Per usual, with the market up for more than 60 seconds the “Ritholtz/”Down Town”/”Common Sense” buy-the-dippers are out in force declaring those who care about valuation and that increasingly esoteric “margin of safety” concept out of touch. The “Common Sense” leg of the less-than-$600 million AUM trifecta that makes up Ritholtz Wealth Management, on August 23, re-posted an article he wrote for Bloomberg View back in June outlining why “this time is different” from a valuation standpoint. This is simply rank stupidity that will be wiped out in the next large-scale bear market.
There are two key legs of the “this time is different” argument: Lower forever interest rates, and higher forever profit margins.
In an August 1 tweet, NDR posted the following two graphics outlining how expensive equities are in absolute terms yet cheap in relative terms.
NDR’s is one of the more robust valuation analyses around, as it takes into account how cheap or expensive each metric was relative to itself throughout history (quoting the report itself):
“For example, the S&P 500 GAAP P/E ratio of 18.4 in December 1972 may not seem extreme by today’s standards, but to someone investing at the time it was one of the highest P/Es on record.”
NDR takes a balanced approach to this valuation conundrum – unlike “Common Sense”, which is the crux of my problem with the ivory tower scolding of valuation serfs – essentially saying that the secular bull market in equities that began in March 2009 can be sustained as long as rates remain low, which is largely in line with Warren Buffett’s conclusion that the market downright cheap IF interest rates can remain at current levels for the next 10 years.
But unlike NDR, Buffett is in charge of deploying actual long-term capital, thus we can judge his actions as well as his words (yes, NDR is making model recommendations based on their conclusion, but they could turn on a dime during the next 10% market dip). So I have one major problem with taking anything actionable away from Buffett’s interest rate conclusion: Why on earth is he sitting on $100 billion of cash if equities are borderline cheap?
Buffett said it himself at his annual meeting. The large cap Tech companies that are leading the current market charge are extraordinarily profitable and require very little in the way of capital to operate and grow. As such, the market’s fair value PE is materially higher than when previous market cycles were dominated by profitable up-and-comers such as US Steel, General Motors, and Sears. In short, returns on capital and profit margins are justifiably higher and thus should be rewarded with an above-average multiple.
It is almost as if the conclusion is that another Facebook, Amazon, Apple, Netflix or Google is highly unlikely to ever rise and challenge FAANG. Or that the rise of Amazon’s highly deflationary drive toward radical price transparency won’t pressure margins across the consumer products spectrum. Or that the politics of “labor” will not again rise to challenge “capital”.
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The explanation is very *simple*: As long as the US economy remains in expansion mode, equities are highly unlikely to enter a large-scale bear market. So unfortunately, until the US enters the next margin- and valuation-compressing recession, we will have to continue hearing from the buy-the-dippers that are preaching “this time is different”.