I am writing today’s letter in Nelson Bay, New South Wales, Australia, from a friend’s holiday home overlooking the Bay. It is the first time in many years that the Berman’s are away, just the 4 of us, and I am loving every moment.
S2N Spotlight
I shared the chart below yesterday saying that we are at an extreme valuation according to the Shiller PE 10-year ratio and future performance from these extremes is below average. However, I made an empty comment without supporting evidence, which bothered me. Today I aim to remedy my sloppiness. I have included in today’s letter some evidence working with 150 years of data. I take the Shiller PE ratio at the beginning of the year and then look at the future performance over 1, 5, & 10 years. I draw a regression line, and you get to see a very clear diagonal getting steeper as the future gets longer. This is just as I would expect it. Predicting that next year’s return will be down sloping from a high valuation is less probable than predicting over a longer time frame because we have all witnessed how markets can become even more extreme or remain elevated for long periods of time, so time gives nature more chance to rectify imbalances.
Tip: Making short-term predictions when valuations are the factor is counterintuitively less accurate than longer-term forecasts. The problem is everyone is impatient and focused on the short term.
S2N Observations
Last week I reiterated my case for going long the Chinese stock market mainly via the Hang Seng vs. the S&P 500. My reasoning is that one market is overvalued and the other is potentially undervalued but definitely underperforming on a relative basis.
Let me share a visual reference. You can see crocodile jaws desperately looking to snap shut if history and economics are to be relied upon.
Yesterday the Governor of the Chinese Central Bank announced a major stimulus package that is all over the news. The Chinese economy is on its knees at the moment and is desperately trying to fight off deflation. Many economists see this as nothing more than a bit of a sugar high. Clearly, the Shanghai and Hang Seng Index enjoyed the news.
I am naturally weary of an economy where you read in the Wall Street Journal a disturbing story like this:
“A prominent economist at one of China’s top think tanks was placed under investigation, detained and removed from his posts after he allegedly criticized leader Xi Jinping’s management of the world’s second-largest economy in a private chat group, according to people familiar with the matter.
The investigation of Zhu Hengpeng, who for the past decade was deputy director of the Institute of Economics at the state-run Chinese Academy of Social Sciences, comes as the Communist Party ramps up efforts to suppress negative commentary about China’s economic health.”
Despite the negative feeling towards the above behaviour, an autocratic lead economy can command things to move favourably over a shortish time frame before the chickens come home to roost. So my thesis stands.
I will end today’s letter with one interesting table by Vanda Research. 20% of retail investors portfolios comprise NVIDIA and Apple.
Performance Review
For those who are new to the letter, the shading is Z-Score adjusted so that only moves bigger than usual for the symbol are highlighted.