The Valuation CAPE

Conclusion: CAPE valuation is at a level last seen on July 2011.


In the past, we’ve written a number of notes discussing the valuation of the broad equity markets and the implications of this metric.  Anyone who watches CNBC, has often heard the refrain that the market is either cheap, or expensive, based on earnings multiples.  Therefore, based on the valuation, the stock market is either a buy or a sell.  Most often market pundits quote forward earnings estimates as their proxy for valuation.   Unfortunately, these estimates are only as good as their inputs.


In the chart below, which is courtesy of McKinsey Consulting, we highlight the trend of S&P earnings estimates at the start of the year versus the actual realized earnings estimates going back to 1985.  In 22 of the 24 years, the earnings estimates at the start of the year were higher than the actual estimates at the end of the year.  To put that in context, 92% of the time over a 25-year period, analysts were too optimistic for SP500 earnings.  


The Valuation CAPE - chart2



Now, of course, the world is replete with bad predictions, and I’ll flag a couple for some midday humor:


“Heavier-than-air flying machines are impossible."- Lord Kelvin, president, Royal Society, 1895


“I think there is a world market for maybe five computers."- Thomas Watson, chairman of IBM, 1943


The disturbing thing with many predictions or estimates is that they are made by perceived experts and are often wrong.  Even more disturbing is when the perceived experts are wrong because of an obvious bias.  As it relates to earnings estimates, there is clearly a positive bias among Wall Street analysts.  For the time being, we will set an analysis of Wall Street 1.0 biases to the side, but just wanted to flag caution when buying a stock or equity market based on consensus forward earnings.  History tells us that they are consistently too high.


We obviously have a number of factors we utilize when contemplating the direction of the markets.  From a valuation perspective, we actually think that Yale Professor Robert Shiller’s methodology is a very relevant way to consider broad market valuations.  By way of background, Professor Shiller uses what is called CAPE, or Cyclically Adjusted Price to Earnings.  In terms of the numerator, or price, Shiller uses the monthly average of daily closes for the SP500.  To derive the earnings data, in this instance the denominator, Professor Shiller uses the quarterly earnings data from the SP500’s website and utilizes an interpolation to provide earnings data by month.  He then adjusts both the numerator and denominator for inflation using CPI from the Bureau of Labor Statistics.  Finally, the inflation adjusted price is divided by an average of ten years of real monthly earnings to determine the CAPE.


In the chart below, we show the CAPE ratio going back to 1881, so more than 130 years.  On this long range analysis, the current CAPE valuation, as the chart below shows, is clearly elevated.  Currently, the ratio is at 21.94, which is the highest level since July 2011.  Coincidentally, the SP500 began an almost 14% correction from early July 2011 to early August 2011.


The Valuation CAPE - chart1



To better quantify where the market currently is based on CAPE versus its long run averages, we split the CAPE ratios into quintiles.  As the table below shows, the current valuation is in the highest quintile of the past 120 years. 


Quintile Ranges of CAPE Rations 1


The Valuation CAPE - chart3



Certainly, a valuation case can be convenient, but if we look at the long run normalized cyclical earnings of the market, reversion to the mean suggests there is more downside than upside.  Unless, of course, earnings growth accelerates dramatically, which isn’t a scenario we see in the current slow growth environment.



Daryl G. Jones


Director of Research





Short Selling Opportunity: SP500 Levels, Refreshed

POSITIONS: Long Utilities (XLU), Short SPY, Short XLI, Short XLY


Much like my call last Tuesday “Short Covering Opportunity”, this one is explicit. There should be no mincing of words associated with my positioning. Ahead of tomorrow’s option expiration and inflationary CPI report, I’d love the opportunity to short 1401.


Across my core risk management durations, here are the lines that matter most: 

  1. Immediate-term TRADE overbought = 1401
  2. Immediate-term TRADE support = 1372
  3. Intermediate-term TREND support = 1290 

In other words, I’m looking at 3 points of upside versus almost 30 on the downside (wicked asymmetry). And since few agreed that there were 30 points of upside from last Tuesday’s 1345 line (there was 55), I say game on.


As (hopefully) many learned during the tops of Q1 2008, 2010, and 2011 – tops are processes, not points.


Manage this immediate-term range of risk accordingly,



Keith R. McCullough
Chief Executive Officer


Short Selling Opportunity: SP500 Levels, Refreshed - SPX








Initial jobless claims for the week ended March 10th came in at 351k versus 357k consensus and a revised 365k for the week prior (initially 362k).


THE HBM: SBUX, RUTH, PFCB, BWLD - initial claims



Commentary from CEO Keith McCullough


The good news is Greece is out of the Bloomberg Most Read (Today = #1 Goldman, #2 China, #3 Apple):

  1. ASIA – post the USA meltup in everything Apple and celebrations in Financials to a made-up test, Asia has basically been down for the last 2 days (Equities), with China and India leading the decline. Bulls were begging for India to cut rates last night and they didn’t (inflation), so the Sensex dropped -1.6% on that and snapped TRADE line support of 18,023, again. China’s FDI print was down -0.9% y/y – not good.
  2. SPAIN – acts like le chien de Sarkozy; the IBEX continues to flash a major negative divergence vs Global Equities as of late (Spain -1.4% YTD w/ Germany +20%!); when your stock, currency (Euro), and bond markets are all falling at the same time – not good.
  3. TREASURIES – here’s your hat-trick of ‘not goods’; if you are long anything in Fixed Income, that is (who would be?) – Treasury Bonds are getting blasted – 2yr yield have moved +44% to the upside in 2 weeks. It’s a good thing there is zero asymmetric risk w/ the Bernank’s zero bound policy.

People chasing performance can convince themselves this rally in Japanese, American, or Venezuelan stocks is all about Growth – or they can be realistic and just call it a chase. They chased into March end of 2008, 2010, and 2011 – that didn’t turn out so well by August.







THE HBM: SBUX, RUTH, PFCB, BWLD - subsectors





SBUX: Deutsche Bank increased its price target on Starbucks from $59 to $61 on possible catalyst for sales from the company’s light roast launch.





RUTH: Ruth’s Chris has kicked off its “Sizzle, Swizzle and Swirl Happy Hour” premium bar menu at select locations, featuring food and drink items for $7, according to


PFCB: P.F. Chang’s was raised to Hold from Sell at Argus Research.


BWLD: Buffalo Wild Wings CEO Sally Smith appeared on CNBC’s show, Fast Money, last night and was not asked about wing prices once.  March Madness is good for business, though.


THE HBM: SBUX, RUTH, PFCB, BWLD - egg sets vs wing prices black





RRGB: Red Robin Gourmet Burgers gained 2% on accelerating volume.





Howard Penney

Managing Director


Rory Green



Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.


TODAY’S S&P 500 SET-UP – March 15, 2012

As we look at today’s set up for the S&P 500, the range is 32 points or -1.81% downside to 1369 and 0.48% upside to 1401. 












  • ADVANCE/DECLINE LINE: -1436 (-3249) 
  • VOLUME: NYSE 853.21 (-5.94%)
  • VIX:  15.31 3.45% YTD PERFORMANCE: -34.57%
  • SPX PUT/CALL RATIO: 1.01 from 1.42 (-28.87%)


TREASURIES – here’s your hat-trick of ‘not goods’; if you are long anything in Fixed Income, that is (who would be?) – Treasury Bonds are getting blasted – 2yr yield have moved +44% to the upside in 2 weeks. It’s a good thing there is zero asymmetric risk with the Bernank’s zero bound policy. 

  • TED SPREAD: 39.24
  • 3-MONTH T-BILL YIELD: 0.08%
  • 10-Year: 2.29 from 2.27
  • YIELD CURVE: 1.82 from 1.74 

MACRO DATA POINTS (Bloomberg Estimates):

  • 8:30am: Empire Manufacturing, Mar., est. 17.5 (prior 19.53)
  • 8:30am: PPI (M/m), Feb., est. 0.5% (prior 0.1%)
  • 8:30am: Jobless Claims, week Mar. 10, est. 357k (prior 362k)
  • 9am: TIC Flows, Jan., est. $40.0b (prior $87.1b)
  • 9:45am: Bloomberg Consumer Comfort, week of Mar. 11, est. -36.0 (prior -36.7)
  • 10am: Philadelphia Fed., Mar., est. 12 from 10.2
  • 10am: Freddie Mac mortgage rates
  • Treasury Secretary Tim Geithner speaks to Economic Club of New York, Noon 


  • President Obama travels to an Prince George’s County Community College to talk about energy
  • FERC meets to discuss Exelon-Constellation merger, PJM plan for capacity pricing, 10am
  • House in recess, Senate in session:
    • Senate Appropriations subcommittee hears from Transportation Secretary on agency’s budget, 9am
    • Senate Appropriations subcommittee hears from FBI director on agency’s budget, 10am
    • Senate Environment subcommittee hears from Nuclear Regulatory Commission chairman on lessons from Fukushima, 10am
    • Senate Finance Committee hears from Deere & Co. Chairman on establishing normal trade relations with Russia, 10am
    • Supreme Court not in session 


  • Cisco Systems said to be in advanced talks to acquire NDS Group for $5b: Calcalist
  • Yahoo! investor Third Point plans to file preliminary proxy statement “within the week” to seek shareholder votes on proposed slate of four new directors
  • LSI Corp. filed complaint with ITC against Funai Electric, MediaTek and Realtek Semiconductor over technology used in audiovisual devices
  • Credit-card cos. report monthly net charge-offs, delinquencies
  • Schlumberger said to seek buyers for unit that distributes oilfield supplies, business that may fetch as much as $800m
  • Google will present changes to search engine over next few months that could affect millions of websites: WSJ
  • Morgan Stanley preparing to invest millions in Mexican energy cos. as country opens up industry to private capital
  • Foreclosure filings in the U.S. fell 8% in Feb., smallest y/y decrease since Oct. 2010: RealtyTrac
  • House Republicans pushing for new round of budget cuts this year, congressional aides say, raising possibility of govt. shutdown shortly before Nov. election
  • Tropical cyclone Lua forecast to strengthen on Australia’s northwest coast as Chevron evacuates workers from gas projects, iron ore ships steam out to sea 


    • Quebecor (QBR/B CN) 6 a.m., C$0.91
    • Hanwa Solar (HSOL) 6 a.m., $(0.30)
    • Aurizon Mines (ARZ CN) 6 a.m., C$0.13
    • Gabriel Resources (GBU CN) 7 a.m., $(0.01)
    • Scholastic (SCHL) 7 a.m., $(0.70)
    • Winnebago (WGO) 7 a.m., $0.04
    • Cato (CATO) 7 a.m., $0.34
    • AMC Networks (AMCX) 8 a.m., $0.60
    • Ross Stores (ROST) 8:30 a.m., $0.85
    • Athabasca Oil Sands (ATH CN) Pre-mkt, C$(0.03)
    • Crescent Point Energy (CPG CN) 9 a.m., C$0.12
    • Dole (DOLE) 4:05 p.m., $(0.12) 


  • Cocoa Rally Fading as African Rains Erase Shortage: Commodities
  • Soybeans Near Six-Month High as Brazil Crop May Miss Estimates
  • Oil Trades Near One-Week Low on Supply; Goldman Sees $130 Brent
  • Copper Swings Between Gains, Losses on Chinese, U.S. Economies
  • Gold Rebounds in New York as Low Interest Rates May Spur Demand
  • Cocoa Falls to One-Week Low as Rains Boost Crops; Sugar Advances
  • Global Food Prices Seen Declining as Demand Growth Slows
  • Rubber Shortage Widening to Bolster Prices, Producers Say
  • Oil Exports Ease Crude Sting for U.S. Economy: Chart of the Day
  • Obama’s Keystone Denial Imperils Refiners’ $25 Billion Oil Bet
  • Oil at $126 Boosts BP Ability to Pay More for Gulf Spill: Energy
  • Checking German Power May Trim Poland Price Gap: Energy Markets
  • Orange-Juice Price Seen Unaffected by End to U.S. Brazil Duties
  • Iron Ore Seen Rallying as China Lending Policy May Boost Demand
  • Fortescue Raises $2 Billion From Junk Bonds After Doubling Sale
  • Impala’s Hand Forced as Zimbabwe Starts Nationalization 










SPAIN – acts like le chien de Sarkozy; the IBEX continues to flash a major negative divergence vs Global Equities as of late (Spain -1.4% YTD w/ Germany +20%!); when your stock, currency (Euro), and bond markets are all falling at the same time – not good.






ASIA – post the USA meltup in everything Apple and celebrations in Financials to a made-up test, Asia has basically been down for the last 2 days (Equities), with China and India leading the decline. Bulls were begging for India to cut rates last night and they didn’t (inflation), so the Sensex dropped -1.6% on that and snapped TRADE line support of 18,023, again. China’s FDI print was down -0.9% y/y – not good.










The Hedgeye Macro Team


Don't Hate The Debate

This note was originally published at 8am on March 01, 2012. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“You have to choose not to spiral into hate.”

-Izzeldin Abuelaish


On red yesterday I took up my positions in US Equities and Commodities to 12%, respectively, buying Utilities and Gold in the Hedgeye Asset Allocation Model. I also sold my entire US Dollar position (9%) on green. Don’t hate me for moving fast. Sometimes that’s just what I do.


‘Trading, Fast and Slow’ might be a good title for a new book (or maybe just a high-frequency tweet). It uses 3 words that some people in our business love to hate. Trading? Oh no, “I’m not a trader, I am an investor.” Ok. Do you invest fast or slow? Do you manage risk? Yes, we know – you actually have to trade to answer both of those questions.


While plenty of people from The Old Wall are just punching the over-compensation clock at this point, I think we have entered the thralls of creative destruction. These are the most exciting times of my 13-year career. There is so much to Re-think, Re-work, and Re-build.


We have an entire industry that needs to be debated. Every process. Every premise. Every minute of every day offers you an opportunity to not only get in the game, but be the change we all want to see in this profession.


If that sounds a little speechy, it’s because it is. As Ray Dalio at Bridgewater likes to say, this business is all about figuring out the truth. In the final pages of Izzeldin Abuelaish’s ‘I Shall Not Hate’, he comments on the same principles of risk management in the Middle East:


“I’m not talking about the light of religious faith here, but light as a symbol of truth. The light that allows you to see, clear away from the fog – to find wisdom. To find the light of the truth you have to talk to, listen to, and respect each other.” (page 196)


The partisan politics, economics, and investing styles that have failed us over the last 5yrs are broken. Don’t Hate The Debate. Embrace change and progress. We can always do better. We always have.


Back to the Global Macro Grind


One of the most heated debates I have with clients remains centered on the interconnectedness of the world’s reserve currency to market prices that are primarily denominated in that currency (US Dollars).


Since most of Western academia has not taught us to re-think markets this way, their dogma is now our dilemma. That’s why we need to slap on the accountability pants and hash this one out, fast. It’s time for the professors to be held accountable to the debate.


If you don’t think Fed Policy drives the US Dollar and Inflation/Deflation Expectations of assets priced in Dollars, try that theory at home with your own money. If the Fed were to even whisper about a rate hike, Oil and Gold would get hammered.


That’s why managing risk around big up/down moves in the USD is critical to getting Big Beta right. With the US Dollar Index up +0.8% on the day yesterday (one of its biggest up days of 2012), here’s what happened underneath the Globally Interconnected Market hood:

  1. Silver = down -6.9%
  2. Gold = down -5.5%
  3. Basic Materials (XLB) = down -1.9%

It’s a good thing the Dollar isn’t correlated to Apple.


Notwithstanding that the Chairman of the Federal Reserve didn’t mention the words (and hasn’t since 2006) CORRELATION RISK in his entire semi-annual testimony yesterday, we’re still not in the business of taking his word for it on what is or is not happening out there.


I know this is a touchy subject – particularly to the legions of Nobel Prize winners who get paid to be willfully blind to it. But this is America, not Russia. We, The People, have a fiduciary responsibility to hold central planners accountable.


Transparency, Accountability, and Trust?

  1. Transparency: Bernanke to Ron Paul yesterday on defining inflation - “I’ll talk to you about that offline”
  2. Accountability: Bernanke’s prepared remarks on his mandate for PRICE STABILITY -“as we expected, inflation was transitory”
  3. Trust: Bernanke on his forecasts – “my projections are considerably lower than last year”

Alrighty then.

  1. So there is no inflation because Bernanke chooses to define it with what’s just universally considered not true
  2. And as long as commodity markets oscillate between bubble and crash mode, price inflation/deflation is “transitory” and stable?
  3. And if you’re willing to take his word for it on forecasts that he’s had dead wrong, we can soft land this puppy perfectly

I really don’t hate the man. I Don’t Hate The Debate either. As an immigrant to what I genuinely felt was the last bastion of free-market of capitalism in the world, I just find being held hostage to an un-elected central planner who is obfuscating the truth un-American.


My immediate-term support and resistance ranges for Gold, Oil (Brent), Utilities (XLU), US Dollar Index, and the SP500 are now $1697-1735, $122.21-126.02, $34.74-35.68, $78.09-79.06, and 1363-1372, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Don't Hate The Debate - Chart of the Day


Don't Hate The Debate - Virtual Portfolio

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