Valuation is an Art – But that Doesn’t Mean it’s Always Pretty

Fri, AUG 4th, 2017

Monet was brilliant with color and stroke. Picasso used interesting shapes and had an uncanny ability to impart mood. Renoir celebrated sensuality. Each had critics, but all share a common trait: artists widely regarded as great in their field. We can squabble about taste, but there’s little debate around their influence. Ansel Adams once said “there is nothing worse than a sharp image of a fuzzy concept.” Indeed. Whether it’s art, engineering, or investing, eminent concepts and high quality work are timeless.

On traditional time-honored metrics like P/E, earnings yield, “Fed model” and equity risk premium – i.e., the Monets, Picassos, and Renoirs of equity valuation – current stock price levels and fundamentals look reasonable. This market is not overvalued. Nevertheless the preponderance of pundits, pros, and portfolio provocateurs find themselves somewhere along the scale between outright gloomy and resistive participation. This has been an enduring feature for much of this contemporary bull market. Outside of small pockets here and there (existing in any environment) exuberance remains extinct. Despite this there are those who seem to make a living off trying to scare investors out of their skulls. Over the past week I have noticed a new chart and narrative getting some traction. Similar to the “scary” parallels between now and 1929 and other unavailing bearish correlations this chart from the equity strategy team at BAML seems to make intuitive sense with a cursory glance. It may even generate churn in brokerage accounts from clients who digest its contents. (I am sure the Thundering Herd’s brokers won’t mind). They call it a “classic euphoria signal.” Hardly.

This view is typically presented to imply some sort of direct relationship between Fed asset levels and stock prices. I don’t deny that Quantitative Easing had some indirect impact on equities, primarily by way of driving down longer-term bond yields. But this chart isn’t helpful in forecasting where stocks are headed. As with anything in markets, the right context matters. So, I did some digging. Below you can see what this relationship looks like when you zoom out some 33 years (max data set for FRED). The chart, which in full disclosure isn’t exactly the same data set BAML uses – they use Federal Reserve assets while I use monetary reserve base, but it’s effectively the same thing – shows the Fed’s balance sheet relative to the broader Wilshire 5000 index. Through this lens the purported correlation breaks down and it’s clear that stocks can and have rallied even when central bankers are not playing Pac-Man in the bond markets.


It’s earnings, not central bank liquidity that’s driving stocks. Charts like BAML’s can get wide dissemination among trading desks and the investing public. They are often both cherry-picked and misleading; the staple recipe for cooking up clicks on spooky market headlines. Take them with a pinch of salt, and stay the course with your investment plan. If the macro economy and corporate earnings continue to expand and stock prices don’t aggressively outrun that pace, high quality valuation metrics will tell the correct story. Just keep that in mind the next time someone tries to tell you that their Dogs Playing Cards is just as good as Houses of Parliament.

Jason L. Ware, MBA / Chief Investment Officer
Albion Financial Group
(801) 487-3700

About Albion Financial

Established in 1982, Albion Financial Group is an independent, fee-only financial planner and investment manager located in Salt Lake City, Utah.