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Viral Valuation

Tony Hellenbrand • March 16, 2020
The Dow Jones Industrial Average is currently down 2,769 points, at 20,416 down nearly 30% from the all-time high.

A common thought we’re hearing from investors is “I’m done. The market just killed my retirement. I have to work longer. I don’t have any more money to save…”

Many investors have a MASSIVELY overpriced asset in their portfolio and just don’t know it.
Bonds.

If you own bonds today...congratulations. If you plan to own them going forward, WHY?

The Bond Risk/Return Ratio

We are at all-time lows in rates. The most likely scenario is that a bond bear market is ahead of us. The last time we had sustained rising rates, bonds lost 60% of the wealth invested in them!

Barclay's Aggregate Bond Index (a combination of long and short term bonds) is currently yielding 1.82%. According to the U.S. Bureau of Labor Statistics, 12-month inflation is 2.30%. We don't need a calculator to know that's a losing proposition.

If you're paying an advisor, paying taxes, or have any other investment-related fees, this pushes your bond yield further into the red.

10-year treasuries are now yielding 0.76% Think about that for a moment. Someone buying a 10-year bond right now is willing to pay 131 times earnings for an asset that they know can’t grow earnings for 10 years.

Interest rates are at all-time lows. As they rise, bonds lose money. Looking forward here is what we can expect from interest rates:

If you’ve been sitting on cash and money markets for years afraid the market might crash, congratulations. If you still plan to sit on that cash for the foreseeable future...why? What are you waiting for? Stocks to be cheap?

“Cheap” Stocks

Valuing the stock market as a whole is a simple exercise. You need to know:
  • The “Risk-Free” Rate
  • Long term earnings growth rate
  • Current earnings of the market as a whole (you know what it was)
  • Long-term risk premium (how much “extra” return you get from stocks)
If you assume that the virus has not impacted the economy long-term (i.e. over the next 10 years) and that the long-term extra return you get from owning stocks is relatively stable, you can look up 10-year treasury rates, and bingo - you have 75% of the data needed to “value” the index.

You can then run various scenarios for earnings and see different “Fair Values” of the stock market as a whole. Want to see what happens if earnings fall 20% and take 5 years to "earn" them back? 

Calculating... S&P Fair Value 3,015.

What if earnings drop 20% and only recover 75% of that ground by 2025? 

Calculating... S&P Fair Value 2,860.

What is the market telling us about the economy?

You now have stocks pricing in a horrific picture going forward. Even if S&P 500 earnings fell 50% this hit took 5 years to rebound, fair value on the S&P today would be...2,903. 

In the financial crisis, S&P earnings fell 75% but had recovered to 2007 levels by 2010 and record highs by 2013. Mr. Market is now pricing in something worse than 2008. (Intrinsic value in this scenario is S&P 2,791. The S&P is currently at 2,458.)

* Don't just take our word for it. The "Godfather" of fundamental valuation, Aswath Damodaran (NYU Professor of Finance) voices comes to the same conclusion. 

Now, is everything from here sunshine and roses? No. Do not rush in and deploy all the money you have. Make sure you have an emergency fund. Make sure you are psychologically willing to wait out this market for 2 years or more. Dollar-cost average. Be diversified.

One thing is clear: On a 5 or 10-year forward-looking basis, the market is already very cheap. So why not rush in and buy everything in sight? The answer: We have left the realm of mathematics and are now in the realm of psychology. Cheap can get cheaper. Panic begets more panic. Calling bottoms is impossible.

BUT for the person that starts a calculated entry plan here, they are very likely to be rewarded for their presence of mind for years to come.

Please do not take this article as advice double or triple down on the market. Everyone's situation and risk tolerance is different and that will translate into different advice. This article is used for illustration purposes only. If you would like to be advised on using the information in this article to improve your situation, please call (920) 544-0576.

File at 62 vs. Delay: At What Age Do I Break Even on Social Security?

By Eric Sajdak, ChFC® • July 7, 2020
"If I delay my Social Security benefit, at what age would I breakeven versus simply filing at 62?" We field this type of question frequently from retirees. The Social Security system allows you to file anytime between 62 and age 70. At first glance, filing at 62 seems to make the most sense. After all, there are 12 months in a year and eight years between ages 62 and 70—That's 96 months of monthly paychecks that you wouldn't be getting if you delayed. However, you get penalized for taking your benefit early. Below is a diagram showing the penalties and delayed credits for someone whose Full Retirement Age is 66:

Fair Value, Now What?

By Tony Hellenbrand • June 30, 2020
Lately I’ve been getting asked how I was able to “Call the Bottom” in late March. I want to make something clear: I didn’t. If you go back and look at the article from March 16th or read the email I sent out to subscribers on the 26th, (pure dumb luck), I ran a bad case, a best case, and a base case valuation on the S&P 500. I arrived at a base case valuation of 2,950, and at the time the S&P was hovering around 2,300, so we started recommending clients initiate buying plans. These plans did not mean “This is the bottom” or “Go all in.” Far from it. Many of our clients were buying several days before the precise bottom, and several days and weeks after. Regardless of how clearly I try to make this point (that we simply were buying something the math said was likely cheap) this morning my inbox is chock full of people asking what I think about valuations now. Are we in a bubble? Is the market ahead of the fundamentals? Are we going to double dip? Will the market crash? Will we need a second stimulus? Maybe. I have no idea. Here’s what I know, when you accumulate all of the available earnings estimates and make a conservative estimate of fair value, you end up with a fair value of about 3,060 on the S&P 500. As I type this we sit at 3,080. Regardless of whether the number is 2,950 or 3,060 or 3,080 or 3,150, any way you slice it, we’re at fair value, now. Analyst Earnings Estimates:

Risk-Free Assets

By Tony Hellenbrand • April 1, 2020
Greenwich, CT. May 2008. Feels like forever ago. Another life. Hard to believe it was just over a decade ago. My first “Real” job. Analyst for S.N. Phelps & Co., a firm that managed money for a bunch of insurance companies. In the open office environment, my boss, the firm’s proprietor, the late Stanford Phelps, sat directly across the desk from me. After exchanging pleasantries and sipping my coffee, Stan asked me a question: “What assets are risk free?” As with all of his questions, it was a test, a teaching moment and a trap, all rolled into one. I knew the academic answer of U.S. Treasuries wouldn’t cut it, here. My mind raced. I knew Stan was a well known student of George Patton and demanded fast answers, even if incorrect. “There aren’t any.” I answered, praying for my job. Thankfully I had a month-to-month lease. Please don’t fire me. Please don’t fire me. Please don’t fire me. He smiled “That’s an ok answer…” I exhaled. “But there’s a better one,” Stan continued, “EVERY asset is risk-free IF you buy it cheap enough. This building. If I bought it for a nickel, is there really any way I lose money on it? Even if I do, I lose a nickel. If I buy Manhattan for a buck, can that really hurt me?” “No.” I answered. “Even if it goes up and down in value 95% every day, it doesn’t matter.” Stan smiled and pounded the desk with glee, “That’s exactly right!” Will I make the case that stocks are risk-free at these levels? No. Definitely not. However, there is a price where they are so cheap that it’s difficult to lose. Is that level 20,000 on the Dow? No. But some individual names are already getting down to the point where someone beginning a buying plan from these levels that can stick it out for a few years is going to make generational wealth. “Buys of a lifetime.” According to Kyle Bass’s recent CNBC interview where he exclaimed “You can be a value buyer again!” This concept of price and risk can also work against you. Return-free risk. If you paid $1 Trillion ($1,000,000,000,000) for the device you’re reading this article on, there’s realistically a 100% chance you lose all the money. I would argue we’re seeing this in the market right now, in the form of bonds. As I type this, the 10 year Treasury is paying 0.63%. An investor buying a 10 year Treasury today is paying 158x earnings for an asset that can’t grow earnings for 10 years. If you own bonds today... Why? So-called “Safety” is ludicrously over-priced at these levels. How dangerous is a stalwart like Clorox (CLX)? The chart would say it’s not nearly as dangerous as the rest of the market, holding up well the last few weeks. You “only” have to pay 27x earnings and collect a 2.42% dividend, essentially 4x as good of a value as bonds. Not cheap enough? Diageo, one of the largest liquor distillers in the world, is currently at 19x trailing earnings. Put differently, Diageo, a large, stable, growing business, has an earnings yield over 5%. Why accept 0.86%? Not cheap enough? Let’s get real crazy. The Dow Jones Industrial Average is trading at 17x earnings. That’s a 5.9% earnings yield. Is more trouble ahead? Yes. Will some of them fall to zero? Yes. Is the bottom in? Who knows. (probably not.) All I know is if you can wait 10 years, I’ll take 5.9% over 0.63% every time.
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