Crying Wolf Barometer
It’s been a while since we’ve updated our Crying Wolf Barometer (CWB). We introduced the CWB in March of 2018 and periodically send out updates when the S&P 500 makes a new high or takes another dip, as is the current scenario. The latest news regarding trade talks, fears of recession, impeachment, and Brexit have led to an almost 5% drop in the S&P 500 from its recent record high. This indicator serves as a reminder to focus on the fundamentals and not let emotions adversely impact our decision making. The genesis of this indicator was a discussion from an investment meeting in February 2018. We were debating whether the February 2018 sell-off, due to “fears of wage inflation”, was the end of a nearly 10-year-old bull market or was is it just another dip that eventually will be dismissed as a false alarm? Given our well-documented views on the death of inflation and absolutely nothing in the economic data to suggest inflation was a problem, we assumed the latter. As a reminder, the reason we decided to call this the “Crying Wolf Barometer” is that today’s 24/7 news cycle reminds us of the Boy who Cried Wolf fable. In the story, the shepherd created so many false alarms that the villagers start ignoring all his warnings, even when a real wolf shows up. The moral of the fable, “no one believes a liar, even if they tell the truth,” leads us to our quandary as investors. While we don’t mean to imply that media pundits are liars, we do believe they have an incentive to create concern, and therefore interest, in their programming. We certainly are not dismissive of the news cycle, we are aware that one day the news may identify an important concern that precipitates an actual bear market. Our challenge as investors is to stay vigilant and distinguish between what is a false alarm and what is actually a wolf. We therefore decided to research and document material sell-offs since 2008 where there was a clear reason in the news cycle for the sell-off. The credit crisis of 2008 caused the last bear market. This was an economic event that should and did cause a bear market. Ironically, there was little to no mention of a credit crisis until after it occurred. In March of 2018, we sent out our market commentary identifying false alarms that have caused market dips during the current bull market. As always, we enjoyed and appreciated your responses. Two responses, in particular, caught our attention; “Don’t forget that Little Red Riding Hood ends up being eaten by the Big Bad Wolf” and, “that’s the ugliest and noisiest graph I’ve ever seen”. We love all your feedback and encourage more of it. So, while it is true that Little Red Riding Hood does get eaten by the Big Bad Wolf, that’s an entirely different fairy tale. We find it unlikely that this is the same wolf from The Boy who Cried Wolf. It also is doubtful that this wolf is the same wolf that threatens to blow down the houses of The Three Little Pigs. We're not sure if your Little Red Riding Hood response was meant as humor. Regardless, it gave us a wonderful laugh. Thank you. We must admit, the wolf in Little Red Riding Hood does bear an uncanny resemblance to the other wolves.
As far as our graph being ugly and noisy, we plead guilty. Here is the original chart and table from our 2018 market commentary. We throw ourselves on the mercy of our readers. What were we thinking!
We decided it makes sense to split the graph of the entire 11-year bull market up into 2 graphs over shorter time periods. We’ve also done our best to make the formatting and color schemes more appealing to the eye. Admittedly, this was not a high hurdle. Lastly, we raised the hurdle for what qualifies as an episode. We think identifying fewer but more meaningful episodes is more impactful.
While the moral of our fable is to avoid the noise and focus on the fundamentals, it's interesting to look back at what had markets worried during each sell-off. Our guess is most of us barely remember most of the episodes only a short time after they pass. Here's another expression that seems apropos, "today is tomorrow which you worried about yesterday". We've argued the reason this bull market is the longest bull market in history, is because it is also the most hated bull market in history. The constant promises of impending recession and disaster have kept this stock market in check. Without a stock market surge, it's difficult to get a stock market collapse. While there has been plenty of volatility, the surge-collapse pattern has been absent. Despite the S&P 500 advancing nearly 20% this year, valuation is very reasonable. A forward earnings multiple of 16.3X is arguably low given the low-interest rate and low inflation environment.
Stock market prices are not rising faster than stock market earnings and revenues. Valuation is below where it was 2 years ago and at the midpoint of this economic recovery.
With the daily doomsday warnings and alarms we hear on the financial and non-financial news, perhaps the most applicable warning is this; when the wolf does show up he will likely be in sheep's clothing. Put another way, it's usually not the headline issues that ultimately matter. While we are concerned about the seasonal component of our equity model, we are not overly concerned about the latest impeachment talk. Whether stocks move up or down from here will likely depend on Q3 earnings which will be released over the next couple of weeks. Once again, analysts have revised down their estimates ahead of the actual earnings reports. We don't understand this phenomenon, but it's amazingly consistent.
Despite a clear slowdown in earnings growth, we think this likely allows reported earnings to once again beat their estimates. All else being equal, this would favor markets to once again move higher. As we often repeat, our research has shown that Bull Markets do not die of old age, they die because of recessions and overvaluation. We don't see either on the immediate horizon. We expect volatility to remain higher than normal, perhaps with some large pullbacks, but until we see signs of a recession and an earnings collapse, our expectations are for markets to continue moving higher. Fashionably yours, The GreenPort Team