Where Are We In The Cycle?

Dano:
[0:03] Welcome to the sonoma wealth advisors youtube channel my name is dano weir i am stepping in for host Daren Blonski this week on on the markets uh Daren shall return next week chris to the chagrin of many many of our viewers or dozen of viewers uh it's the co-host again this week are you going to be okay yes

Chris:
[0:26] Yes we'll make it through again uh hopefully no creed references this week.

Dano:
[0:31] I tried to but we will leave creed and the band creed with last week um we're talking about cycles this week chris and i decided to take this picture of the ocean because that feels sometimes a little bit like the economy yes

Chris:
[0:48] Unpredictable uh in many ways but also the cycles yes we want to we want to

Chris:
[0:54] kind of visit where are we in the cycle or where do we where might we be in the cycle let's.

Dano:
[1:01] Roll this first and then we'll get into the show

Music:
[1:04] Music

Dano:
[1:38] Now, Chris, a lot of people don't know, but that's actually you on guitar. You wrote and performed that song.

Chris:
[1:44] I wish. Yes, I wish my skills were up to that for sure. Yeah, sorry, lack of memes this week or funny memes, but Daren sent me this quote from one of my personal heroes, Charlie Munger. I don't know if he was trying to cheer me up or what, but for those that are just listening and not able to read the quote says I didn't get rich by buying stocks at a high price to earnings multiple in the midst of crazy speculative booms and I'm not going to change which I guess I don't know for sure that Charlie Munger said that but it seems like something he would say and pretty much exactly how he would say it he had a very matter of fact way of, of putting things. Um, and of course, if you didn't know, Charlie Munger was, uh, Warren Buffett's business, longtime business partner, um, and who passed away, uh, like earlier this year, maybe late last year. Um, but he has a lot of, uh, great things that you can learn from, from Charlie, uh, including his reading list, which I would highly recommend, um, going through his reading list. He was very widely read and has a lot of good recommendations.

Dano:
[3:03] And Chris, this taps into something we looked at last week, which is the crazy price to earnings ratio multiples of many, many companies, including surprise companies like Visa.

Chris:
[3:16] Yes. Well, that was actually price to sales, but yes, good memory. What he's referring to here is another valuation metric. So there's a lot of different ways you can try to value companies relative to others in their sectors. You can try to value them based on where they've been historically, and not only for themselves, but also stocks in general. And so that's what we kind of be taking a look at a little bit today.

Chris:
[3:50] And going back to the business cycles and the economy, the cycles of the economy, you know, we've shown over and over again, you don't really know for sure where you're at. You can never know in a complex adaptive system like the economy. It's a lot like the weather, but also like the weather. You know, the, the norms tend to play themselves out eventually, you know, eventually fall comes, eventually winter comes and, uh, uh, eventually summer comes and spring. So there's, there are cycles within those, within those cycles, though, a lot of strange things can happen. So it makes it difficult to kind

Chris:
[4:29] of know where you are sometimes. Uh, so on the one week performance this week, a good week in the market. The S&P ended at another all-time high. This is from Finviz showing the different companies, the quilt of companies on the weekly performance. And you can see Apple had a good week. NVIDIA is back not quite to an all-time high yet, but it's definitely knocking on the door again. But pretty green across the board here in all the different areas of the market. So pretty broad participation that we're seeing.

Dano:
[5:05] And this graph, just to clarify, is cap-weighted, meaning if it's a larger box, it's a larger company. Green means they're up, red means they're down, and black means it's about even.

Chris:
[5:17] Yes, that's very well put, Dano. So sentiment indicators this week. Let's take a look here. Talked a lot about sentiment last week and why we look at it. We're down a little bit on the bullishness at 45.5.

Dano:
[5:34] Bearishness ticked up just a little bit.

Chris:
[5:36] The CNN fear and greed index is still at 71, which is greed only down from 74 greed a week ago. Good old Bitcoin jumped up to 73 greed, which was up from 32 fear last week. I was going to say.

Dano:
[5:51] I thought I could have sworn we were just talking about extreme fear.

Chris:
[5:55] Yes it's a very manic uh asset class and things happen quickly there of course following price you know the price jumped up quickly and um so uh yeah if you want you want action uh bitcoin might be might be the asset class for you it's always doing something if you like.

Dano:
[6:17] Drama bitcoin for you

Chris:
[6:19] Yes, but taking a look at those valuation metrics and just trying to understand where we're at. I don't know of anywhere you could point to that in terms of the valuations, when you're talking about, you know, wide, wide measures like market level, you know, sure, there's some companies that are cheap, some companies that are expensive. But when you're looking at it kind of on average, it's hard to find a place, at least in the U.S., that is cheap in terms of the valuation metrics. Now, this is one of the metrics that's cited regularly by different analysts called the Shiller PE ratio. This is named after the professor Bob Shiller, I believe he's at Yale, that came up with this. And it's a smoothed out price to earnings ratio. So it looks at smoothed earnings over the previous 10 years to give you a more, I don't know, a more smoothed out number, basically. And so that it's easier to compare it to past historical times. And I love this chart. This is something anybody can look up if you search Schiller PE ratio.

Chris:
[7:36] And you can see where we are relative to historical valuations, roughly 37.2 here in the U.S. and up in the top right, you can see what is the mean and median is right around 16 to 17. The maximum was in December of 99 when we were at 44. And you can see that big spike in 2000. That was the top of the dot-com bubble where, you know, a lot of times we're kind of referencing the dot-com bubble for a lot of the things that are happening now because there's a lot of parallels. Um but on the other hand there's some things that are different like the companies that are leading now are making tons of money where back in the in the internet bubble a lot of those companies didn't have any profits to speak of so there are there are some key differences here but nonetheless we're back to uh pretty frothy via uh valuations compared to where we've been historically right up to where we were in 2021. You know, when the last time when we had this kind of bullish sentiment in the markets.

Dano:
[8:44] So this is basically showing that we're at a very high point in the United States market history for stocks basically being expensive. Is that what you're saying?

Chris:
[9:00] Yes, that's what I'm saying. Now, Critics of this will say that the companies of today deserve a premium because of how high quality they are. And I think there's a real argument for that. If you think about the U.S. Back in the Great Depression, which is the spike that you see in 1929, when there was a mania in the market during the roaring 20s. And you compare companies today to companies of that time and the United States position at that time. We were not the global superpower yet that we are now. The financial system that the companies were coming up in was the absolute wild, wild west.

Chris:
[9:51] So yes, there's more of a premium now because of the quality and of those earnings. But when you take a look around the world and see some of the other valuations that are available in other places, and this is from Ciblis, I think is how you pronounce that, or Ciblis Research, and they're showing, this is as of June, so it's a bit outdated, but take, for instance, Canada at 19 times earnings.

Chris:
[10:25] The UK at 18, several European countries on here, Russia way down at five. Now there is a scale here because the cheaper you get, there's a reason for it. There's a lot of risk there. It's kind of like if you equated it to investing in real estate, if you go into the nicest neighborhood in your town or in your, in your state, um, that's surrounded by other nice places, great schools, you know, everything that everybody wants, like, you know, the price is going to be high versus if you go into a place that's got high crime, the houses are all falling apart. There's probably vacant houses around you. Um, yeah, you can get a great price, but it's also super risky. Right. Um, so, so there is a happy medium here. Um, but you can see other countries that are, uh, fairly highly priced as well, like India. A lot of growth is already priced into those stocks. And so, you know, just something to keep in mind when you take a look at the valuations globally to kind of reference where we're at here in the U.S.

Dano:
[11:35] And the U.S. is almost at the top, baby. Number one, the biggest number, the most overpriced. That's right.

Chris:
[11:43] Now, those things can go on for a very long time and don't get too confident in your own projections of things. Can you guess when this headline was from, Dano?

Dano:
[11:58] Oh, gosh. I mean, if you had to ask, I would have said, you know, the start of the year, but let's just say 2022.

Chris:
[12:07] Yes, it was from two years ago on Wednesday or Thursday this week in Bloomberg. And it says on the headline forecast for U.S. Recession within a year hits 100 percent. 100 percent uh it's it's funny it's funny now right it's funny now um how could you ever how.

Dano:
[12:33] Could you ever forecast 100 if it's a forecast there is no percentage

Chris:
[12:38] Right well yeah usually you would get some sort of hedge with that like i think there's a 50 probability or an 80% probability, but 100% should have been our tip that it's not going to happen. So that was two years ago. The S&P is up something like 67% in that amount of time. Of course, we have not seen a recession. Although when that headline came out in October of 22, we had just gone down through a pretty major drawdown in pretty much all markets. Stock market was down significantly that year, about 30%. The bond market was absolutely destroyed, its worst year in history. So financial markets really took a hit in 2022. However, this is just something to keep in mind whenever you hear experts, whenever you think to yourself that you're fairly confident about some outcome that is going to happen, especially on a macro level,

Chris:
[13:46] you know, it's a spectrum of possibilities. And a lot of times the least expected thing is what ends up happening. And so, you know, it's just fun to bring back some of these headlines, you know, back from the past and just check yourself, right? Right.

Dano:
[14:05] And always just trying to rephrase it to yourself. Imagine a phone call like this. Chris Sipes, Chris Sipes, it's me, your client. I'm so freaked out. I saw a headline that the sky is falling. Who told you that? The organization that purposely is trying to get me upset so that I watch their product. Because that's what all media is, right?

Chris:
[14:24] They're just purposely trying to upset you.

Dano:
[14:26] Get your attention in any way possible. What a great reason to have an advisor on your side to help you talk through these things, someone who's on your side and not on the side of trying to own your attention.

Chris:
[14:41] Yes, bad news sells, that's for sure.

Chris:
[14:45] Now, going back to the vibes of now and where we are in the cycles, this is from the University of Michigan showing the current value of stock market investments in the U.S., and this is median value at $250,000, which is very high relative to at least the history on this chart. Going back to, it looks like maybe 2011. And I think of note too, is the kind of catapult in the value just within the last three or four years here. And I was listening to a podcast this week and they were just talking about all the things that have happened financially since the pandemic. And again, something nobody would have guessed back when, when that initially hit, we all thought the world was ending. Nobody knew what was going to happen when you get, get the, the, you know, when you got COVID everybody was shutting down businesses and everything. And, and Hey, you know, here we are a few years later and somehow financially you know, a lot of markets are much higher. People are better off financially at least so far. I still feel like the jury's out given the amount of debt that we took on to make that all happen globally.

Chris:
[16:15] Maybe the bill hasn't come due on that yet. Maybe we've just charged up the credit card and we're living it up on vacation right now and we'll pay the bill when it gets here in a month.

Dano:
[16:27] That is lurking in the background, but that would mean it's either going that'd be fine and we move forward or, you know, there's some sort of catastrophe lingering back there, but that would be the only two kind of outcomes.

Chris:
[16:41] Yeah, yeah, definitely. So anyway, I think that's an indicator of how people feel about the markets right now. We've got the, for the first time, this is from Bloomberg, the first time in 22 years, bonds are yielding more than stocks. And the way you come up with the earnings yield is you take the inverse of the price-to-earnings multiple. So let's say you've got a 15 multiple. Then, oh, I'm violating one of the rules of podcasting, which is to not do math while you're on a podcast.

Dano:
[17:23] Right. No live content.

Chris:
[17:24] But if you take, if you take, let's say you have a 15 price to earnings multiple and you divide one by 15, you get about 6.6%. That's the, that's what they say is the earnings yield. Meaning that, um, you know, you buy a share of the average company earning price to earnings multiple at 15, the earnings that they're paying back to you in one year is going to be about 6%, 6, 6.6. All right. So, um, you know, if you're, if you're much higher than that,

Chris:
[17:57] um, like if we do one by, uh, 37, we get 2.7. So quite a bit lower on that earnings yield. And what this is saying is that the average 10 year treasury, um, is paying a higher yield than, than stocks for the first time in, uh, in the last 22 years.

Dano:
[18:19] How is that even possible when you just showed that the S&P is hitting all-time highs?

Chris:
[18:26] Well, think about it in terms of a rental house. You're going to buy a house to rent out, and you can only rent it for whatever the market's going to bear in your area. Let's say average rent in your area, I'll use Northern California as an example. Let's just say $3,000 a month, right? That's going to be your rent. That's going to be your earnings. Of course you have, you're going to have your expenses come out of there and there's not much you can do about that, but, but you know, that, that is going to be your earnings. Okay. Now your yield on what you invested is going to be higher the less you pay for that property. So if you pay, let's say $100,000 for that property and you're getting $3,000 a month, you've got a 36% earnings yield. Great. But if you pay a million dollars for that house, you've got a 3.6% yield. Not as great. And if you pay $10 million for it, you're less than 1%, less than a third percent.

Dano:
[19:40] So does this go back to where we were saying before how expensive and premium stocks are right now? So they're delivering a lot, but you're paying a lot for them, whereas a bond is paying as much and you're going to be making ostensibly net more?

Chris:
[19:55] Correct. When you're, when you're an investor, you have to think, you know, you make your money when you purchase the investment, right? Because you make your money based on the price that you pay for it going in. And if you pay a higher price, there's a lot of growth already baked in there. And so it's, it's harder to make more money to hire the price that you pay.

Chris:
[20:20] So that's why it matters now could we be in the midst of an expansion well that's definitely possible this charts from lizanne saunders at schwab and she says compared to the last four expansions the current one is still relatively young especially when looking at the two most recent expansions that started in 2009 and 1991. Both of those expansions lasted for 120 and 128 months, where the current expansion since 2020 is at 54 months. So a little young, basically, compared to some of these other expansions, really the closest, next closest one would be the 2001 expansion at 73 months. But even then, that gives us a couple more years if we were going to be in that category. So possible we're at the beginning of this expansion and that the prices are reflecting more growth to come and the market's just pricing that growth in.

Chris:
[21:33] Um, financial stocks, uh, seem to be doing very, very well. Now, um, this, uh, this was from Dean Christians, uh, and he says over 90% of the S&P 500 financial sector stocks closed within 5% of a 252 day high, a scenario that has resulted in a gain every time a year later for the sector and the S&P 500. And also I would say that Stan Druckenmiller, one of the famous traders out there, has always mentioned that, look, don't listen to economists, don't listen to analysts, listen to what the stock market is saying because the best predictor of what's going to happen in the economy is the inside of the stock market and financials being a big key to that. And usually you don't see financials doing well if things are deteriorating in the economy. And so that's kind of where we're at now. So no signs of stress here.

Dano:
[22:44] Give me an example of some financial stocks like Schwab or BMA.

Chris:
[22:50] Uh yeah so uh jp morgan the big banks would all be considered financial stocks um insurance companies uh so lenders those type of uh those type of stocks would be in the financial sector the other thing that we don't have a chart for this week but would be the fixed income market and the spread so that would be the bond market the spread between treasuries which are considered to have no credit risk, U.S. Treasuries, and corporate bonds, that spread is very tight. So meaning that you're not getting paid very much more to take on the risk of lending money to a corporate versus lending money to the U.S. government. That's also something that you don't typically see when things are going south in the economy. If the bond market is sniffing out problems and stress, usually it's going to require a bigger return to take on more risk in light of that. And we're definitely not seeing that stress at the moment in spreads.

Chris:
[24:03] This was a cool chart from Callie Cox because this will challenge a little bit of that narrative with the strength in gold we've seen this year. Gold, one of the top performing asset classes this year, has done better so far this year than even the S&P, the mighty S&P. And she shows here, she says, this chart right here is why you should prepare for a recession right now. Not because you're a doomer, but because the 10-year yield won't stay at 4% if growth is faltering. And what she means by that is that when you look at treasuries, which are the gold bars here, they tend to do well in recessions. And that's because interest rates go down. When interest rates go down, bond prices go up, and bonds tend to do well. Gold similarly does very well during recessions.

Chris:
[25:05] And it does okay during a midpoint of an expansion, does horribly at the start to the midpoint section. So gold and treasury is both pretty middling otherwise, but do very well during a recession. And stocks, on the other hand, do extremely well during the start point of an expansion. So check the box there. We've got stocks doing very well, but it's kind of a conundrum because we also have gold doing very well. So which one of these is wrong?

Dano:
[25:40] I was going to say, where are we in the cycle? Well, this is totally busted because we, quote, didn't have a recession. And yet I feel like the green bar on the right, the 16% is a little bit more accurate to how gold's been doing versus a the one on the left.

Chris:
[25:56] Yes. Disorienting sometimes. So now I would definitely say there's been areas of the market that have seen their recessions, real estate being one of them, even though the price of real estate has stayed high and actually continued to grow, that's masked a pretty brutal market in the real estate world over the last couple of years. And that's what you can see here with the purchase index, the MBA U.S. Purchase index from Lizanne Saunders again, she said, still no major signs of a rebound in the MBA mortgage purchase index stuck in a range over the past year and near more than a decade low. So we're going back to when the real estate market was in absolute shambles after the great financial crisis to get to these lows on the Purchase Index. So, sorry, we should have warned everybody right up front. No candles again this week since Daren wasn't here. So if you're looking for shooting stars, hammer candles, or some of the others, resistance.

Chris:
[27:11] Not going to see it this week, so apologies on that. We're just going to use some boring charts with no candles, but we do have the moving averages in here that you can see in the blue and yellow to give you an idea of the 50-day and the 200-day moving averages for all these asset classes, just to give you an idea where the trend is, the overall trend. So we've got the S&P to start us off. We hit another all-time high today, and the trend is up. No question about it. It looks very strong at the moment. If we go to the next chart, we've got the IFA index, which is the developed market. So think Canada, Europe, many parts of Europe, Australia, etc.

Chris:
[28:03] Also in an upward trend, albeit not as steep as the US, but still a healthy upward trend that we're seeing. And all these charts that you're looking at today are a three-year basis just to kind of see where we're at over the past three years. So developed markets looking strong. We go into the emerging markets, also strong-ish beginning, right? You saw that spike from the Chinese stimulus, the stimulus from China that was announced about maybe a month ago now. So they're really going out to support their stock market and that's reflecting in the emerging market so signs of life there still too early to tell i mean you look at we're still way below where we were three years ago in the emerging markets and if this was panned out even further the emerging markets have been pretty stale dead money for quite a while, which going all the way back to our price to earnings metrics you know they really hit their highs prior to the great financial crisis, where at the time they were the hot stocks. I don't know, Dan, do you remember the term the BRICS? Oh, yeah. You remember that term? Yeah. Everybody wanted a piece of bricks. Yes, Brazil, Russia, India, and China.

Chris:
[29:25] Those were the brick countries. They were all the rage at the time. They got bid up in values, and it's been dead money ever since.

Chris:
[29:36] And so we're still waiting to break out of those doldrums. We'll see if that's happening now. Uh u.s small companies uh speaking of doldrums we're still not quite back to where we were in 2021 but signs of life in the u.s small company index again strong upward momentum we're seeing there uh the trend is up and uh and those companies are doing well um and so a lot of a lot of movement there um and then we head into bonds uh where you know i think it's important we start kind of quoting what current yields are because with bonds, really the main reason to buy them is for current yield. You're trying to collect income from bonds. They're not really meant for price appreciation as much as say stocks. And so the current yield on the ag right now is right around 3.54% annual percentage yield based on the latest distributions.

Chris:
[30:37] And you can see the trend is kind of up to sideways.

Chris:
[30:43] I wouldn't say anything to write home to mom about yet, but on the plus side, we finally have some decent-ish yields because back when the bond prices were so much higher in 2020, the yield was extremely low on the ag. I want to say it was sub 2% on the ag at the low. I'd have to look that up, but it was extremely low on the coupon.

Chris:
[31:10] And so there's some room now for, for fluctuations in, in that price on the, on the egg. Uh, the ag is about seven to 10 years. If we go back to the previous one, sorry, Dan. Uh, yes, the, the average term on the ag is, uh, between seven and years. Um, the TLT, this is the 20 plus year. So this is long-term rates. This is long bonds and boy, talk about the doldrums. Uh, this is us treasury bonds. They just cannot seem to get out of their own way. Uh, every time you think they're starting to show signs of life, they peter out again. And here we are back down to the 200-day moving average on TLT. But current yield on that is 3.89%. So a long-term yield of 3.89% is what that is offering at the moment. So going back to that chart of assets in different environments, the longer the term on the bond, the more upside you tend to see in recessions when interest rates drop.

Chris:
[32:18] And vice versa, they go down a lot more when interest rates go up, which anybody that's held long bonds recently is intimately aware of. So I wanted to save the last gold here.

Chris:
[32:31] Very healthy. It's a trend that looks very similar to the S&P. So you know uh stocks and stocks and gold that seems to be the the place to be at the moment um but as always we we believe in diversification uh we believe in not trying to time the market don't believe uh your own best held beliefs because uh they're probably wrong and the market loves to humble us all so stay diversified stay humble uh stick to prudent long-term investing strategies that, you know,

Chris:
[33:11] are going to be good in the ups and the downs because eventually the seasons will cycle. Yeah.

Dano:
[33:17] So that was my question for you to wrap up the show here. Where do you feel we're at in the cycle?

Chris:
[33:23] My best guess is that we're a little bit later in the cycle on the U.S. Side, and I believe it's been somewhat delayed by the massive amount of stimulus that we did during COVID. We did more than pretty much anybody else relative to our GDP. And so I think that the normal cycle has been a bit thrown off given the massive monetary and fiscal experiment that we're running currently in the U.S. and abroad. Other central banks are doing the same thing, but the U.S. is doing it more so and is really the leader. And so we'll see how this all plays out. There's a bit of a moral hazard there too because a lot of people believe that, if things go south the central banks will be there to bail us all out again like they have the last few times that things have gone wrong in the market and so, that's what they call moral hazard in the insurance world Are.

Dano:
[34:28] You saying that the United States did something in an obscene quantity that had never been done before

Chris:
[34:33] Without adequate testing.

Dano:
[34:36] There's no i don't love the united states yeah my usa no way

Chris:
[34:40] Basically yes and at the moment there seems to be very little in the way of ramifications of that right and right but i will also say that because there was inflation and because of the way it was done And even though, you know, on mass, we are wealthier than ever, people are also seem to be unhappier, right, than ever. So when you look at the confidence indexes and everything like that, people are still very upset. It's a head scratcher, you know? So it's kind of like the way it happens. I don't know. It's just people have a real aversion to inflation. That's for sure.

Dano:
[35:26] Can draw some interesting conclusions there and more discussion for next week when Daren Blonski cfp will return to the show uh thank you to everybody for hanging with me the guest host dano i pop in when as needed uh for uh Daren and chris and uh we appreciate you checking out the show if you've not yet subscribed to our youtube channel please do so we have a new podcast on here as well called it's all money among other videos chris thanks for a great show today and looking forward to next week.

Chris:
[35:57] Same. Thanks, Dan.

Music:
[36:00] Music