Thursday, April 9, 2020

Looks Like Recession Started Last Fall

Sales of heavy weight trucks (the blue line) peaked in September 2019. It previously peaked in the autumn of 2006, 1999, and 1988.

At roughly the same time, the 10 year / 2 year (red line) and 10 year / 3 month (green line) yield curves inverted, just as they did in 2007, 2000, and 1989.

Some other notable economic series:

What is amazing is how expensive the market was in January/February of 2020 despite this. The Shiller PE ratio was over 31x, a level that was only exceeded during the 1929 and 1998-2000 bubbles. Jeremy Grantham has talked about this:
[T]he market should equal replacement cost, which means the correlation between profit margins and P/Es should be −1. Or, putting it in simpler terms, if you had a huge profit margin for the whole economy, capitalism being what it is, you would want to multiply it by a low P/E because you know high returns will suck in competition, more capital, and bid down the returns (conversely at the low end). But what actually happens? Instead of having a correlation of −1, our research shows it has a correlation of +.32. The market can’t even get the sign right! High profit margins receive high P/Es and vice versa, and the correlation is much greater than +.32 at the peaks and the troughs. Right at the peak in 1929, we had record profit margins and record P/Es. In 1965, there were new record profit margins and record P/Es (21 times). Now, think about 2000. We had a new high in stated profit margins and decided to multiply it by 35 times earnings, a level so much higher than anything that had preceded it. In complete contrast, in 1982 we had half-normal profits times half-normal P/Es (8 times). I mean, give me a break. We were getting nearly one-third of replacement cost at the low, and almost three times replacement cost at the high in 2000. This double counting is, for me, the great driver of market volatility and, basically, it makes no sense.
The S&P 500 earnings peak last cycle was in 2006 at 87.72 and the trough was 2008 at 49.51, a 44 percent decline. The index fell 54%, so most of the decline can be attributed to the earnings decrease and the residual would be attributable to multiple contraction.

What I notice right now is that investors buying the dip are excited because things seem cheaper than they have in a while... but they are looking at TTM earnings because those are all that is available.

It takes a long time for economic activity (and corporate profits) to come back after a recession. After the 2008 recession, total vehicle sales did not return to the 2005 peak for a decade. Same with total private construction spending, it took a decade to recover.

1 comment:

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