Sooner or later, the Great Humbler strikes us down to bedrock valuation. Look at tired blue chips like AT&T and General Electric. Ma Bell flub-a-dubbed entry into the wireless spectrum while General Electric still suffers from mindless acquisitions made decades ago by its headman, Jack Welch.
Longevity on Broad and Wall is a sometimes thing. Yes, I know Warren Buffett has sailed on for over 60 years with American Express, but even Warren shed his newspaper stocks which decades ago he termed as regional monopolies. Then, the internet was spawned.
I just banged out Alibaba which a couple of years ago I thought was headed to $500. But, Jack Ma, its headman, dissed his Chinese regulators. They’ve torn Alibaba apart and it trades closer to $90. I thought its Ant Financial holding was headed towards being the biggest money management operator in town, particularly in money market funds. But, it’s not getting there anytime soon.
Meanwhile, the International Monetary Fund just downgraded our GDP growth to 2.9% for 2023 while 2022 was shaded to 2.3%. Global inflation is put at 6.6%. Consider, I’ve tracked IMF forecasts over 50 years. They are never on the money. Even they admit their forecasts are useless for making policy calls over a 12-month interval.
It raises the question why make policy calls at all. Our Federal Reserve Board is no forecasting genius, either. Its forecasts, normally, are for 3% growth in GDP, but the numbers consistently come in above or below this trendline.
Same goes for the Street’s brokerage houses. Even Goldman Sachs, which carries plenty of research heft never gets it right. They’ve been too bullish on S&P 500 earnings power and keep reducing their numbers, quarter after quarter. The S&P 500 Index is selling around 19 times forward 12-month numbers. This is an absurdly high valuation considering recession is in the air while the Fed leans to higher interest rates, maybe longer than the next 12 months.
Then, there’s the financial press which does nothing about attempting to interpret the macro numbers released by the FRB and put on their page one. This is woebegone passivity. Security analysts at major brokerage houses widely miss their earnings projections, particularly on internet houses like Meta Platforms, Alphabet and Amazon and show minimal regard to future price-earnings ratios.
Meta plunged down to $160 after posting a dreary quarterly report. Most analysts hardly reduced their price points for the stock below $260. Why do research partners allow such nonsense to get out of the shop? In my day, analysts who fairly consistently missed their numbers were shown the door.
Can the market breeze through even a minor recession that seems to be taking shape in personal consumption expenditures, capital spending, employment and now retail sales? Look at Walmart’s revenues, which disappointed. They’ve been great merchants since Sam Walton’s day over 50 years ago. How elongated can a retraction in housing last if mortgage rates hold over 5% on single-family homes?
Let’s blame the Fed for our inflation rate, over 6%. They were late to change policy towards tightening. Historically, when you look at what happens to price-earnings ratios when inflation runs at 6%, you’d begin to shudder, uncontrollably. The market never sells above 15 times earnings and can go as low as 10 to 12 times earnings. This chart remains stark reality.
Based on my earnings forecast for next 12 months, the S&P 500 can shrink from 4,100 on the S&P 500 Index by as much as at least 20%. The Street has turned a blind eye on such a scenario as too painful to process and take remedial action on.
Lemme get down to bedrock on an investment portfolio that deals with historical macro indicators that looks so dire when they arrive on our doorstep. I’m overweighted in the energy sector because it’s a political football that makes forecasting on oil futures quotes impossible to model. Rather, I assume OPEC, Russia and the U.S. remain at cross purposes and futures hang in over $100 a barrel. If this is so, the earnings power of major integrated operators like Exxon Mobil, Hess and even leveraged operators like Occidental Petroleum surprise on the upside. Such stocks presently sell at no more than 10 times earnings power over the next 12 months. I expect energy to emerge as the biggest sector in the S&P, at least equaling and possibly exceeding technology. I’m talking about a 25% sector weighting.
I’ve put more money in master limited partnerships like Enterprise Products Partners which I consider the most comfortably capitalized MLP, paying a reasonable rather than outsized percentage of operating cash flow. Near term, these stocks are tied to daily fireworks in oil futures.
I can’t rationalize being more than 40% in equities. Meanwhile, my junk bonds act like death-warmed-over. Time to oversimplify, so I placed 40% of assets in 2-year Treasuries. It’s the old story. Be tactical, but still sell down to your sleeping level.