David Fuller and Eoin Treacy's Comment of the Day
Category - Autonomies

    Email of the day on valuations, Dow/Gold and anti-trust:

    Thanks for your comments which are very interesting, especially your focus on technology and its potential to alter radically the investment landscape.

    I have 2 points of my own to make. Using gold as the standard of value for stocks is interesting but I would think valuation metrics are more useful. As you know the Shiller PE, derived by comparing the S&P to the 10-year moving average of real corporate earnings- GAAP (not adjusted)- is at the highest level since the TMT bubble popped in 2000. The ratio of market value (the Wilshire 5000+) to GDP was at all-time highs in January. We have lived through a decade of extraordinary monetary policy (almost zero interest rates and QE), which is now being reversed. I think S&P market value to S&P sales may also be at all-time highs, but I may be wrong about that.

    So the starting point is pretty rich. The PE is at 25 times 4 quarter GAAP earnings, implying a 4% earnings yield. The Moody's Baa 20-year bond yield is around 4.6% so the equity premium has been negative the last 5-6 years for the first time since 1961 when the Bloomberg series started. On average equity holders over this period have earned a premium of 1.62% to reward them for investing in the riskier part of the capital structure, but now they must pay for the privilege.

    However, this does not address your major point about the enormous earning potential of companies involved in future technology. Now a standard criticism of your point is that competition between businesses will reduce the excess profits to "normal profits". What economists call "consumer surplus" consists of the extra value that is transferred from businesses to consumers for free due to the operation of the competitive market which eliminates excess profits.

    This flows from the ideal world of independent competitive enterprises. Anti-trust laws in the USA have been around since 1890 (Sherman Anti-Trust Act) and were designed to cause real world behaviour to better approximate the theoretical. 

    What I have found interesting is that Anti-Trust is no longer as big a deal as it was when I was a student. In fact, when Mark Zuckerberg testified he named 5 or 6 tech companies that are competitors of Facebook's. In this list he mentioned WhatsApp and another company (Telegram?) that he has already bought and perhaps one or two others. He also mentioned Skype, which Microsoft has bought. The big tech companies have the where with all to buy smaller rapidly growing companies and maintain tight oligopolies and thus earn outsize profits. I doubt whether many of these purchases would have passed muster from the Department of Justice's Anti-Trust division one or two generations ago.

    So the key may be to watch politics and see whether the populists at some point turn their attention to Anti-Trust.

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    Email of the day another email on the CAPE and the merits of cash

    In your 30th April response to my email, you say as follows "The only problem I have with comparing the current environment to that which prevailed from the early 1960s is that the market spent 13 years ranging from 2000 to 2013 so it would be unusual to begin another similar range so soon after the last one ended"

    My response:  Yes, it is true that it would be unusual to "commence a similar such range so soon after the last one ended."  However, in this circumstance, there are a range of other very unusual related circumstances.

    In the last 10 years, we have had a unique period of historically extreme money printing with very little consumer prices inflation as measured by the official CPI number, but this extreme period of money printing has caused very high asset price inflation - pushing many sectors back up into fairly extreme valuations as measured by historical norms.

    We can also look at this phenomena from another. If we look at Professor Robert Shiller’s cyclically adjusted price/earnings ratio series commencing 1880, we can see that secular bear markets have typically ended with a single digit CAPE - at the end of a secular bear market, the cyclically adjusted P/E has been in the range of 5-7 in 1982 and 1921.

    By contrast, the January 2018 peak in the US cyclically adjusted P/E of 33 was the second highest instance since 1880 - only being surpassed by the dot com peak in 2000 but surpassing the 1929 peak by a small margin.

    So, by this (Shiller CAPE) normally fairly reliable valuation measure, the US share market on broad averages is at a fairly extreme level. I think it is fair to say that if you buy expensive assets, you should expect poor to bad average real returns over the following 10 years or so.

    One last point to you 30th April comments, to the section where you say "The stock market is a better hedge against inflation than bonds because companies have the ability to raise prices and therefore dividends while bond coupons are fixed."  In a period of rapidly rising inflation like the 1970s, all listed securities including shares and bonds tend to do poorly because of the rapidly rising discount that needs to be applied when valuing such assets. By contrast, in Australia at least, during the 1970s, cash and hard assets like gold and commercial property were better investments. 

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    Global surge in air-conditioning set to stoke electricity demand

    Thanks to a subscriber for this article by Ed Crooks for the Financial Times which may be of interest. Here is a section:

    Over the next 30 years, air-conditioning could increase global demand for electricity by the entire capacity of the US, the EU and Japan combined, unless there are significant improvements in the efficiency of the equipment, the IEA warned.

    In a report released on Tuesday, the agency urged governments to use regulations and incentives to improve the efficiency of air-conditioning units, to avoid a surge in demand that could put strains on energy supplies and increase greenhouse gas emissions.

    Fatih Birol, the IEA's executive director, said: “This is one of the most critical blind spots in international energy policy.”

    Air-conditioning has had an enormous effect on the quality of life in hot regions, but its use is unevenly distributed around the world. About 90 per cent of homes in the US and Japan have air-conditioning, compared with about 7 per cent in Indonesia and 5 per cent in India.

    Electricity used for cooling in the US is almost as great as the entire demand for power in Africa.

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    Email of the day on the long-term outlook and potential for inflation

    In your 10/April long-term themes review, you said: "So, the big question many people have is if we accept the bullish hypothesis how do we justify the second half of this bull market based on valuations where they are today? ..... However, the answer is also going to have to include inflation. "

    My thoughts, not in any particular order:

    If we look at Robert Shiller's research ~1870-now, on the US share market, his studies show that historically, extreme valuations in the US share market (as assessed by cyclically adjusted P/E ratio) have always been followed by poor average real return over the following 10-20 years."
    You point to inflation as to how a secular bull market (in nominal terms implied) can now occur for the US share market (by implications I think you are reflecting on the US share market) over say the next 10-15 years (say).  You use the experience of Argentina and Venezuela as justification for your argument - where from memory, there was hyperinflation in the periods to which you refer.

    First, I do not think you are suggesting hyperinflation for the USA .... mismatch 1.
    For Argentina and Venezuela, I think their currencies also crashed. I do not think you are suggesting the US dollar is going to crash. Possible mismatch 2.
    Rather than a comparison with Venezuela and Argentina, perhaps a better analogy is to the period in the USA following the late 1960s, when US share markets where at quite high valuations (though not nearly as expensive as now on a CAPE basis). Following the peak valuations of the late 1960s, the US share market went sideways (with some large dips) over the next 16 years or so.

    In summary, I am not sure that your argument is particularly robust.  Yes, the technological revolution is a critically important new phase which will have a huge impact over the next 10 and 20 years..... and there may well be a secular bull market in that sector ... but does that really mean that the technology sector by itself will take the whole S&P500 with it in a secular bull market for the next 10 or 20 years?

    Your thoughts?

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    Amazon in Trump's Crosshairs: Here's What the President Could Do

    This article by Ben Brody, Todd Shields and David McLaughlin for Bloomberg may be of interest to subscribers. Here is a section:

    President Donald Trump renewed his long- running assault on Amazon.com Inc. with an early morning tweet Thursday. But what measures can he actually take against the online retail giant?

    He could push for probes of consumer protection, privacy and antitrust issues. He could also step up his support for allowing states to collect sales tax on third-party purchases from Amazon, or seek to have the Postal Service charge more to deliver packages. And he could thwart Amazon’s aspirations to win a multibillion dollar Pentagon contract for cloud services.

    Even with those powers, Trump’s ability to act has limits. Inquiries by the Justice Department or the Federal Trade Commission could take years and bear a high burden of proof. The FTC and other enforcement agencies guard their independence, as does the board of governors of the Postal Service. Changes to the tax law would require cooperation from Congress, which just passed a tax overhaul and may have limited appetite to reopen negotiations.

    The feud pits the world’s most powerful man against one of the world’s biggest corporations -- a global titan with $684 billion in market capitalization and more than half a million employees. At stake is its reputation, revenue and, potentially, ability to continue to disrupt markets as it reshapes retailing.

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    Protectionism Risks? What's Next?

    Thanks to a subscriber for this report from Morgan Stanley which may be of interest to subscribers. Here is a section:

    Email of the day on the MidPoint Danger Line

    Trust you and your tribe are well.

    Just a quick question. I don’t seem to have heard the phrase ‘mid-point danger line’ (MDL)for quite a while. Is the MDL irrelevant these days?

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