Revisiting Valuation Extremes - 2008 to Now

Last week we took a look at how much price to book multiples have expanded since 2008. Today, we are undergoing the same exercise but this time we are looking at price to cash flow multiples.

Using 150 industries from the MSCI World Index, the average price to cash flow ratio at the end of 2008 was 9.4x. As of the end of May, the average price to cash flow ratio was 14.3x or an approximately 52% increase since 2008. This is just slightly more than the 48% increase we observed when using price to book value.

The median price to cash flow at the end of 2008 was 7.7x and at the end of May the median value as 13.3. Therefore, the median price to cash flow valuation expanded by 73%, quite a bit more than the average valuation.

131 industries have had an expansion in multiples while only 19 have seen their multiples contract. The average percentage change since 2008 is 90% and the median percentage change is 74%.

Agricultural products multiples have expanded by an astounding 1079% over the past six and half years. Multiples in this industry started at 2.6x in 2008 and are now over 30x. There are 12 industries that have seen their multiples expand by at least 200%.

On the flip side, mortgage reits, unsurprisingly, have had the greatest contraction in multiples going from 9.1x to 1.7x. Specialized consumer services is right on their heels with a contraction in multiples of 80%. There are six industries that have had their multiples contract by at least 50%.

The full list of 150 industries is below.

Yield Plunge Implications for Cyclical Performance

This year's steady decline in French and German 10-year bond yields accelerated this week, with French OATs making new all-time lows:

France (1.60%)


Germany (1.26%)




Whether prompted by a lack of confidence in the ECB's announcement of various supportive measures earlier this month, unimpressed by less than encouraging data out of the region, or spooked by geopolitical tensions, the move lower has negative implications for the performance of European cyclicals:




Weakness in cyclical sector momentum so far this year would appear to be at risk of further deterioration:

Excluding Tax Increase, Japanese Consumer Prices Are Already Back in Deflation

The recent sales tax increase in Japan is wreaking havoc with price statistics, making year-over-year comparisons basically useless. To address this problem we have begun to make a very simple adjustment to the published price stats which is to subtract the impact of the tax increase starting in April 2014. The one important assumption we are making is that the full 3% sales tax increase is being passed onto the consumer.

As the chart below shows, when we adjust for the tax increase consumer prices in Tokyo are already posting negative readings on a year-over-year basis through June (the blue line is our adjusted statistic). If this trend continues the probability of BOJ doubling down on asset purchases in the fall months will increase dramatically.

Foreign Investors are Flocking Back to Japan

For 15 months, between March 2013-June 2014, foreign investors were net sellers of Japanese equities. It seems, however, the tide has turned. Over the last few weeks foreign investors have started accumulating Japanese shares (first chart below). For those invested in Japan this is a welcome development. As the second chart below shows, 1-quarter percent changes in the Nikkei correlate well with foreign investment flows into Japanese stocks.

European Banks Are Backsliding

Over the last week, European banks have been the worst performing industry group in the MSCI World index.  As a group, they are down 4.57%, on average, and have underperformed the MSCI World index by 5%.  While banks in North America and Asia are not market leaders, they have not experienced the hit that their European peers have in the last week.  Since bank relative performance is often an input in models of financial conditions, this would suggest a slight tightening in financial conditions in Europe recently.

MSCI Europe Industry Groups Performance (%)

MSCI North America Industry Group Performance (%)

MSCI Asia Industry Group Performance (%)

Only 3% of the banks in Europe experienced positive performance over the last week.

MSCI Europe Industry Groups - Percent Positive Performance

Banks in have Europe have been some of the structurally weakest stocks recently.  In the table below, we show the percent of companies in each industry group, in Europe, above 5 and 20 day moving averages.

MSCI Europe Industry Groups - Percent Above Moving Average

The move has been broad as only 9% of the European banks have outperformed the MSCI World index over the last 20 days.

MSCI Europe Industry Groups - Percent Outperforming MSCI World Index

World Stock Investors are Treading Water

We are always keen to measure the behavior underlying stock price movements and one way in which we do that is to keep track of investor accumulation and distribution of stock. Investor accumulation of stock as prices rise signals confidence, and vice verse.

The way we measure accumulation and distribution is to tally up over a period of months all the days in which the ratio of advancing to declining stocks is heavily skewed in one direction or the other. We consider days skewed towards advancing issues accumulation days and days skewed toward declining issues distribution days. We then net out the number of accumulation days with distribution days to form our indicator, and then we compare our indicator to World stock prices.

What we find is that for pretty much the whole year our accumulation/distribution indicator has ranged from +1 to -1 (i.e. there's been meaningful accumulation or distribution on net). Meanwhile, stock prices have obviously shot up as the MSCI World Index has gained 4.6% YTD in USD terms. The obvious conclusion here is that prices have risen while investors have pretty much tread water when it comes to accumulating stock. This conclusion is supported by numerous other indicators painting the same picture of weakness in market breadth statistics, but lack of breadth hasn't stopped this market so far. In any case, we'd prefer to see our accumulation/distribution indicator catch up to stock prices as a signal of growing confidence.

Regional Divergences in Cumulative Net Advances

One year cumulative net advances in the MSCI World Index surged from the end of April until just a few  weeks ago:



By region, MSCI Asia Pacific exhibited very similar behavior to the World Index while net advances in MSCI Europe maintained elevated levels seen since a year ago:




Meanwhile, cumulative net advances in MSCI North America have diverged noticeably from price trends and fallen steadily since last November:

Stocks Have Gone on Another Statistical Run

Many of our readers are probably familiar with the concept of a "random walk" in which stocks are just as likely to go up as down on any given day (i.e. the outcome is a coin flip). Empirical analysis shows that this "random walk" assumption generally holds over long periods of time, but that over short periods of time stock market outcomes can deviate meaningfully from 50:50.

To help illustrate this point, think of a baseball player who over the course of a season bats .300, but occasionally goes on a month-long run batting .400 or a month-long slump batting .100. In a similar fashion the stock market can go on "runs" in which over the course of four months 65% of the trading days can post gains or "slumps" in which over the course of four months only 40% of the trading days can post gains.  

In the chart below we measure exactly that: the percent of days over the previous four months in which the stock market has gained. What we find is that over a four month observation period the stock market rarely posts gains more than 60% of the time (a statistical run) and when it has it is usually followed by a period in which the market only gains 45% of the time (a statistical slump).

We point this out because we are currently in the process of coming down from a statistical run that appears to have ended on June 9th. If history is a guide, we should now expect a more random outcome of stock market performance over the next several weeks and months and may even experience a period of statistical slump. Note that runs and slumps don't always coincide with massive price gains or losses, but this chart shows that it is possible.

What do Australian Mining Trends Tell us About Raw Material Prices?

Australia has thoroughly enjoyed the boom in its mining sector that started around the time China entered the WTO in 2001. The additional demand for raw materials from China and other EMs induced higher prices and the predictable supply side response of more capacity (i.e. CapEx) from Australian producers. Indeed, mining CapEx (blue line in chart 1 below) increased 10x from 2001-2011 as the CRB Raw Materials Index (red line in chart 1 below) increased from about 220-600. But raw materials prices as defined by the CRB peaked in 2011 and have been basically flat for more than two years. Australian mining CapEx peaked a bit later, in 2012, but has been in clear decline since then. What's even more interesting, however, is that corporate expectations for mining CapEx (blue line in chart 2 below) have also clearly hooked lower suggesting continued weakness in raw materials prices going forward. This would seem to make sense as the growth rate of Chinese fixed asset investment continues to slow (last chart).

Put/Call Ratio - Looking A Lot Like 1999

The 1-year moving average of the CBOE Total Put to Call Ratio just dropped below levels seen in early 2010 and is currently at the lowest level since March 2005. More importantly, as the chart below shows, we are now seeing a major divergence developing as stocks continue making all-time highs and the put/call ratio continues to fall. The last time we saw a formation such as this develope was in the late 1990's. Once caveat is the absolute level of the put/call ratio is much higher than it was during the late 1990's.

Oil is Close to Breaking Out, But Not There Yet

The price of oil has gotten some attention lately as WTI has rallied YTD from about $92 to 106 and Brent has rallied from an April low of about $104 to $115. Still, according to our work both WTI and Brent have a little way to go before we would consider either to have completed a breakout above what appears to be pretty significant resistance. A decisive breakout above these resistance levels (the light blue line in the charts below) would significantly raise the probability of higher prices in the future, but we are not there yet.

Below we show our proprietary point & figure charts of WTI and Brent crude oil.


WTI Crude:


Brent Crude:

French Business Climate: Un Petit Problème

French business sentiment followed in the footsteps of the disappointing German Ifo survey from yesterday (see here):



Are this indicator's relationships with employment, industrial production, and GDP cause for concern?

Bund-Treasury Spread Continues to Widen

The difference in yield on 10-year U.S. treasuries (grey line) compared to German bunds (blue line) has surpassed recent extremes of 2005/2006 and now exceeds more than 130 bps-- a level not seen since 1999, the year the euro was born.

US Consumer Confidence And New Home Sales Make Multi-Year Highs

The economic data out of the US recently has been somewhat "meh" recently. It hasn't been overly encouraging but it also hasn't been disastrous. This can be seen in the Citi Economic Surprise Index where the index has been hanging out just below the zero line for most of the past two months.



Today, however, we had a strong consumer confidence number as well as a very positive new home sales release. Consumer confidence rose to 85.18 (consensus estimate was 82.2) in June which is the highest level since January 2008. The present situation component rose to its highest level since March 2008 and for the first time since the Great Recession the percentage of consumers who believe that current business conditions are good is slightly higher than the percentage of consumers who believe that current business conditions are bad.  







New home sales, meanwhile, surged nearly 19% month-over-month in May to a six year high. The surge in sales brought the month's supply down to 4.5 months and the median months for sale remained steady at 3.3 months.