Review of a few Positions

This week’s post will review the performance of a few positions I currently have interests in.  Unless explicitly stated, this is not an endorsement of getting into these positions at this time. This is because the reasons for purchasing them may have changed.

Conduent

In January after the spinnoff, I purchased 100 shares of CNDT at $14.38, today the price is near $15.02, representing over a 4% return in a month.  As stated in the original post, the holding period for this stock is closer to 2-4 years.  I expect that this company’s actual share value is closer to $22/share, so such a move is simply confirmatory. TDAmeritrade indicates that the institutional investor commitment is a mere 16.75%.  One of the things I am looking for is an increase from the institutional investments to closer to 50% before selling this security.

Mylan

This week, Pharmaceuticals jumped on bullish call options for Mylan.  This appears to have something to do with David Tepper who reduced his position in Apple in favor of increased or new positions in Mylan, Pfizer, and Allergan.  Tepper is one of the few hedge fund managers that has performed well since the financial crisis according to Forbes magazine.  Tepper’s positions were revealed on Valentines Day and rose almost 5% that day and the next-solidly placing the price just over $42/share.  Consequently those call options seem to be indicating that the market movers expect a move beyond $42.5/share because many of them were placed at that price.  The open interest in $42.50 call options expiring on March 17 exceeds 7,800 contracts showing an extremely bullish sentiment for this company.

Market overall

I still think the market is in for some volatile days ahead.  The Trump trade we have discussed in several posts is still showing exuberance that seems to think nothing could go wrong.  Donald Trump seems to be a shoot from the hip type of president which could cause some uncertainty-Wall Street traders are fickle and seem to hate uncertainty.  They could respond quickly to some unfavorable policy and send the market down as quickly as they pushed it up during the election.  I may be wrong, and hope that I am because this would indicate a better economy for the coming years, but the skeptic in me keeps me from a full commitment of funds due to such a possibility.

Dow over 20,000 and overpriced

The last two weeks we experienced the Dow Jones Industrial Average (DJIA) topping 20,000 for the first time in history.  This milestone was inevitable, but at the current time and price multiple it is too high.  This week’s post will look at it from a different perspective, what are people saying about this historic rise in DJIA prices?

Say what you will about the ultimate importance of the Dow reaching this big round number, but it certainly got there in a hurry. The 9% the Dow has added since Election Day is the sort of move that is usually reserved for market rebounds after big tumbles as opposed to when it was already in reach of its record high. – Justin Lahart, Dow 20000 Means Stocks are Pricey, WSJ.com

Even if I understood quantum mechanics, this (rally) wouldn’t make sense but oh well. Rally on!! – Heath Anderson WSJ.com forum

So what’s the alternative to stocks? Bonds, paying zilch if they’re solid and a few percent if they’re not (do you really want to lend to Chicago?) Real estate? REITs seem to be taking it on the chin with more mall defaults on the way according to an article today. Individual property? That’s more sunk illiquid capital for a long-term spec bet than most investors can stomach.

I guess there’s always unicorn farms.” – John Rogitz, WSJ.com forum

Yes. P:E’s are above the levels pre dot.bomb and pre derivative/housing crash. And the Dow is jiggered by removing losers and inserting winners. Celebrating a single index is like sacrificing goats to make it rain. – Marty Anderson, WSJ.com forum

It’s really disappointing how the markets can react to perceived opportunities/disappointments in the future without knowing any specifics. Premature ejaculations never really result in material benefits. Can’t we wait until specifics are delivered? Does business award bonuses for ideas that never see the light of day? – Bob Schafer, WSJ.com forum commenting on the fast run up of financial stocks since the election (up between 15-36% in the last few months).

The Trump trade seems to be an excuse to overprice the companies in the stock market.  When the DJIA passed 10,000 for the first time, the phrase irrational exuberance was used to describe the market.  The metric then passed the 10,000 mark over 30 times before crossing 20,000.  The Trump trade is all focused on what he is planning to do, and very little on what he will actually do.  The market seems to think that his policies will be very one-sided and only include upside opportunities.  For over three months, the market appears to only be considering the upside potential.  Several articles this week indicated that Wall Street is taking its cues from Washington.  Until earnings and more importantly cash flows begin to catch up, I think that the markets will be more volatile.  Therefore, I am currently maintaining 50% of my investment accounts in cash and cash equivalents.  Consider Warren Buffett:

Be fearful when others are greedy and greedy when others are fearful

Stock Market Forecast 12/17/2016

Stock market value determination is fundamental to an investor interested in purchasing portions of the market at a reasonable price.  Forecasting is an important part of any active investment style.

“The cost of a thing is the amount of what I will call life which is required to be exchanged for it, immediately or in the long run.”
― Henry David Thoreau, Walden

The time spent understanding a situation is the ‘life’ Thoreau mentions in the preceding quote.  When considering the cost required to value the market, lets look at ways that capitalize on the amount of time required in exchange.  This post will discuss a little wisdom from Benjamin Graham, some analyst reports one might consider, and some current trends in the news.

A Thought from Ben Graham

Benjamin Graham used the price to earnings (P/E) ratio to identify when a security was over priced or priced at a discount.  A simple way to look at this is to compare the P/E ratio’s current level to that of the security’s average.  When the P/E is lower than the historical average P/E, then Graham proposed that the price of the underlying security is trading at a discount.  Historical data that identifies the monthly average P/E of the S&P 500 to be roughly 15.60 (from data found on www.multpl.com).  This is the average of over 100 years’ of data.  Note that over the past 20 years this average is trending upward.  This indicates that if the S&P 500 drops below a P/E of 15.60, then it is at an appropriate entry price.  The S&P 500’s current P/E ratio of 24.98 (found on wsj.com) would indicate that the average is about 60% overpriced.

Professional Advice

Professional services share their perspective of where they expect the market to be heading.  My personal favorite is the Value Line Investment Survey, but there are others to consider.  Warren Buffet was once quoted stating that he liked the S&P report.  These companies that do this type of work are not all the same so if you are using their information make sure it is from a reputable organization.

Value Line’s weekly report indicates the anticipated price change for the stocks in the Value Line survey will be over the next five years.  The highest expected five year return was 185% during the financial crisis, last week it was 35%.  Value Line uses a proprietary arithmetic formula for its calculation and the investor will have to pay for such advice-or get access to it at a local public library.  Most public libraries will have this in their section on investing.

The S&P Capital IQ Outlook report is another paid service.  This report is free to those with a TDAmeritrade account.  The S&P outlook for 2017 states that the current bull market is the second most expensive market top since WWII with a trailing (meaning the last 12 months) P/E of more than 25x! The Outlook report also points out that the S&P 500 fell an average of 2.7% during the first year of a new Republican president.  The report states that only once did the year following the election of a new Republican president end with a gain.  Finally, S&P predicts that this market will continue to stay ‘aloft’ through the next year.

The Argus Market Watch Report is also free with an account from TDAmeritrade.  This report compiles several different analysts and provides a diary of a 12-month forecast for the S&P 500.  This forecast puts the price of the S&P 500 to be somewhere between 1,800 and 2,250.  The S&P 500 is currently trading just over the high end of this range.  Argus does not appear to have updated this range since December 2015, making any confidence in this prediction low and leading the reader to question how current it is.

These agencies can be wrong they provide predictions because their customers ask for it.  In fact there exists a strong argument to anyone wanting to lay some blame of the financial crisis at various rating agency’s feet.  They also use words that try to make their predictions less clear like the S&P report use of the word aloft.  However, they do give a good idea of the sentiment that is current in the market and most of their customers want to see the logic behind such predictions.

Current News

Stories in the news talk of the way people are piling in on the purported “Trump trade”.  The “Trump trade” is the price jump that occurred in the US stock market after the election.  This price jump was sharp and had very few losses over the past few weeks.  This indicates that the index may be overpriced.

Assessment

My experience with P/E ratios, professional advice, and news articles teaches me that this data needs confirmatory evidence.  The evidence I considered for this post causes me to conclude that the stock market is currently trading at a premium.  This post ends with my personal assessment of the S&P 500 price expectation in the next six months.  Confidence level: MODERATE, I assess that the S&P 500 has a 70% chance of retreating at least 10% (or to $2,033.07) at some time in the next six to twelve months.  Note: this assessment is my attempt to identify market prices over the given period, I use this type of conclusion for my own investing. Before you commit funds to any investment or trade, I encourage you to do your own analysis of the investment vehicles you are looking at.

ACTION ITEM: What price changes do you think will happen in the stock market over the next six months to a year?