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  • Martin Sosnoff

Sharp Pencils Don’t Work Modeling Growthies

Serious players build a schema for the stock market. For me, it begins with extrapolating financial ratios based on recent years statistics. Today, however, the Magnificent Seven’s numbers are inscrutable and impossible to model.


Starting with Apple and Microsoft, such seven growthies comprise 70% of the NASDAQ 100 Index. Call it “buy hysteria at work,” but it’s what we’ve got.


I own Microsoft and Amazon, which have grown to near 10% positions for me through appreciation. For such hubris, I could pay dearly. What am I supposed to do? Run out and buy Exxon because I think it sells near intrinsic value?




This chart on the declining ratio of dividends to GDP unnerved me on valuation. The 1973-’ 74 recession demolished all the bulls. 


Money managers and analysts alike pointed to Boeing's expected growth in cash flow years ahead as their valuation yardstick. But, for an aerospace operator, a blown hole in an aircraft in flight is serious business likely to pressure Boeing's price-earnings ratio for years to come.


I’m fixed on the soft landing scenario for the market. Inflation subsides while the Fed soon shows its hand for easing rates. Oil futures can churn aimlessly. The economy has already sustained its spike in recent wage contract settlements. Wars, inflation, a punishing FRB, even a broad recession in real estate do crush investments. 


All this gets factored into the heady price-earnings ratio for the market, approximately 20 times forward, 12-months earning power. Buoyancy rarely exceeds such valuation. Wars, inflation, a punishing FRB, even a recession in real estate do crush investors.




Unless you can forecast interest rates with some feel for trend and direction.  You are lost. 


You can never project price-earnings ratios for stocks. Look at the amplitude of change in 1984-’85. Rates peaked at over 14% in U.S. Treasuries, then fell to 10% a year later. Price-earnings ratios, tracked down, too.


Overvaluation in price-earnings ratios never gets its due in the investment setting.  Check here the serious depression in valuation that lasted over 20 years. Largely the working of FRB tightening. 




Disparity in sector returns runs wide, and deep, too. Look at yearend 2014, which was led by healthcare, even utilities. Energy was a loser and materials languished at a 5% weighting. Calling sectors on the money is a major performance factor. Healthcare may repeat, but tech at 20% seems too extended for the Magnificent Seven to sustain leadership.


My bottom line is the Fed doesn’t kill us off. Commodity prices look reasonable but 8% mortgage rates can keep housing in check. Price-earnings ratios can shade their present buoyancy. The value sector outperforms growth stocks. Speculation in low priced stocks intensifies in my scenario. Net, net, today there’s plenty of room to be wrong-footed, because valuation already is stretched.


The overweight penalty for stocks in an earnings breakdown is over 10%, overnight,  Tesla was marked down so the analyst consensus on growth stocks is worn shabby as guidance.


Conversely, when a stock and its sector hangs in despite blah numbers, take a look. Energy paper now hangs in, suggesting we’ve reached fair value with sustainable dividends. This is unlike healthcare and the financials. They act like jumping jacks. On the grounding of Boeing’s 737, stocks of airlines hardly budged. My turnaround pick is American Airlines. This is a luxury because its numbers can’t be sharp-penciled near term. I find it hard to sharp pencil anything. 


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