“Everything that can be counted does not necessarily count; everything that counts cannot necessarily be counted.”
Valuation is an analytical staple in deciding whether an asset, company or asset class should be bought or sold. The challenge with valuation? As a decision making tool, the inputs are often more important than the outcome. Regularly on Wall Street, especially when some of the large investment banks are involved, valuation becomes an even more amorphous thing.
Yesterday our CEO Keith McCullough discussed price targets for the S&P 500 in 2014 (see video "Is Consensus Too Bullish?") that are being established by some of our peers and the arbitrariness of the multiples being applied to come up with the target. Now to be fair, coming up with a view on the future price of a market is difficult at best because as Einstein notes all the factors that matter “cannot necessarily be counted”. (In part, this is why we stay away from precise long-term price targets on the broad market.)
Valuing a company has its challenges as well. Take for instance the Kinder Morgan companies, which are a massive group of pipelines, terminals and oil and gas productions assets cobbled together by billionaire Rich Kinder over the years. We are currently short $KMI and $KMP on our Best Ideas list because we, simply put, think the company is grossly overvalued.
I won’t steal his thunder but my colleague Kevin Kaiser will be giving an update on his short thesis on Kinder Morgan today at 1pm EST and his presentation starts with the following views on valuation:
- “Cheap” is a LONG WAY DOWN. We believe Fair Values are:
- KMI: $15 - $20/share
- KMI Warrant: near $0
- KMP/KMR: $30 - 40/unit (Preferred Way to Play This)
- EPB: $25 - 30/unit
Back to the Global Macro Grind...
In my inbox last night was a summary note on the equity markets that was titled, “Equities Explode.” I’m hoping it was a tongue in cheek title because up 1.1% on less than impressive volume was far from an explosion. In the Chart of the Day today, we take a look at the last three weeks and highlight the point of accelerating volume on market down days.
The equity bulls are trying to regain the market’s upward momentum, but meanwhile the bond bulls have just experienced the euphoria of a meaningful move in rates. Since January 2nd the 10-year bond yield has declined from +3.0% to the most recent yield of +2.7%, for a +12% expedited move down in the last twelve days. So, now the Fed has finally starting tightening by the way of tapering, why are yields falling?
Simply put, economic growth is decelerating in the U.S. and Mr. Market is beginning to price this in. As a result, the SP500 is down -2.9% on the year and the VIX is up +26.0%. We see these market signals even more glaringly in sector performance. The only sectors that have had positive performance in the year-to-date are healthcare up +1.8% and utilities up +2.1%. Meanwhile the most negative two sectors in terms of performance are staples down -4.7% and energy down -4.6%.
In a recent book by Frank Partnoy, he shows that decisions of all kinds, whether “snap” or long-term strategic, benefit from being made at the last possible moment. The art of knowing how long you can afford to delay before committing is at the heart of many a great decision—whether in a corporate takeover or a marriage proposal.
The reality in the investment management business though is that you literally can’t wait until the last minute unless you have unlimited duration on your capital, like say Warren Buffett. The rest of us market minions actually have to try and stay ahead of market moves and shifts in economic outlook. This is why in our macro process identifying economic and market changes on the margin is so critical, and why long term valuation targets can be so misleading.
The question of course is whether it is possible to front run (legally) moves in the market. For example, did any of the bulls on Japanese equity shift quickly enough in 2014 to avoid the almost -9% drawdown in the Nikkei in January? Perhaps, but unlikely. After all it is human nature to value and project things for perpetuity based on the most recent data points.
An example is Kinder Morgan using $95 oil in their projections for oil or European bears projecting an abject failure of European markets when the sovereign debt turmoil was at its worst. On the last point, the healing of Europe and European credit markets has been staggering over the past few quarters.
Currently, the Spanish 10-year yield is +3.73% and the Italian 10-year yield is +3.85%, which are literally the lows for the Eurozone. This morning Italy also sold five year notes at a record low yield of 2.43% with a bid/cover of 1.49 versus a bid/cover 1.28 on December 30th.
This rampant improvement in European sovereign debt obviously begs the question of whether we are closer to the bottom then the top in European debt. But one thing is for certain, if the European debt markets are again working fluidly, it is positive for corporations that need to borrow to grow. It also begs the question of whether a short European debt and long European equities play is the best relative value play around. But, as they say, valuation shmaluation!
Our immediate-term Global Macro Risk Ranges are now:
SPX 1 (bearish)
Nikkei 141 (bearish)
VIX 15.31-20.41 (bullish)
USD 80.17-81.19 (neutral)
Gold 1 (neutral)
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research