During their latest episode of the VALUE: After Hours Podcast, Brewster, Taylor, and Carlisle discuss Stocks In A ‘Death Zone’. Here’s an excerpt from the episode:
Tobias: This is from John Rotonti, mike Wilson on the death zone. Have you heard this? He’s talking about the low in October versus now.
Tobias: He says, “When stocks started rising in October, they had a much lower valuation with the price to earnings ratio of 15% and an equity risk premium of 270 basis points. So, the equity risk premium is the difference between the expected earnings yield and the yield on safe treasuries higher number. Meaning, that you’re being compensated more for the investments in stocks.” This is me. This is not the article. That equity risk premium has been tested extensively and it’s not predictive at all. [Jake laughs] You’re better off just looking at the absolute return in equities, not adjusted for interest rates, but that’s still– [crosstalk]
Jake: Looking at actual earnings yield, instead of– [crosstalk]
Tobias: That’s the Fed model. Yeah, that’s right. You look at the earnings to– [crosstalk]
Jake: Copying it to treasury difference.
Tobias: Which doesn’t really make any sense, but when you test it, that’s the answer. But it’s still regarded– That’s the Fed model. That’s how they do it.
Tobias: “By December, however, the air started to thin with price to earnings down to 18% and the equity risk premium down to 225 basis points.” He says, “In the last few weeks of the year, we lost many climbers who pushed further ahead in the death zone. [Jake laughs] Investors began to move faster and more energetically talking more confidently about a soft landing in the US economy. As they have reached even higher levels, there is now talk of a no landing scenario, whatever that means. Such are the tricks the death zone plays on the mind, one starts to see and believe in things that don’t exist.”
Jake: That’s a great analogy.
Tobias: Back to Wilson, who says, “The price to earnings ratio is now 18.6%, equity risk premium at 155 basis points. Meaning, we are in the thinnest air of the entire liquidity driven secular bull market that began back in 2009.”
Jake: By the way, that denominator on the price earnings is not going in the favorable direction right now.
Tobias: He says, “The bear market rally that began in October from reasonable prices has turned into a speculative frenzy based on a Fed pause pivot that isn’t coming. Now, I admit that is my bias too. So, I enjoyed that a lot.”
Tobias: That’s how I feel. I felt like the cheap stuff from October through January, but then February has just gone bananas.
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