You can add David Einhorn's voice to those concerned about the current market conditions.
Speaking at the Robin Hood Foundation gathering this week, he responded to a question about the market saying “It's really hard to say. There are certain aspects of the market and certain stocks that are behaving like we're in a bubble." That follows on the heels of Carl Icahn telling the Reuters Global Investment Outlook Summit that “I am very cautious on equities today. This market could easily have a big drop.”
The activist pointed out that earnings are a result of manipulation and debt funded buybacks not improving business conditions telling the summit attendees "Very simplistically put, a lot of the earnings are a mirage. They are not coming because the companies are well run but because of low interest rates."
The chorus of negativity on the market form some notable voices has been growing in the past few months.
Sam Zell compared the market to real estate in 2006 while Seth Klarman of Baupost has predicted severe stock market conditions when the fed begins to taper.
Speaking at the same summit as Mr. Icahn, Jim Chanos advised, “If you're the typical investor, it's probably time to be a little bit more cautious.” Jason Ader of Spring Owl Asset Management added, “I think I'll have an opportunity to buy the positions I want to own 20-30 percent lower if I'm patient, so I'm going to be patient I don't feel the need to deploy capital just because I've got excess cash.”
There is a growing chorus of very smart, very successful people that are concerned about the direction of the stock market. As deep value investors we try to keep our heads down and ignore noise and market predictions but there is another voice speaking volumes about the stock market level that is much harder to ignore.
Cheap stocks are becoming very rare and it is very difficult to find investable ideas.
Out of more than 4500 domestic listings with a market cap greater than 90 million, only 145 of them trade at a discount of 10 percent or more to tangible book value. Most of those are financial companies, including smaller banks and insurance companies. Of the non-financial companies, less than 30 of them pass any sort of credit or fundamental check that would make them worthwhile investment candidates for an asset-based deep value investor.
It is even worse if you look at the larger capitalization stocks. Only 24 stocks in the S&P 500 ($SPY), or about 4.8 percent of the listings, trade for less than book value. All of them are either financial or basis material companies. Compare that to 2008, when well more than 20 percent of the index traded below their book value and were bargain purchase candidates.
Of the 465 profitable companies in the index, just 13 trade with a single digit PE ratio. Just 10 index components trade for less than 10 times free cash flow. No matter which value metric you care to apply, the large cap stocks are simply not cheap right now. Even if you use the very optimistic PEG ratio favored by the growth at a reasonable price crown, only 29 stock trade with a ratio below one.
It can be easy to ignore the growing chorus of really smart folks who are concerned about the stock market.
After all, David Tepper of Appaloosa and Stephen Einhorn at Omega are pretty smart guys as well and they are making pretty bullish comments on the stock markets potential direction. As value investors a big part of our success is based on ignoring market forecasts and reacting to what does happen rather than attempting to predict what might happen.
What we find it more difficult to ignore is the fact that we are running out of safe and cheap stocks. As the markets have moved higher a lot of stocks purchased over the past few years are reaching full value and are being sold by deep value investors. With a lock of new investable opportunities cash levels are rising in deep value portfolios. While holding cash can be frustrating (especially when it pays pretty much zero), but history has proven that it is best to wait for an inventory creation event.
In the past, every time the pool of investable deep value ideas have shrunk to very low levels, it was a huge red flag and investors were better off practicing patience and waiting for better values. That is very likely the case this time as well.