Month-end Thoughts on Valuation

Friday, May 29, 2009

Hard to believe it's month-end already. Gee, time sure does fly when you're having fun. (Or.....B.) In any event, the lack of massive equity moves, such as we've observed for most of this year, should preclude the sort of month-end fixing/rebalancing jiggery-pokery that's been observed for the past six months. Perhaps the most interesting thing will be to observe what the asset allocators do. Bonds have cheapened nicely against equities this month and are entering a seasonal purple patch. Equities, however, will be in solid "go away" territory for the next five months.

Not that any of this will necessarily matter, of course. Seasonals are all well and good, but should arguably be swamped by the importance of the incoming dataflow. Yesterday's comments section contained some interesting debate about the valuation argument for equities, so Macro Man has delve a bit deeper.

One commenter posited that European equities looked attractive because of the dividend yield of certain companies. Now, Macro Man has neither the competence nor the mandate to trade individual stocks, so he is forced to look at things from a top-down, er, macro, index-level.

One of his favourite markets to trade is Eurostoxx, where not only are there listed options and futures on the index itself, but also listed options on the dividends paid out by the index consituents. Although payour ratios are not constant, these represents a decent proxy for market-implied earnings trends and, one could argue, economic growth.

It is a peculiarity of the Eurostoxx that most of the index dividends are paid or committed early in the year, meaning that they actually represent a good bit of the prior year's earnings. So for example, last year the Eurostoxx paid dividends equivalent to roughly 158 index points, a record high....representing earnings accrued primarily in 2007, before the worst of the financial crisis hit. 2009 dividend payments are expected at 112.6 on current pricing, and some 93 points of that has already been paid or committed. That decline represents the impaired earnings power of 2008. Next year, the market is forecasting divvy payments of 76.9 points, representing declining earnings this year.

Now, what's interesting is that the strip is pricing the nadir of dividend payments to occur in 2011, meaning that the bottom in Eurostoxx earnigns is likely to occur next year rather than this. Moreover, divvy payments are not expected to exceed 2010 levels until 2015, implying that 2009 earnigns will not be bested until 2014!!!

Call Macro Man crazy, but that hardly strikes him as an attractive proposition. If the dividend futures are correct, we can expect basically zero earnings growth for the next five years. Why the hell should we want to buy equities then? And if divvy futures are underestimating the likely trajectory of earnings, aren't they a better buy then equities (given that you don't have to worry about getting the mutliple right.)? By way of disclaimer, Macro Man has been long various segments of this strip for most of the year as abottom-of-the-drawer "eventual recovery" trade.

Put graphically, the implied dividend yield of the Eurostoxx index in future years (using a forward index level implied by swap yields) doesn't look like anything special...and that's before you consider things like volatility and uncertainty.

Frankly, for a no-brainer valuation trade at this juncture, Macro Man personally requires a much higher equity risk premium to be enthused about jumping in.

Failing that, all we have to fall back on is money-market cash levels. And while "everybody else is doing it, so why don't we" can on occasion be a persuasive argument, it's also paved the road to some of the most spectacular crashes of the past couple of decades. Put another way, just because some other doughnut decided that it'd be fun to buy GM stock (which traded in positive territory for most of the day) the day that they announced their imminent bankruptcy timetable doesn't mean that it's a good idea for you or Macro Man to do it.

Posted by Macro Man at 10:19 AM  

25 comments:

Well GM is priced in dollars, so duh. Not to be alarmist or talk my short book, however is there any analogy to be inferred from Lehman to GM's swan dive?

H(oratio) said...
11:16 AM  

Agree on the SX5E divs, much better buy than the index, any thoughts on the FTSE ? OI building slowly, but getting there.

Also hearing DAX & SMI to list at the end of the June.

Anonymous said...
11:37 AM  

Not really looked at FTSE much. The more popular (and liquid) these things get, the better, as far as I am concerned.

Macro Man said...
12:39 PM  

UBS did a piece on FTSE divs last Fri which is worth getting hold of. Still think SX5E divs make more sense as don't take the $ fx risk implicit in FTSE.

MM, ultimately the aggressive v-shaped recovery in margins priced seems unsustainable but would rather wait for S&P 1000 to express that short whilst the relative return guys sh*t themselves about having missed so much of the rally.

Bonne chance,

DC

Anonymous said...
12:45 PM  

i can't, for the life of me, see why anyone (except aviva and fortis, the powerhouses) would buy any european stock at these prices. and we swift all 3,500 of them one by one regularly.
even when times were good they were reporting in terms of adjusted ebitda. now they moved up to sales only. pretty soon we switch to volume. or employees.

hopefully anon said...
3:02 PM  

You might want to check the dividend futures for consistency against the dividends implied by current option box (spread) prices.

cfarley said...
3:47 PM  

What is the bloomberg or exchange ticker of the SX5E dividend.

Anonymous said...
4:17 PM  

MM - thanks. That's a marvelous post and offers up a lot of insight about the post. Is it possible to do something similar for any of the other major indexes ?

Gracias.

dblwyo said...
4:20 PM  

DEDZ0 is the 2010 future, DEDZ1 is the 2011, etc.

dblwyo, the only other listed divvy future that I know of is the FTSE, and I've never looked at those in any great detail as they are substantially less liquid that the Eurostoxx (which themselves still aren't uber-liquid.) Other markets trade OTC, but I have no price history or anything for those.

Macro Man said...
4:38 PM  

In re US MMF assets, it has been my impression that same already have been flowing out since the March bottom -- and there is more to come, as folks get sick of 0% yields. My bet is that this has been a classic bear-market rally, and that it is sellable on the way up. So far my sell prints during Geithner Week aren't looking too great, but I am patient at times like this.

That cash need not flow entirely or even largely into equities, after all. There are still a lot of positions out there senior in the capital structure that will deliver equity-like returns in a recovery, and mitigate downside in the economic L-bottom I predict.

Full disclosure: market-neutral, at least in dollar terms; effective beta likely net long (see 'equity-like' above).

wcw said...
5:26 PM  

oil new high
feds buying 10yrs
gold rising
euro aud kiwi brl cad unstoppable
hmm
equity index discussion is semantics.
we are going to 950 spx soon
mpm

Anonymous said...
7:13 PM  

oil = global money velocity

as long as thats going up we are healing. and the inflationary envior will be accelerated through the healing

feds toiling - is just extra gravy

mpm

Anonymous said...
7:24 PM  

Interesting there are so many momentum traders posting here --- seems a lot of people have no fundamental view whatsoever and are happy to just to buy what's going up / sell what's going down. That's fine, but it's not what macro is about, so railing against MM for not doing the same is nonsense.

Anonymous said...
9:13 PM  

commenter above.
im not momentum.
ive said the same exact thing since mid march

also- i do not believe you know the fundamental landscape better than i do. to claim u get fundamentals in a 75 vol world doesnt exist. you need different vision. its vision and feel.

mpm

Anonymous said...
9:20 PM  

also mm knows i respect him. ive told him

this is the only site i go to

mpm

Anonymous said...
9:23 PM  

feds not buying 10y treasuries (index extension doin their bit), but mortgages yes ... so we all now their balance sheet quality becoming more turd like by the minute ... so combine that with leftist domestic policy, and weakness targeted by foreign interest groups (north korea, iran, brics) amd you get weak dollar and higher gold. so yeah we get higher stock prices by default.

for all the deflationary forces at hand, short term, the velocity of money is accelerating ... and too fast ... stocks may go up, but inflation will get priced into bond market and that will correct the process ... time for the fed to signal exit strategy or commodities and rates will choke recovery gradually over this year.

thanks to these idiot central bankers, there will be once more a bubble waiting to be popped. and thats gonna hurt the scum sucking baby boomers even more.

Anonymous said...
10:16 PM  

Bubble-economics. We need them to keep this chain gang rocking. Once that goes, we're all in deep sheiss.

Anonymous said...
11:04 PM  

...we can expect basically zero earnings growth for the next five years. Why the hell should we want to buy equities then?
I've been thinking about that too and then it came to me.
As long as the music is playing (i.e. Government Sachs are doing their job to inspire confidence) we can sell them to someone else at a higher price.

Clive Corcoran said...
12:27 PM  

10:16 now we are talking my friend

mpm

Anonymous said...
2:31 PM  

so lets all buy stocks knowing they are all over valued turds ... but when do we decide to sell? why stop at 950? why not 1250?

if you don't know/care where fair value is, then how can you have conviction to slap on risk, size your trade or know where to get out or place your stops?

Anonymous said...
5:36 PM  

hi
this is rich poems in your blog
do u know persian poets ?
and i have veri tooop photo blog !!!!
check it [at]> pix.akharin.ir

kevin said...
8:04 AM  

I Macro Man,

Take a look at the following I think this is the kind of article you would like:

http://you-buy-the-high-i-sell-the-low.blogspot.com/2009/05/do-anything-in-haste-and-repent-at-you.html

Anonymous said...
10:16 AM  

http://sahilkaps.blogspot.com/2009/06/usdjpy.html

USDJPY is about to break down. what are your comments??

Anonymous said...
8:56 AM  

like a lot of derivative markets the price tells you more about the risk appetrite of the particiapnts rather than the probability of the event. Any structured product is essentially hedged through the forward market which means investment Banks are effectively sellers of dividends. The discount to actual predicted dividends is maintained through lack of liquidity on the buy side. A lot of hedgies used to play this trade but got squeezed out last year. It's an interesting market but should not be confused with a predictor of dividends - and not a prop to support the ongoing "all equity markets are mad" trade. As noted before, they are not irrationally bullish, they have just unwound the irrational bearishness of January. Unlike a lot of noise markets they don't keep going down on every piece of "bad news". At some point (March) it is in the price. Equities may still be in a bear market. More interesting, are bonds still in a bull market?

Mark T said...
9:19 AM  

"commenter above.
im not momentum.
ive said the same exact thing since mid march

also- i do not believe you know the fundamental landscape better than i do. to claim u get fundamentals in a 75 vol world doesnt exist. you need different vision. its vision and feel.

mpm"

1) The comment was not aimed at you specifically (I have a Carly Simon song in my head, now).
2) How you can claim to know the funamentals better than another anonymous poster is beyond me.
3) What assets (ex-single stocks) are trading on 75 vol as of 2009/05/29?

Anonymous said...
7:49 PM  

Post a Comment