There Is No ‘Value’ Here, So Just Stop It.

Sometimes I think common sense is something that no one uses when it comes to analyzing markets, making capital allocation decisions, and/or penning market commentary.

There’s a demonstrable tendency for people to get lost in the data or else find themselves blinded by the proverbial light, whether “light” is too much goal seeking on the analytical front or more poignantly, an overriding urge to participate when everyone else is making money even when you know that what everyone is participating in makes little sense.

This is manifesting itself currently on many fronts, not the least of which is the near round-the-clock effort to figure out ways to “explain” why equities are not in fact as expensive as they seem.


Make no mistake, that’s a useful exercise under normal circumstances, because there are always going to be arguments for why something is more or less expensive than it looks and when it comes to allocating capital, you don’t want to be the guy/gal who makes decisions based on the equivalent of a Yahoo Finance screen for a couple of metrics that everyone learns on the first of day of Finance 101.

That said, I think it’s useful to remember that past a certain point, common sense reasserts itself as the only “metric” that should matter even for sophisticated investors with the resources to literally engineer compelling excuses to justify positions in stretched assets.

There is no question that equities are expensive. And this crusade to explain that away by screaming about bonds being even more expensive or worse, about how it’s fine because the companies that are driving benchmarks to new records every other session somehow represent “the future” of humanity and thus cannot be evaluated let alone judged based on traditional analysis, now borders on the absurd.

It goes without saying that you want to compare the attractiveness of one asset versus the attractiveness of alternatives – that’s what capital allocation is. So you are not saying anything new (actually you’re not saying at all) when you claim that stocks have to be evaluated relative to bonds. But it makes little sense to point to a bond market that has been commandeered by a global cabal of policymakers armed with printing presses as a rationale for owning overvalued stocks. That’s like pointing to tulips ca. 1636 as a justification for owning Bitcoin at $8,000 or vice versa (if you had a time machine).

With all of that in mind, I wanted to show you a couple of quick charts out today from Goldman and highlight a few sentences from the accompanying color.

“The current bull market has been one of the most impressive in history, particularly for US equities but many indicators signal we are late cycle and most valuation metrics are elevated, so there may not be much left to the rally,” the bank writes, in a piece out this morning.  Here’s the ERP chart which seems to suggest that there’s still some “value” to be had in stocks:


As Goldman goes on to write, things look different now than they did in 2000 or 2007, “when most valuation metrics signaled little value, including the ERP (Exhibit 2).”

But obviously – and I can’t believe anyone even has to say this – this is relative value. Not absolute value. “We think this divergence in valuation signals is happening primarily because the ERP is a metric of value in equities relative to bonds, as opposed to a measure of absolute value in equities, which is the case for other valuation metrics such as P/Es and dividend yields,” Goldman goes on to write, stating the (painfully) obvious, before adding that “a high ERP can signal either that returns will be low to bonds or that returns will be high to equities, or both [but] right now we think the former is a more significant factor than the latter.”

Right. You are doubly screwed in bonds because you’re not getting shit for income and if central banks start to gradually tighten, you’re not going to get shit in the way of capital returns either.

Here’s a chart that shows you the divergence between the ERP and other measures of equity valuation:


And the excuse for this is always the same. It goes something like this: “well we have to own something.”

Ok, fine. If “you” are indeed a “we” (that is, if you are an asset manager), then that works – although I’m not sure that’s going to help when clients ask why you were buying the Nasdaq two weeks before it collapsed.

But if “you” are not a “we” but are in fact just a “you” (that is, if you are just an average investor), well then no, you do not “have” to own anything.

Now enter the straw man, which always goes something like this: “ok, fine, then I guess I’ll just sell everything and buy ammo, gold and kerosene lanterns.” Again, that’s a straw man. Your options are not confined to “stocks and bonds” or “gold, AK bullets and kerosene lanterns.” In the same vein, your choices for hedging are not confined to the world of far OTM puts.

So you know, let’s get back to some semblance of common sense because I can promise you that when the “everything bubble” bursts, you won’t find much solace in telling yourself that you “had to buy something.”


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