Market Valuations
 
As the market struggles to maintain current levels, companies are increasingly challenged to deliver earnings that justify their lofty stock prices. Because of recent significant losses, prudent investors are looking for other methods to generate growth and protection of capital, but to date have felt limited in their investment choices.

Lang Asset Management offers products geared to the prudent investor:

About the market...

  • One hundred and fifty year high in current price-earning multiples.
    The current earnings multiple based upon reported (GAAP) S&P 500 earnings is well above its historical average. That is, investors believe that the prospective environment is so attractive that they are willing to deem irrelevant over 150 years of investment history (periods that include booms, busts, wars, high and low inflation and high and low interest rates). In the mid-1980's, companies began to use forward estimated operating (pro forma) earnings for reporting purposes. These earnings disregarded many ordinary expenses that all businesses experience from time to time. The historical p/e on forward operating earnings has been 11, so if operating earnings are utilized, the market is even more overvalued.  
  • Stock earnings yield versus bond yields (the Fed model).
    This model relates the reciprocal of the p/e ratio of the S & P 500 to the 10-year Treasury bond yield. However, there are three major flaws with this model. First, the model is based upon data going back to about 1970. The problem is that the 10-year T bond rate is now lower than at any point in the model, meaning that the model does not include even a single data point that covers the current period. In fact, prior to the late 1960s, interest rates were lower for 100 years than they were from 1970 through 1997. Yet never during that time did the market sell at more than 23 times earnings. Secondly, it is difficult to assess what earnings to use (trailing or forward, broad indices or narrow, S & P or Nasdaq, operating (pro-forma) or reported (GAAP) or core. Thirdly, comparing risky stocks with non-risk bonds does not make intuitve sense.
  • Significant risk even at multiples below historical average.
    At the beginning of 1929, the forward p/e ratio was 16.2, and the p/e in Oct. 1929, just before the 88% decline was 13.5! The market is now selling at about 17.5 times our smoothed trendline GAAP earnings, a P/E ratio associated with market peaks for almost 200 years prior to the last decade
  • Price to sales.
    Corporate earnings are quite volatile, and difficult to assess. Thus, p/e ratios are somewhat nebulous, and various iterations can be presented, depending upon the author's biases. However, corporate revenues are much more stable, and ratios based upon corporate sales reflect much less volatility. Comparing the current price to sales ratio of 2.0 to the historic average of 0.8 suggests the market is selling over a 150% premium to its long-term average. There are fundamental reasons for the market to have sold, on average, at 0.8 times sales. If one pays much above this level, it becomes very difficult to earn a reasonable rate of return on your investment over an extended period.
  • Dollar is vulnerable.
    A former member of the Federal Reserve Board, recently stated: "Theoretically, some day that process (foreigners funding our current-account deficit) will come to an end, the flows will turn against us and there will be a crisis that will result in rapidly rising interest rates and a rapidly depreciating dollar that will be very disruptive. But I don't know what to do about it". It is difficult to believe that a member of the Fed would make such a statement, and very unerving that they have no contingency plan should that situation eventuate. Continuing: "In order to correct it with income growth, we have to have artificially depressed growth pushed down below our trading partners in order to correct it... But over time, I think there is only one direction (for the dollar)."
  • High equity expectations.
    Polls indicate that investors anticipate stock returns in the future will average 15% per year, and that corporate earnings will increase 15% in 2017. This presupposes that profit margins will maintain current levels, which are now close to all-time highs. We strongly doubt this, given the huge overhang of debt. Surely, these investors will be disappointed.

Copyright 2000 Lang Asset Management All Rights Reserved.

Home

"Mr. Prechter’s Conquer the Crash is a must read. It gives the investor a unique insight into the market that is not available anywhere else. If Mr. Prechter's thesis is correct (and I believe that it is), and action is taken accordingly, financial devastation will be averted. If he is wrong, you will have only lost an “opportunity cost”, which may or may not be meaningful. At a time of record high stock prices, rampant speculation, and valuations higher than in 1929, the choice would seem to be easy."

 

BARRON'S • Profile Going Short, Winning Big Talking With Julie Lang Kirkpatrick, Portfolio Manager, Lang Asset Management By J.R. Brandstrader Updated Jan. 19, 2009 11:59 p.m. ET THE WORST MARKET IN MORE THAN 75 YEARS HAS BEEN pretty darned good to the clients of Julie Lang Kirkpatick. Their separately managed accounts were up smartly in 2008, with many hitting double-digits. Kirkpatrick pulled off this feat by following three strategies, she says. The portfolios of some her clients were made up largely of short positions in stocks, or bets on price declines; those accounts shot up more than 50%. Another group had a mix of short and long positions -- and a nearly 25% gain. Finally, Kirkpatrick's investors who chose to stick with municipal bonds enjoyed 8%-plus returns, despite convulsions in that market. The daughter-father team has a knack for short-selling stocks, and investing in muni bonds. Craig Bromley for Barron's: Strong returns appear to be nothing new for Kirkpatrick, 54, who runs Atlanta-based Lang Asset Management with her father, Robert B. Lang, 79, Lang Asset Management, Inc.