TEN YEARS

I started blogging on January 3rd, 2009, wishing that writing and publishing my analysis, views and thoughts on economic and financial matters would help me be a more thorough, objective and disciplined investor while offering the same to others who might stumble on me on the web.

I wanted the blog to be like my personal notebook where I would

• dutifully note all the important facts necessary to understand what was going on (first blog name was New$-to-Use)
• detail my objective interpretations of these facts and trends,
• present intelligent, well supported counter views and arguments,
• track and understand earnings and margins,
• do objective valuation work,
• make all this accessible and understandable to ordinary investors,
• and critique widespread views and opinions based on false, biased or misleading data or facts.

Always displaying my sources, I also wanted to help people access the best sources of info (facts and views).

The last 10 years have been unique in finance: a very long economic cycle, extraordinary central bank interventions and experiments and no inflation on wages nor prices. Meanwhile, information and opinions have become much more available thanks to the internet and the long cycle. The information smorgasbord coupled with the capability for anybody to publish whatever views and ideas they, or others sharing similar views, have can make it very difficult for many to form solid, well informed and objective views on financial matters. Here’s my unpretentious approach to see through this information overload world.

FACTS PLEASE

The Wall Street Journal remains a daily must read. Bloomberg is also very good and it also helps see what is “trendy” in finance, helping feel sentiment shifts. I also read Reuters, the Financial Times and the Globe and Mail Report on Business daily. Since November 2016, I also read the Washington Post and the New York Times for D.C. news.

Financial media do not always report all the facts and can offer biased presentations and interpretations. Haver Analytics is a free blog with a lot of the important stats and charts. Other free blogs I use frequently are Bespoke, Advisor Perspectives and Zero Hedge, the latter mainly for its negative bias. Ed Yardeni, an excellent and generous economist, offers a free blog and access to tons of useful charts. John Mauldin is also a great read.

I pay for several investment services but the only two I find really exceptional are David Rosenberg’s and Grant’s.

I read many other publications, letters and blogs but I find that they are too often biased towards the author’s views of the moment to be useful for the less discerning people. They provide me with other views, stats and charts that can be used on the blog. If your time is restricted, the WSJ, Bloomberg, the free blogs mentioned above and, if you can afford them, Rosy and Jim Grant will give you a very solid investment base.

ITS THE EARNINGS, STUPID

Equity markets can seem very complex, even more so when you read several strategists displaying their science. At the end of the day, earnings and liquidity are what matter most. The long-term correlation between trailing EPS and the S&P 500 Index is 97%. Even since the trough of March 2009 and all the extraordinary experiments by central banks, the correlation is 92%. Last 2 years: 86%.

Incredibly, I have found that very few pundits and media really focus on thoroughly analysing earnings on an on going basis. Back in 2008-09, very few analysts truly tried to understand what was really happening to published earnings, operating and GAAP, given the numerous bankruptcies, writes offs and mark downs. In early March 2009, based on official data, the S&P (at 666) was trading at 97 times trailing GAAP EPS and 15 times trailing operating EPS. The former was extraordinarily high and scary, but really useless, the latter, however appealing, was derided by most experts as manipulated and bogus. A more thorough analysis (here) led me to the firm conclusion that equities were then selling at generational lows offering little absolute downside and huge upside, even in the then very scary environment.

Even after a 10-year bull market, I find that earnings are still not well analysed. Some people will use earnings that fit their narrative. A few days ago, John Mauldin sent his subscribers a “GMO white paper” written by James Montier in December 2018 with this line that Mauldin highlighted so we would not miss the point which also happened to fit his own narrative:

Let’s start with P/E. The long-run historical average P/E has been 14.5x. The P/E on the S&P 500 today stands at 24x.

The last time the S&P 500 traded at 24x was in 2002 if you use operating earnings and December 2017 if you use GAAP earnings. There is no precise date for the publication but assuming Montier wrote at the December 3rd high of 2804, he was thus using earnings of $116.83. I have no clue where he dug such earnings number. This guy is a senior partner at famous Grantham, Mayo led by Jeremy Grantham, and his paper, highlighted and distributed by also famous John Mauldin, uses earnings that are 17% lower than the lowest number I can find and 25% lower than the consensus to claim that the current P/E is ridiculously high. As John Galbraith said: “you can have your own opinion, but not your own facts, sir”.

THE RULE OF 20 VALUATION METHOD

From the onset in 2009, I have been using the Rule of 20 as the most reliable and objective method to assess the valuation risk/reward equation for equities. This is what equity investing is really about: risk management, upside potential vs downside risk.

Amid all the analysis on the impact of QEs and interest-rates-through-the-floor of the last 10 years, the use of the simple and straightforward Rule of 20 with actual trailing earnings and inflation was, as always, the best way to modulate equity exposure. The chart shows the stable range of P/E + inflation over the last 60 years covering all kinds of financial, economic and inflation cycles. The red dots point at bear market lows.

In early 2009, the financial crisis created such a panic that the Rule of 20 P/E fell below 12 for the first time since 1954. It briefly touched the “20” neutral level in December 2009 when earnings bounced back but it has stayed in the “lower risk” zone through 2014 even while the S&P tripled. The Rule of 20 P/E marked time along the “neutral” line (valuation upside = downside) throughout 2015 but dipped to 18.3 in January 2016 before its final cyclical move toward the high end of the “rising risk” area reached at 23.5 in January 2018. Modulating equity exposure as equities fluctuate within the Rule of 20 range of 16-24 has proven very rewarding with excellent risk management, all using actual trailing data.

Why virtually nobody talks about the Rule of 20 while digressing on CAPE or other methods remains a mystery. Jim Moltz, who developed the Rule of 20 at C.J. Lawrence in the 1980s, was no Nobel prize winner but he was a very practical strategist. Perhaps the Rule of 20 is too simple to build a lucrative career or become a guru based on such an easily accessible method to assess equity markets.

Its beauty rests in its stable 20 median (incorporating what inflation does to P/E ratios), its very stable long-term range and the fact that it always returns to the mean. Its meandering within the range reflects investors sentiment fluctuating predictably from fear to greed to fear.

Do a minimum of earnings analysis, watch inflation and use discipline and patience to buy low and sell high. Build equity exposure as the Rule of 20 descends below 19, reaching maximum weight below 16. On the upward trek, reduce exposure to neutral near 20 and manage it down on the way up to minimum exposure at 23. You can then use your profits to travel and enjoy life until valuation returns to neutral and you start accumulating again.

Adapt your min-max to your own particular situation and risk profile, modulate your beta near extremes, and you’re all set. You don’t even need Edge and Odds any more!  

THANK YOU

I truly enjoy writing this blog and I solicit no money. It will always remain freely accessible with no annoying ads and pop ups. I am thus especially thankful to readers who nonetheless generously send donations my way, whatever the amount. The long cycle has naturally inflated costs for most financial services and your help allows me to maintain quality.

I do no marketing (no time for it) and no social media (no time, no interest). My readers essentially stumble on the blog and, thankfully, like it enough to keep reading it. Many readers have been with me for quite a while now for which I am honoured. Thanks to the blog, I have reconnected with old friends and made new ones.

Life is short so

1. It’s important to do what one likes to do.
2. Be thankful if you actually can do #1.
3. The most important words for me in life are: health, love, friendship, caring and sharing.

Amid this truly chaotic and increasingly scary world, let’s all have a healthy and happy year.