr1Q

Another minor note—
He suggests that he thinks the on-trend normal level of the S&P 500 would be about 2500 today.
On the notion that the smoothed real earnings yield is the best metric for the broad market,
and using my own set of figures and smoothing method (a bit smoother than Shiller’s E10),
that suggests that he expects the current normal valuation level to equal the average multiple observed since about January 1983.

Though I do buy his line of reasoning, I’m a bit dubious of that particular figure.
Personally, I think the modern economy really is “different this time”.
Not that different, but different enough not to expect the normal of 50 years ago to be fully relevant.
For one thing, historically the great majority of earnings were constrained by access to capital,
but that is no longer a good characterization of the global economy.
This changes the broad profile of the cost of capital: slightly lower demand for capital would general mean slightly lower yields on all kinds of securities.
Lacking any better idea, I expect future “normal” to be something like a move back to the average since a start date somewhere in the 1990s.
That’s about the most optimistic/bullish view, anyway, so the bear market implications are perhaps the mildest that remain rational.

Using the average trend earnings yield observed since 1990 would suggest “normal” around 2975 for the S&P 500.
Using the average trend earnings yield observed since 1995 would suggest “normal” around 3194.
Using the average trend earnings yield observed since 2000 would suggest “normal” around 3102.
So, rock and roll, I think maybe his 2500 is a bit dour and 3000 might be a more reasonable expectation of normality these days.
He expects a drop of about -42%, I expect a drop more like -31%. From these heights it doesn’t seem like such a big difference.

But of course, my relative bullishness–only a 30% drop!–is not that much comfort.
That’s the figure I kind of expect as a future average.
If that were so, presumably stocks will be cheaper than that “normal” level about half the time, sometimes quite a bit.

Jim

29 Likes

So in broad terms you’d expect BRK to do a little better, perhaps 25% worse case, so that’s a 230 per b floor 22/23. 230-250 would be a good entry point.

So in broad terms you’d expect BRK to do a little better, perhaps 25% worse case, so that’s a 230 per b floor 22/23. 230-250 would be a good entry point.

I don’t really have any numerical idea of what Berkshire’s price might do in a market drop, particularly since I don’t know when or how lasting the next bear market will be.
Nor how deep, though those numbers above at least give a blurry image of what might be sensible to expect.
My gut feel is that Berkshire will drop with the market on any short term drop, but at some time during the fall it will mostly stabilize.
But that’s just a general sense, not any kind of prediction.
The “drop right in line with the market” part seems very likely, for the first part of any drop.

The only firm expectations that I really bank on are pretty normal real value growth rates and pretty normal future valuation multiples for Berkshire shares.
And somewhat better performance over the next full cycle than the broad market.

I hope for a really low price bottom for BRK, as I always enjoy double-loading the truck at a great valuation level.
Sign me up for a boatload at peak-to-date book per share.

Jim

12 Likes

For comp I just looked at the drop in 2020. The S&P dropped 30% BRK 25% before the rebound.

2 Likes

I’ll add my 2 cents. I would not surprise me one bit if investors fleeing the market would choose something to chase temporarily. Energy? Berkshire? In a market sell-off of course it isn’t going to sustain but these things do happen.

Life is great if you can stand it. Remember if you sell out you’ll one day need to get back in. And when you get back in, given most here (but not all div 20!) are value investors and we tend to get back in way too early!

HA!

9 Likes

Great Finaancial Crisis 2008-09 BRK 50% S&P 52% identical basically.

1 Like

And in terms of timescales.

It took 5 yrs in the GFC for BRK to get back to the previous peak 08-13 and 11 months in 2020.

Decline took 1 year top to bottom in the GFC and 1 month in 2020.

I’d expect a situation more like the GFC this time rather than 2020 given what Grantham says.

1 Like

In both the 2008-2009 and 2020 crashes, Berkshire dropped to near book value. Depending on the severity of the next bear, that may be the bottom for Berkshire.

Yes, book value is less meaningful than it used to be due to the share buybacks and the carrying cost of assets (which are not marked to market in the calculation of book value), both of which reduce book value, compared to intrinsic value. However, if the lowering impact of these factors roughly equals the overvaluation of stocks such as Apple, then these factors may cancel out and book value would still be meaningful. Jim’s data confirm that to be the case.

2 Likes

"It took 5 yrs in the GFC for BRK to get back to the previous peak 08-13 and 11 months in 2020.

Decline took 1 year top to bottom in the GFC and 1 month in 2020.

I’d expect a situation more like the GFC this time rather than 2020 given what Grantham says."

That’s correct but BRK was overvalued going in to the GFC (if I recall correctly, Jim sold shares in late 2007 as the price to book was around 1.8). In contrast, it was slightly undervalued going in to the 2020 crash. That may partly explain the time it took to get back to the previous peak in the two cases.

This time, BRK is not meaningfully overvalued, which may reduce the time for it to get back to the earlier peak, compared to during the GFC.

8 Likes

It took 5 yrs in the GFC for BRK to get back to the previous peak 08-13 and 11 months in 2020…

That’s a good number, but it is a little dependent on what valuations were like before the plunge.
The price did spike in the early days of the crisis 2007, for example, trading briefly over 1.9 times book.
If a spike sets the high you’re waiting to hit again, a longer wait will be likely.

A alternative metric might be “how long did it stay below a reasonable valuation multiple?”
In the modern era, 1.4 times “peak to date” book per share has been about par for the course.
If that’s your test, it stayed “too cheap” for 2.1 years.

If you figured 1.45 constituted the end of the “too cheap” stretch, it was a bear of 3.28 years.

If you needed to see 1.5 to consider it a decent multiple, the dark ages lasted a full 6 years.
(The second longest stretch ever waiting for the 1.5 hurdle ended just this month, at 3.24 years).

Jim

13 Likes

book value is less meaningful than it used to be due to the share buybacks and the carrying cost of
assets (which are not marked to market in the calculation of book value), both of which reduce book value,
compared to intrinsic value. However, if the lowering impact of these factors roughly equals the overvaluation
of stocks such as Apple, then these factors may cancel out and book value would still be meaningful.

Another factor is how long it has been since a big acquisition.
Money spent internally on capex generally has an intrinsic value worth a multiple >1 of the cash spent.
That’s why the average company is worth a significant positive multiple of book.
Money spent on shares of a company (public or private) are worth about what was paid for the first while.
That’s why funds aren’t worth more than book (NAV).

Jim

4 Likes

I would say that the selloff is not just imminent; it’s begun. The S&P 500 is 9% below its peak; the NASDAQ is 16% below its peak; the Russell 2000 is 21% below its peak.

It sounds like most people on this board plan to ride BRK and the market down if they fall significantly, and then ride them back up. That’s not a bad approach, depending on one’s investment timeframe. Averaging down is also not a bad approach. Few people here, it appears, have significantly reduced their asset allocation to equities, and that’s OK, too. Timing the market is difficult, and paying capital gains tax is costly. Grantham, in his personal account, has rotated into less overvalued segments of the market, specifically emerging market value stocks, and he has shorted the NASDAQ and the Russell 2000. GMO’s approach has been to remain fully invested, but to “overlay a long-short portfolio” equal to about 30% of the base portfolio. They say that their research has show this to reduce the drawdown. All of these approaches are reasonable, but some will have better 5-year returns than others. What do you think the best approach is?

1 Like

FYI: I sold some BRK and purchased some AMZN and DIS (just a small amount however).

tecmo

book value is less meaningful than it used to be due to the share buybacks and the carrying cost of
assets (which are not marked to market in the calculation of book value), both of which reduce book value,
compared to intrinsic value. However, if the lowering impact of these factors roughly equals the overvaluation
of stocks such as Apple, then these factors may cancel out and book value would still be meaningful.
=====
Another factor is how long it has been since a big acquisition.

Ok, and another big factor is that Berkshire is itself a big holders of securities, and these would presumably fall during a sell-off, while Berkshire’s official book value (published every 3 months) remains the same.

Berkshire’s operating company side should not suffer much in a general sell-off - it’s already at fair value, maybe about 2x book.

Berkshire’s stock holdings, however, constitute almost half the value of Berkshire, and presumably are worth about their market value, or slightly less, given the future capital gains taxes owed on these. Almost half of Berkshire’s value is in this collection of stocks, half of this being Apple but the other half is arguably overvalued too. If the stock holdings sold off by 40%, but this had not yet been updated in a quarterly report, Berkshire’s share price might go to very low multiples of the most recently published book value, even if the multiples (1 and 2) on these two parts of the company had not changed.

If someone is following Berkshire and looking for a good price to buy back in, I think it makes a lot of sense to separate out these two components. Mr Market may be schizophrenic, but he’s not stupid.

dtb

7 Likes

The amazing thing to me is how rigidly investment managers of foundations, target funds and the like have stuck to their strategic asset allocations during the stock and bond bubbles, earning nothing in bonds and risking significant loss in US equities. One foundation that I talked to said that the Uniform Prudent Investment Act (UPIA) required them to use the asset allocation that they were using. This is somewhat true. The UPIA does require that managers use Modern Portfolio Theory to allocate assets, but it does not require them to use silly assumptions about the near term returns of those asset classes. Bonds and US equities face poor, near term returns. All asset allocations need not be based on 30 year forecasts.

1 Like

“He [Grantham] suggests that he thinks the on-trend normal level of the S&P 500 would be about 2500 today.”

There are many ways to to calculate the trend. The basic approach is to plot (log-log) the S&P index against something upon which it logically depends, such as revenues or earnings (not time). I tried plotting it against GDP. As in Jim’s analysis, the trendline as of 12/21 depends on the start date of the plot. If I start the plot in 1929, the trendline as of 12/21 is 1,915. If I start the plot in 1945, the trendline as of 12/21 is 2,186. If I start the plot in 1985, the trendline as of 12/21 is 3,413. It’s good to include in the plot a number of periods when the S&P was clearly undervalued, such as 1981, and clearly overvalued, such as 1999.

1 Like

He [Grantham] suggests that he thinks the on-trend normal level of the S&P 500 would be about 2500 today.

I have seen research where they are talking about SP500 23 earnings pegged at $250. Economy is still doing good, it can take a hit after rate increase, etc, but now doing good. If it continues and we actually have $250, are you expecting sp500 will trade at 2500 level?

The chances of wide eyed bull succeeding is far higher than a strong bear. I can understand being cautious but not that negative.

I have seen research where they are talking about SP500 23 earnings pegged at $250.
Economy is still doing good, it can take a hit after rate increase, etc, but now doing good.
If it continues and we actually have $250, are you expecting sp500 will trade at 2500 level?
The chances of wide eyed bull succeeding is far higher than a strong bear. I can understand being cautious but not that negative.

Earnings are cyclical.
The 2023 earnings could be high or low, but the 2023 cyclically adjusted earnings will be pretty predictably between the two.

Extrapolating GDP and estimating public market profits as a likely percentage of GDP makes a lot of sense. GDP growth is pretty predictable over fairly long timeframes.
A simpler method is just to extrapolate the real net earnings of the index over time, which is pretty close to the same thing.
Then it depends what sort of time frame you consider. Bullish optimists take shorter time frames because the tax cuts make a nice steep slope to the trend line.

The trend line of real S&P 500 earnings (and cap weight predecessors) using any start date 2010-2014
or anything 1999-2005 gives a pretty cheery figure in the $141-146 range in today’s money for calendar 2023.
Any start date for the trend prior to that gives a lower extrapolated figure for 2023.
For example, a trend line starting 1995 would extrapolate to 2023 earnings of about $135 in today’s money.

So, sure, $250 is entirely possible for that particular year, but it would be about 75% above trend, give or take.
Most of the value of any equity is far in the future, so no single year matters much.

Jim

10 Likes

I have seen research where they are talking about SP500 23 earnings pegged at $250.
Economy is still doing good, it can take a hit after rate increase, etc, but now doing good.
If it continues and we actually have $250, are you expecting sp500 will trade at 2500 level?

The trend line of real S&P 500 earnings (and cap weight predecessors) using any start date 2010-2014
or anything 1999-2005 gives a pretty cheery figure in the $141-146 range in today’s money for calendar 2023.

PS
Let’s say the 2023 S&P cyclically adjusted earnings come in at the midpoint of that extrapolation in today’s dollars, $143.50.
In that case, Mr Grantham’s target of S&P 2500 would be 17.4 times cyclically adjusted earnings.
My very rough expectation of something more like 3000 would be 20.9 times cyclically adjusted earnings.
Those don’t sound like crazily pessimistic figures.

Jim

5 Likes