Overvalued and undervalued?

Here we are 2 weeks into the new administration and the pace of change for what we normally expect of government is being turned upside down.  Every day brings changes and uncertainty in terms of the outcome on the economy.  So far markets are still sanguine.  Averages have made new highs or are near new highs.  With equity markets making new highs, at the same time, the bond market is having a more significant reaction in the new year.  While short term interest rates are following recent Fed interest rate declines, interest rates on US Treasuries 5 years and longer continue to head higher. The left over from exceptionally high returns in 2023-24 mean that historical valuations of the equity markets continue to be at peak historical measures. Markets can remain overvalued and undervalued for long periods of time.  Most analysts use a forward-looking price earnings average to measure the most critical measure of valuation, price/earnings ratio.  The earnings number is based on an analyst's projection of earnings that are a best guess almost always incorrect at being overestimated.  Also, a more accurate price earnings ratio would be the last 12 months earnings that are known fact. The average past 12 month price earnings ratio is about the typical earnings dance companies perform is to talk down earnings to analysts and then over perform on the announcement.  This game becomes more dangerous as valuations get stretched.  Year to year earnings can be very volatile so many years ago an economist Robert Shiller created a 10-year average price earnings ratio between 15 and 16.  The current past month 12 month p/e is over 30.  According to FactSet research is "The forward 12-month P/E ratio is 22.2, which is above the 5-year average (19.7) and above the 10-year average (18.2). This P/E ratio is also above the forward P/E ratio of 21.5 recorded at the end of the fourth quarter (December 31)."  

Although we do not time markets, our firm outlook is caution. Valuations are at historical highs and markets are valued for perfection.  The risk of uncertainty from a policy and economic standpoint is high. We have political risk in the Federal government reaching its debt limit, not to mention ongoing deficits and a potential tax bill reducing federal revenue by billions.  Federal interest payments will be 17% of the Federal budget in 2025 rising each year.  And the price of eggs continues to rise.  Inflation continues to be contained for the moment.  Animal spirits seemed to have consumed equity markets so far.  

 

The predictions for mergers and acquisitions for this year are very bullish. Isn't the rule buy low and sell high?  Is it comforting to know corporations have the same bias as individuals.

The insurance crisis continues.  One important note is to if your named insured on your homeowners/condo policy is you as an individual and the title of your property is owned by your trust make sure your insurer adds your trust as an insured.  This is problem homeowners are running into in LA.