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This week I had a great market brainstorming call with my friend Peter Boockvar. We took a hard look at the numbers, discussed the real story behind the bubble we're in right now, and tossed around some profit recommendations. I opened up the line for 500 Zenith Trading Circle members to listen in, and we took questions live.
If you're not familiar with Peter, he's one of the smartest people I know. He's a trained economist, Chief Market Analyst with The Lindsey Group, and editor of The Boock Report. I read Peter's analysis every day and forward it to my editors, and I highly recommend it.
Of course, I can't release the full transcript of our call – that's reserved for Zenith subscribers. If you're a member, you can click here now to read the whole thing, including our live answers to audience questions (and I'll have the recording up soon).
But I was able to preserve quite a lot of the discussion for Sure Money readers – including several very interesting recommendations.
Here's your transcript.
Subscriptions Available: If you like what you hear from Peter, I encourage you to subscribe to The Boock Report for daily access to the same market analysis and recommendations I read every day. It is a fantastic resource. Go to https://boockreport.com/become-a-member/ and enter code MONEYMAP25 for $25 off a Personal subscription or MONEYMAP50 for $50 off Professional. To be clear, I don't get anything out of recommending him – I just know you'll enjoy it.
EXCERPT: Conference Call Transcript with Peter Boockvar and Michael Lewitt
Date: Wednesday, Feb. 8, 2017
Conference Time: 1:00 p.m. EST
Operator: Ladies and gentlemen, please stand by, we are about to begin. Good day and welcome to the Zenith Trading Circle conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Michael Lewitt. Please go ahead, sir.
Michael Lewitt: Good afternoon. Welcome everybody. Thank you for joining us. I'm pleased to have this opportunity to speak with everybody and to be joined by my very good friend, Peter Boockvar. I've known Peter for a very long time. Peter is one of the most respected economists and strategists on Wall Street. I've known him going back a lot of years and I think at this point what I would like to do is let him introduce himself. Tell everybody a little bit about himself and what he's done, and then he and I will just start sort of talking about the market. And at the end, I think we're going to open it up for questions. But for now, let me introduce Peter Boockvar. It's a real pleasure to have him on.
Peter Boockvar: Thanks Michael, appreciate having me on. So I am the Co-Chief Investment Officer of Boockmark Advisors, which is an asset management firm. And I'm also the author of a daily written work called the Boock Report, which includes my macro and economic thoughts on a daily basis focusing on, not just in the U.S. but globally in terms of economies, monetary policy, markets, bonds, stocks, commodities, FX, and all of the above. And I'm also the Chief Market Analyst for The Lindsey Group, run by Larry Lindsey, the former Federal Reserve Governor back in the 1990s.
Michael Lewitt: Excellent. Okay. Terrific. So Peter and I, we actually don't disagree all that much about where the markets are right now. I think we both share a view that markets are pretty extended. I think it would be fair to say we both think the bond market's been in a bubble for quite a while. I also think we both think that stocks are extremely expensive.
We've watched the post-Trump election rally sort of scratching our heads. And we've also watched stocks really effectively going nowhere now for several weeks. They seem to be sort of treading water as people watch the action in Washington with a lot of anticipation what policy is expected to bring in terms of potentially lower taxes, less regulation, a different kind of foreign policy, but we're still some distance away from those policies developing.
So you know we're sitting here – everybody's sort of sitting here waiting, but stocks are trading at extremely extended valuations. The way I sort of look at PEs, and you know you can sort of look at different numbers, but in the end there's a pretty big gap between, no pun intended, between GAAP earnings and non-GAAP earnings. But the way I look at it, GAAP earnings are pretty close to $100, so the market's trading at almost 23 times trailing earnings. If you look at the Shiller – cyclically adjusted PE is trading at a much higher level, closer to 28 times. So stocks are pretty expensive and that doesn't seem to bother anybody. So with that I'll sort of turn it over to Peter to sort of talk about his views and then we'll sort of get into it.
Peter Boockvar: Yeah, I'll just add a couple of other valuation metrics. The median price-to-sell ratio is at a record high. It's actually above where it was in 2000 because everything is expensive now. As opposed to in 2000, it was mostly technology stocks. Price to cash flow or enterprise value to EBITDA, another way of saying it, also very extended. Market cap relative to underlying GDP is also approaching its 1929 and year 2000 high. But I think anybody who's been following markets knows that it's expensive. The question is when does expensive matter. Because we know expensive can stay expensive. We've seen that many times in the past. We saw that particularly in the 1990s. I believe that it is beginning to matter because there is a change in the interest rate environment. We saw a plunging yield back in July post-Brexit.
I'm of the opinion that the yields that we saw that took the U.S. tenure down to 1.37%, the Japanese – we saw 13 trillion of negative yielding interest rates. But in Japan going out 40 years, that yield got as low as seven basis points. Now it's 1.07 basis points. And we saw German yield deeply negative back then that have now at least rebounded at the positive territory on the long end. So when rates start to rise, that's when valuations matter.
For stocks, we have the Fed, which I believe is going to be raising interest rates beginning in March. We know QE is over in the U.S. The ECB is reducing their QE by 25% in April. And the Bank of Japan seems on a daily basis, the market is now testing them on the "yield curve control." So yes, Trump has been a huge influence on markets listing equity prices and a lot of optimism. But I'm of the belief that a lot of that has been priced in and that he is going to be battling the, not directly but indirectly, global interest rates and global monetary policy in the Federal Reserve. And that is going to be a tug of war between optimism of fiscal reform, both on the tax and regulatory side.
On the other hand, we are seeing the – I believe the last inning of the 70-year monetary experience and experiment that is now beginning to reverse. And if you believe in free lunches, then focus on Trump and think that no big deal rates are rising and central banks are pulling back. But if you don't believe that there's a free lunch from zero interest rates, negative rates, and many trillions of dollars of QE, then I think you have be a little more circumspect of this rally. And, just to add on one thing that Michael mentioned, the S&P 500 on 13th December closed at 2,272. Today we are less than 1% higher. So a lot of the Trump rally ended a month after the election, and now we've just been churning and chopping around waiting for more details on what's to come.
Michael Lewitt: I mean right now the S&P is 20 points higher, so 2,292. You've had some sectors, particularly the retail sector that's gotten really crunched. That's an area that just seems not able to get out of its way. You have stores like Sears, which seems to be on its… sort of its deathbed. You have just a whole series of companies, Macy's that's troubled, though not really credit trouble just has business troubles. But the whole retail sector if you look from a high-yield bond perspective, retail in many ways has become sort of the new energy. The energy sector has gone through a huge flushing with over a 130 companies that filed for bankruptcy. Now retail is sort of the next one up. It's not going to be as bad, but you have a number of companies like J. Crew, Claire's, a bunch of others that are headed to bankruptcy, and there real structural problems in the retail sector that are really hammering a lot of companies.
The restaurant sector, which is closely related to the retail sector, is also in trouble. A lot of this trouble is sort of mall based, so you're seeing that. But the stock markets seem stalled at what to me is a pretty extended level. So the question is sort of where are we going to find the next leg up. It's certainly not based in my view on fundamentals evaluation; it's got to be based on sentiment. I think Peter follows the sentiment numbers very closely and they're pretty extended. And-
Peter Boockvar: Yeah, today we saw the weekly investor's intelligence numbers that had the level of bulls at the highest since January 2005. And I wrote in my morning note today that, yes, the Patriots won the Super Bowl, but it wasn't the one Sunday, it was the one back in 2005. And that's the last time you saw this level of bulls. Now with getting to an extreme level of sentiment with a 46 point spread now between bulls and bears doesn't mean that you're about to go down, but historically it means that you've very much limited the future gains at least in the short term. So back in December when I mentioned we're barely above that mid-December level, well, that's when sentiment got really extreme. So it coincided with a flat market here.
And if you go back to 2005, with that January reading in bulls, by November of that year with a lot of choppiness in between, you were flat. So you went 11 months of just churn. In the middle of the year, you were down about 6%. I'm not saying that we can't further rally from here, but it's more difficult when you have the boat as full as it is with bulls. If you want to be bullish, you want to see this ebullience, because that's a better set up when everybody is already in.
Michael Lewitt: Exactly. It's just hard to see what's going to push multiples higher. It could be sentiment. But again, sentiment's extended. The discount rate used to calculate and to justify higher stock valuations, it seems that's going to be difficult because the Fed – I agree with Peter – the Fed is going to raise rates. I believe at least twice more this year; the Fed said three times. But you know a lower discount rate I think is not in the cards. So it's hard to see the multiples very high.
So then you look at earnings. I think earnings have been inflated for a long time by low interest rates, by a low effective tax rate, by a wage suppression. So how much are earnings going to go up. You know every time – every sort of year at this time, Wall Street has very high earnings expectations for the next year which generally don't come to materialize. So are earnings going to go up by high single digits? I don't know. I don't think so, but we'll see.
So the case for more, you know, stock gains really comes down to Mr. Trump and tax reform and regulatory reform. I do think the odds of both are pretty high, but also think that you won't see the effects of them as quickly as investors think. I think you know we've already seen the effects – are starting to see the effects of slightly higher interest rates and maybe a stronger dollar. Although Trump's tried to talk that down. But that is more likely to appear before the effects of policy. So you know, we'll see. We may have had a bunch of the rally already and it may not go much further. We'll just have to see. The real question is whether there's something that could reverse things.
Peter Boockvar: Yeah, it's an interesting landscape. Because when you look at the tremendous market rally that we saw of the 09 lows, it was predicated on multiple rounds of quantitative easing, zero interest rates for about seven years, extreme extension of profit margins, which led to almost a V bottom in corporate earnings, and economic activity that was the worst post-recovery of any other recovery we've seen of around 2%.
Michael Lewitt: Right.
Peter Boockvar: Now we have no QE, at least in the U.S. Obviously, we'll get spillover from overseas. We have the Fed raising interest rates. We have profit margins that are now compressing because labor is getting a bigger portion of the profit pool.
Michael Lewitt: Right.
Peter Boockvar: And we have hopes that we're going to accelerate to 2.5 to 3% growth. So stocks loved it the first way and now they love it the second way. That's for now. The test again will be where interest rates go from here to what Michael said profit margins are getting squeezed because labor is getting a bigger portion of that pie. And that potentially could offset any improvement on the revenue side driven by a better economy. So in a perverse way, we can actually see some economic improvement but in terms of actual performance in stocks and bonds, that can be offset by higher interest rates, lower PE multiples, and lower corporate earnings. And just to highlight particularly on the multiple side, because this could be a very big determinant of where the market goes over the next year.
A large part of the rally in stocks over the past couple of years has been multiple expansion. And the PE multiple going into 2013, when we saw the Fed printing a trillion dollars on top of ECB and Bank of Japan quantitative easing, the multiple and the S&P basically expanded from around 13 to 14 times up to 18 times. Earnings growth was somewhat mediocre. In fact, over the last three years, earnings really have done nothing. So you can have an improvement of earnings from here, but if the multiple on those earnings starts to decline because interest rates are going up, which I think they were either Fed-induced or long-end induced, then you're either going to be running in place with respect to stocks or you're going to see a lower stock market.
So for example, Michael mentioned a $100 of earnings that we've seen, well right now the estimates for operating, and this does include non-GAAP so there's a lot of noise in it, is about $130 a share. Well, let's just say the market goes back to 15 times earnings, because that's where it's traded on average for many decades and maybe it goes there because of the rising rates. Well, 15 times 130 is 1950 S&P, which is about 350 points below where we are today, even with an acceleration in earnings. So I think people have to include that in their analysis here rather than just saying okay Trump's president, he's going to cut taxes and we're going to get regulatory, we'll leave[?] by stocks. I think people really have to start paying attention that there's collateral issues that we have to deal with and that that's not just going happen in a vacuum.
Peter Boockvar: Should we talk about any bright sides of investing opportunities out there?
Michael Lewitt: Yes. Hillary's not the president. No, I'm just kidding.
Peter Boockvar: So there's always opportunities. I'm of the opinion that the emerging market bear market, which began in 2011 coincident with peak and commodity prices, bottomed out last year, and I think a lot of fear about emerging markets blowing up again with the recent rally in the dollar has not come to pass. I think you have real change happening in individual countries, particularly Brazil, where you have now a center-right government. Argentina, a center-right government that's business friendly. Venezuela, which is imploding, well at some point, and I don't know when, will move to a center-right government.
I think if you look at changes in Asia, particularly South Korea, where they impeach the president. I think these are signs that people are fed up with corruption. And people are fed up with politicians that have, I guess you can say, screwed things up. And I would be looking at countries where the people are fighting back. And I mentioned Brazil, I mentioned Argentina, South Korea, where the corporate landscape there is dominated by these big conglomerate – what they call chaebols. There's talk about influencing them and breaking them up. And I think they're valuations that are attractive in many emerging markets.
As a contrarian, I also try to even think about okay, what's to come of Europe. And I know there's a big back and forth between the debate of will the euro break up, political chaos, or are they going to be able to keep this experiment together.
Ahead of the French elections, there's a lot of concern on Marine Le Pen possibly winning. But if you look at the polls, she's down like 20 to 25 points against the other candidates, and granted that can obviously change. We saw Brexit, and we saw Trump, but I think if she does not win in France, I think that will calm nerves. Merkel, if she wins again, that will calm nerves, but that's an "if." If Italy does not go to the Five-Star Movement, which I think is not going to happen, nerves will calm there. And actually, if you combine that with the ECB backing off from QE, you can actually see the euro further rallying from here against the dollar, notwithstanding all the bearishness on it. So I think also if you get the ECB backing off and you get some steeping in the yield curve and maybe they get themselves out of negative interest rates, maybe the European banks are an opportunity. They've been a complete mess over the last couple of years, and I think there could be opportunities there, particularly in Spain and in Italy.
Then on the commodity side, Michael and I are on the same page with respect to gold and silver. I love it when Michael writes his monthly pieces and he says buy gold to protect yourself.
Michael Lewitt: Save yourself.
Peter Boockvar: And he's absolutely right. And I think one of the most interesting things that's happened in gold and silver last couple of days is the dollar has rallied and gold and silver have rallied. So maybe people are looking at, okay, gold's a currency just like everything else, just like the dollar, just the yen, just like the euro. And maybe the world is getting fed up [inaudible] currencies. When you have the White House complaining about the strong dollar, and you have the Australian Central Bank the other day complaining about the strength in their dollar, and everyone complaining about the strength in their currency, well, gold's the last man standing in that scenario. So just some ideas to throw out there.
Peter Boockvar: I think we get asked a lot, when's the next recession? What causes the next recession?
Michael Lewitt: Right.
Peter Boockvar: And I argue that the – if you look at the last two recessions, it was caused by decline in asset prices. The collapse in tech stocks led to a collapse in capital spending; a drop in housing prices led to a collapse of obviously the financial system. This time around, it's going to be a decline in asset prices. And it's going to be the 10-year yield that maybe gets up to three, three and a half, even 4% if nominal GDP picks up. And that would then lead to obviously a big crack in the stock market, and that in itself could cause a spillover into the broader economy. Because we're in a very asset-price-dependent economy. This is the Greenspan model of monetary policy, which is to goose asset prices. Hopefully that influences consumer [inaudible] behavior, which then influences production, and so on and so forth. So people should be looking to asset prices and how that effects the economy because that's the bubblicious world that we are now in. And don't fool yourself to think that we're in some sort of normal period. This is the third bubble over the last 15 years. This is pretty much in the bond market, but anybody who uses an interest rate to price an asset, well just by default that could be in a bubble, too. So keep your eye on interest rates, monetary policy, what central bankers do with QE and short rates, because if they lose control of their bond markets, that could be enough to tip the world into a recession.
Michael Lewitt: I think with that, that's a good place to stop. I think we would be happy to open for questions, if people have any questions.
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Prominent money manager. Has built top-ranked credit and hedge funds, managed billions for institutional and high-net-worth clients. 29-year career.