Will the Market Crash? (Part 2)
Continuing our discussion from last week:
Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria. —Sir John Templeton
With that said, do you think there has been any euphoria in the market?
Today, a dominant company like Google is valued at around ~20X earnings. During the dot com bubble, companies like Cisco were valued at 100X earnings! We are nowhere near that. Perhaps there is euphoria in the Tech IPO market, but I don’t really see it elsewhere. Markets are pretty much at All Time Highs, yet sentiment is awfully negative.
Leon Cooperman, former CEO Goldman Sachs Asset Management, has a good framework for thinking about what conditions need to be in place for a prolonged downturn. He says that markets go down for four reasons :
A Weak Economy
A Hostile Fed
Speculative Valuations
An Unexpected Geopolitical Event
When investing, I prefer to focus on company fundamentals rather than “macro” things like these, but nonetheless, let’s discuss these briefly.
Is the US Economy Weak?
It’s hard to argue this is the case. Employment is strong. Consumers are spending money - retail sales are strong. Corporate profits are stronger than expected. The economy doesn’t seem weak at all. It is growing slowly but steadily at a couple percentage per year.
Do we have a Hostile Fed?
On the contrary. Interest rates are at historic lows. And the Fed wants to see more growth. They just cut interest rates. This happened, despite earlier signaling they wanted to raise rates in 2019. I would argue the Fed is being very accommodating, not hostile.
Are Valuations Speculative?
Wall Street consensus S&P 500 earnings are estimated to be ~$164.61 for 2019 and ~$183.35 in 2020. Therefore, at the current price (~3000), the S&P 500 is trading at a ~18X 2019 multiple and a ~16X 2020 multiple.
Comparatively, the market has traded at a ~15X multiple on average for the last 50 years. With interest rates at historic lows, you would expect valuations to be higher than the historical average. Sure valuations are not cheap, but they certainly don’t seem exorbitant at these levels. They seem somewhere in the “zone of fair value”.
Market cycles don’t end at fair value, they end at over valuation.
An Unexpected Geopolitical Event
Of course, this isn’t something anyone can predict beforehand.