The note below covers:
1. Market Comment
2. Current Valuation Ratios
Note 1: Corporate Earnings Have Not Yet Come Down
1. Market Comment
The Macro MRI, which indicates the longer-term trend of the stock market, is becoming less negative. In addition, the Exceptional Macro is very close to appearing for several stock market and bond market indexes. If these do indeed change, they would indicate a bullish view of the stock market (stock prices continuing higher) that could last several quarters or longer. As this shift takes place, we must recognize that the low point of this market decline might have already taken place at the end of September (when the Micro MRI began its upleg). At that time, there was little indication that these positive shifts might take place soon.
Nonetheless, the computer models and algorithms indicate that stock prices (as measured by the DJIA) are likely to be more vulnerable to declines over the coming weeks when the Micro MRI inevitably moves to the downleg of its cycle. Thus, our portfolios are still defensive. Qualitatively, I believe there will be a better time in the future for our portfolios to be aggressive. This view is supported by the high valuation ratios of stocks.
2. Valuations for the DJIA are Still High
The Price/Book (P/B) and Price/Sales (P/S) ratios are most important for this discussion. They are still high compared to the range of values since January 2000. As one can see in Figure 1, the percentile rankings of the current values are both at the 93rd level in this time period. These are high figures meaning stocks are not cheap based on recent actual book values, sales, and earnings. These figures say stocks are expensive.
The markets have been transitioning over the last several weeks and I expect them to continue to do so for the next few weeks. The markets are undergoing a shift from investor concerns being focused on inflation and high interest rates to a concern about recession and high valuations. However, instead of the market moving straight from a) inflation fear, to b) recession/valuation fear, the market seems to be going through an intermediate step: a) inflation fear, to b) everything will be OK (soft landing), to c) recession/valuation fears. A soft landing means that the Fed slows economic growth to curb inflation but does not push the economy into recession. Historically, soft landings have been difficult to achieve.
Currently high valuation ratios support the potential dominance of c) recession/valuation fears. Yet, the MRI are starting to signal an “OK-soft landing” for now. We had a similar situation in the early 2000s, and there was a further decline after a “OK-soft-landing” period of a few months, which the MRI identified. This view is supported by the Peak-Earnings Indicator analysis described in note 1 below. As the transition becomes clearer, we will move either way – becoming more or less aggressive.