Now I’m not going to deny that the recent market rally has got me really worried. I get all the reasons for why it’s happening – US-China trade truce, cyclical rebound, election year etc, but it still feels like it’s coming too fast too soon. I’m sitting on huge gains made just over the past 1 – 2 months. It reminds me a lot of the Jan 2018 market melt-up, just before they dropped for the rest of the year.
Mapletree Commercial Trust is one of my biggest holdings. And when I look at the chart, I can’t help but wonder if the recent rally is sustainable. I bought this back in 2018 when everyone was freaking out over rate hikes, and it has gone from 1.5 to 2.46, or a 60% rally. It’s trading at a 3.7% yield (2% yield spread) and a 43% premium to book. Is this getting ahead of itself? Is there money to be made to cash out and sit on the sidelines for a year or two?
So I wanted to use this article to really examine the hard data, to understand if my hunch is right – is a market crash coming in the short and longer term?
And before we begin, I want you to know that no one knows the answer to this question, myself included. This is just going to be an educated guess based on data available. Anybody who tells you otherwise, who professes to know the answer 100%, is either (1) unaware of the fact that he is wrong, or (2) aware that he is wrong, but is trying to sell something to you, whether it is a product or his services.
Basics: What does the data show?
Let’s start with the long term chart for the S&P500. I love this chart because it really helps to put things in perspective. The current rally has been going since 2009 and is now at its 11th year, setting the record for the longest bull market ever. But of course, there’s no rule that says that bull markets must die after a certain age, they can keep going as long as people keep buying.
What about valuations? Traditional P/E is not a great metric to analyse long term trends because it’s not cyclically adjusted, so we’ll use the Schiller P/E cyclically adjusted price earnings:
Prof. Robert Shiller of Yale University invented the Schiller P/E to measure the market’s valuation. The Schiller P/E is a more reasonable market valuation indicator than the P/E ratio because it eliminates fluctuation of the ratio caused by the variation of profit margins during business cycles. This is similar to market valuation based on the ratio of total market cap over GDP, where the variation of profit margins does not play a role either.
Shiller P/E: 31.5 ( %)
Shiller P/E is 85.3% higher than the historical mean of 17
Implied future annual return: -2.5%
Historical low: 4.8
Historical high: 44.2
S&P 500: 3289.29
Regular P/E: 25 (historical mean: 16.1)
Long story short, Schiller P/E shows that stock valuations are really high right now. They’re 85.3% above their historical mean, and above the heights of Black Tuesday (ie. the great depression) and Black Monday. But it hasn’t reached the insanity of the dot com boom yet.
The thing about valuations is that even though it tells us that stocks are expensive on a historical basis, and will probably go down in the future, it does nothing to tell us about the timing of that crash. Stocks are expensive, but they can get a lot more expensive. Just look at the dot com boom and how high it went.
We’ll need to dig deeper, by looking at some underlying economic data.
Some of you may wonder why I’m using mostly US Charts in this article. And the simple reason is that the US economy is the number one global economy in the world today. The Federal Reserve sets US monetary policy which sets the benchmark for global monetary policy. So as much as we hate it, Trump is right – the world does depend on the US. China is rapidly growing in importance to the world, and they will be relevant to this discussion, but they’re not at the point where they dictate global monetary policy just yet. That requires more time.
I’ve set out the long-term US interest rate trend below. Key takeaways are: (1) We’re on a 40 year long term interest rate cutting cycle (or bond market bull run), (2) monetary policy is going to be ineffective in the coming years because we’re already close to the zero bound, (3) this is going to spark a paradigm shift as the 40 year long term cycle comes to an end. With monetary policy as a tool likely to be ineffective in the coming years, the next cycle will likely see fiscal policy coming into play in a huge way (basically US doing what China did in 2008, huge government and infrastructure spending), which is going to be inflationary.
Market expectations as to interest rate policy is set out below. To break it down simply, last year the market was pricing in huge rate cuts from the Feds, this year – they’re generally agreeing with the Feds that no more rate hikes are required. This seems to indicate that 2020 would be at least relatively stable.
3s10s yield curve is set out below. The 3s10s inverted last year, which historically gives us about 12 to 18 months until a recession. There’s a lot of talk about how the yield curve is no longer effective these days because of how QE has distorted interest rates, but I’m going to skip all that debate here. Yield curve is signalling trouble for the economy going forward. Whether you trust the signal, is up to you.
The unemployment numbers really help to put things in perspective further. Say what you want about Trump, but this has been the greatest US economy in history. Just look at that unemployment curve.
Government debt and private debt as a % of GDP are set out below respectively. Key takeaway is that (1) Government debt is high, and (2) private debt is high but relatively more manageable. This indicates that in the next recession, government debt is going to be a problem. But again, it doesn’t tell us much about timing of the crash.
The CNN Fear & Greed Index is a great (and quick) way to check investor sentiment.