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Alpine Capital Research 3Q20 Commentary: A Value Depression Opportunity

Alpine Capital Research 3Q20 Commentary: A Value Depression Opportunity

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value depression

Alpine Capital Research commentary for the third quarter ended September 2020, titled, “A Value Depression Opportunity.”

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Investors have much to worry about today: a global pandemic, severe recession, and a polarizing election. Yet, we believe these events will soon recede into the rearview mirror of American history, while productivity and profits will continue their long-run upward trajectory. We also think that presidents have far less impact on the macroeconomy than is commonly believed, and that recovery from the pandemic and recession is likely to continue in fits and starts this coming year.

The greatest economic concern is less obvious, in our opinion. The return that an equity investor earns (or doesn’t) is determined by the price paid for future profits. Despite the pandemic, recession, and election, we have a good handle on future profits, as their long-run path is reasonably predictable. We also know prices, and therein lies the worry. In our view, the intelligent investor’s chief concern today should be owning stocks at inordinately high prices.

A Value Depression Opportunity

Fortunately, there is a unique solution to this concern. A major dislocation continues to build as high overall market and growth stock prices increasingly disconnect from depressed value stock prices. Speculatively high prices present the risk of loss and disappointing returns, while the “value depression” offers the opportunity to secure future profits at low prices. Rarely do these conditions prevail in such stark contrast at the same time. The chart below illustrates how the current value depression is on par with the epic value depression of the late 1990s.

value depression

Generally, we prefer more accurate definitions of value (see our October 2019 commentary, “True Value”), but the divergence is so extreme today that these broad measures tell the story. While we do not know how much longer the value depression will last, value stocks are squarely in the bargain bin today when almost everything else is offered at precariously high prices.

Getting here has nevertheless been painful for value-oriented investors—at least on paper. Easy money has been made in many speculative stocks, while value remains depressed. The speculating show-off has much to crow about, whereas the disciplined tabulator of corporate profits looks out of touch. While we believe value will have its day again, perhaps the most important point to understand about the value depression is that no real economic ground has been lost getting to where we are today.

Our analysis shows that the profit value of our Equity Quality Return (EQR) portfolio companies has continued to accrue and that our valuation advantage has grown far more than the amount by which we have fallen behind. The figures below highlight these claims.

value depression

Answering Three Thoughtful Questions

The remainder of this quarter’s commentary will be spent answering three thoughtful questions posed to us this past quarter: (1) What could we be missing? (2) How do such valuation disparities develop? and (3) How will our estimated valuation differential be realized?

1) What could we be missing?

The short answer is that we do not believe we are missing anything significant, but the ACR investment team is always seeking to unearth and understand all relevant economic issues. At the micro level, each company and industry that we evaluate is subjected to rigorous counter-argument. We think deeply about known risks as well as factors practically no one considers. Our analysis includes a review of disruptive technologies that could hurt or help, and we evaluate threats that could impact multiple holdings. The micro risks that we evaluate are far too many to enumerate in a commentary, but we remain confident that we have the company and industry level well covered.

At the macro level, we review general economic developments and themes that could result in different outcomes than we have typically seen or can forecast. The litany of “this time is different” arguments appear to us even weaker today than in 1999 when the economy was arguably overheating. The “fourth industrial revolution” thesis is, in our view, necessary for GDP per capita to return to its historical growth rate, rather than being a catalyst for supernormal growth. Productivity has trended lower in recent years, so we are counting on new technologies such as 5G, the internet of things, and artificial intelligence to directly benefit our companies and raise global living standards.

The most plausible argument for what we could be missing is that some great growth companies will turn out to be “values.” That is, their profit growth will be extraordinarily high for many years to come, thus justifying their high prices today. Certainly, this will be the case for certain companies. While we are skeptical that such a group can be easily identified in advance, our goal is not to beat out a small group of outliers. Indeed, more power to those who can.

ACR’s return goals are twofold: (1) generate a satisfactory absolute return and (2) beat the overall market in the long term as measured by the S&P 500. Regarding the second objective, for the S&P 500 to produce a return greater than 5% per year over the next decade, either corporate profits would have to grow faster than they ever have or price/earnings (P/E) ratios would have to hold steady or expand further. Count us as skeptics on both points.

First, the real growth rate of corporate profits closely tracks real GDP per capita, which as noted above, has been tracking lower in recent years but has never really jumped too much higher or lower than 2% in the long run. Second, the cyclically adjusted P/E is near all-time highs, and we believe is far more likely to decline than rise. The following charts illustrate these points.

value depression

VD

2) How do such valuation disparities develop?

We can only speculate about the reasons. To start, research has shown that value outperforms the market in the long term. A reason often cited for cheaper value stock outperformance is that investors are willing to overpay for inherently sexier growth stocks. Note that ACR does not invest in “value” for this reason. We are just as happy to own a rapidly growing company that is reinvesting its free cash flow as we are a company that is not growing but instead returning its free cash flow to us. Both growth and the return of cash to shareholders are valuable. The point is to properly assess the value of a company based on all relevant factors, including its risk, return-on-capital, growth prospects, and cash returns to shareholders.

Overenthusiasm, a fixture of financial markets dating as far back as the early 17th century tulip mania, is another reason that valuation disparities develop. Market participants can bid prices unreasonably high when new era economic theories are adopted out of miscalculation, ignorance, or greed. Another related reason for valuation disparities is the insidious “performance cycle.” A self-fulfilling phenomenon of outperformance develops as more money is added to “winning” fund managers and taken from “losing” fund managers. Then one day everyone realizes that the “winning” managers are sitting on an overpriced house of cards, and a new cycle begins.

Ultimately, no one can say precisely what drives markets to the kind of extremes we are seeing today. What we can safely say is that markets, much like a pendulum, tend to swing from one extreme to another, and that a keen awareness of fundamental value is the only reliable way to stay grounded during such times.

3) How will our estimated valuation differential be realized?

The EQR valuation differential is estimated to be 250%. This figure is based on the price/value gap between EQR and the S&P 500 ((1 ÷ 0.73) ÷ (1 ÷ 2.56) – 1). It can also be broken down into estimated realized returns.

EQR cash returns are earned as dividends are paid and gains are realized. Realized gains can be further broken down into two components. The first is based on earnings-per-share growth from share retirements and business expansion. The second is a rise in market price relative to intrinsic value. The reason we are confident that the market will confirm our estimated intrinsic value is that we have modest expectations. The EQR cyclically adjusted P/E would need to rise from 8.6x to 11.7x—not a heroic assumption. Putting it all together, the EQR strategy’s estimated return is approximately 12.3% per year based on a 3.3% dividend yield, 6.0% earnings-per-share growth rate, and 3.0% increase in the P/E ratio over a 10-year horizon.

S&P 500 cash returns are earned according to the same mechanics. The difference is that we have much less confidence in the market price declining to meet our intrinsic value estimate. The die is still cast, however, based on the fundamentals. Our valuation model assumes a 1.4% sustainable dividend yield and a 4.3% earnings-per-share growth rate, implying a 5.7% annual return if the cyclically adjusted P/E holds. Given that the S&P 500 cyclically adjusted P/E is near all-time highs, we think it is more likely to contract, resulting in an S&P 500 return that is less than 5%. The more it contracts, the worse the return. An approximate 30% contraction over 10 years would result in an S&P 500 return of approximately 2% per year (1.4% dividend yield + 4.3% earnings-per-share growth – 3.7% P/E ratio contraction).

The ACR investment team takes the disclaimer seriously that current analysis and past performance do not guarantee future results. That is, we could always be wrong. However, the divergence in values is so great today that it is hard to imagine being directionally incorrect. Time will tell. In the meantime, we are especially grateful for the loyalty of our investors. ACR’s success depends upon partners like you who allow us to break away from the crowd, even if that means we are the tortoise in the race while the hare temporarily scampers ahead. Thus, we conclude, as always, with a hearty thank you for your continued trust.

Nick Tompras

October 2020

The post Alpine Capital Research 3Q20 Commentary: A Value Depression Opportunity appeared first on ValueWalk.

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Comments on February Employment Report

The headline jobs number in the February employment report was above expectations; however, December and January payrolls were revised down by 167,000 combined.   The participation rate was unchanged, the employment population ratio decreased, and the …

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The headline jobs number in the February employment report was above expectations; however, December and January payrolls were revised down by 167,000 combined.   The participation rate was unchanged, the employment population ratio decreased, and the unemployment rate was increased to 3.9%.

Leisure and hospitality gained 58 thousand jobs in February.  At the beginning of the pandemic, in March and April of 2020, leisure and hospitality lost 8.2 million jobs, and are now down 17 thousand jobs since February 2020.  So, leisure and hospitality has now essentially added back all of the jobs lost in March and April 2020. 

Construction employment increased 23 thousand and is now 547 thousand above the pre-pandemic level. 

Manufacturing employment decreased 4 thousand jobs and is now 184 thousand above the pre-pandemic level.


Prime (25 to 54 Years Old) Participation

Since the overall participation rate is impacted by both cyclical (recession) and demographic (aging population, younger people staying in school) reasons, here is the employment-population ratio for the key working age group: 25 to 54 years old.

The 25 to 54 years old participation rate increased in February to 83.5% from 83.3% in January, and the 25 to 54 employment population ratio increased to 80.7% from 80.6% the previous month.

Both are above pre-pandemic levels.

Average Hourly Wages

WagesThe graph shows the nominal year-over-year change in "Average Hourly Earnings" for all private employees from the Current Employment Statistics (CES).  

There was a huge increase at the beginning of the pandemic as lower paid employees were let go, and then the pandemic related spike reversed a year later.

Wage growth has trended down after peaking at 5.9% YoY in March 2022 and was at 4.3% YoY in February.   

Part Time for Economic Reasons

Part Time WorkersFrom the BLS report:
"The number of people employed part time for economic reasons, at 4.4 million, changed little in February. These individuals, who would have preferred full-time employment, were working part time because their hours had been reduced or they were unable to find full-time jobs."
The number of persons working part time for economic reasons decreased in February to 4.36 million from 4.42 million in February. This is slightly above pre-pandemic levels.

These workers are included in the alternate measure of labor underutilization (U-6) that increased to 7.3% from 7.2% in the previous month. This is down from the record high in April 2020 of 23.0% and up from the lowest level on record (seasonally adjusted) in December 2022 (6.5%). (This series started in 1994). This measure is above the 7.0% level in February 2020 (pre-pandemic).

Unemployed over 26 Weeks

Unemployed Over 26 WeeksThis graph shows the number of workers unemployed for 27 weeks or more.

According to the BLS, there are 1.203 million workers who have been unemployed for more than 26 weeks and still want a job, down from 1.277 million the previous month.

This is down from post-pandemic high of 4.174 million, and up from the recent low of 1.050 million.

This is close to pre-pandemic levels.

Job Streak

Through February 2024, the employment report indicated positive job growth for 38 consecutive months, putting the current streak in 5th place of the longest job streaks in US history (since 1939).

Headline Jobs, Top 10 Streaks
Year EndedStreak, Months
12019100
2199048
3200746
4197945
52024138
6 tie194333
6 tie198633
6 tie200033
9196729
10199525
1Currrent Streak

Summary:

The headline monthly jobs number was above consensus expectations; however, December and January payrolls were revised down by 167,000 combined.  The participation rate was unchanged, the employment population ratio decreased, and the unemployment rate was increased to 3.9%.  Another solid report.

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Immune cells can adapt to invading pathogens, deciding whether to fight now or prepare for the next battle

When faced with a threat, T cells have the decision-making flexibility to both clear out the pathogen now and ready themselves for a future encounter.

Understanding the flexibility of T cell memory can lead to improved vaccines and immunotherapies. Juan Gaertner/Science Photo Library via Getty Images

How does your immune system decide between fighting invading pathogens now or preparing to fight them in the future? Turns out, it can change its mind.

Every person has 10 million to 100 million unique T cells that have a critical job in the immune system: patrolling the body for invading pathogens or cancerous cells to eliminate. Each of these T cells has a unique receptor that allows it to recognize foreign proteins on the surface of infected or cancerous cells. When the right T cell encounters the right protein, it rapidly forms many copies of itself to destroy the offending pathogen.

Diagram depicting a helper T cell differentiating into either a memory T cell or an effector T cell after exposure to an antigen
T cells can differentiate into different subtypes of cells after coming into contact with an antigen. Anatomy & Physiology/SBCCOE, CC BY-NC-SA

Importantly, this process of proliferation gives rise to both short-lived effector T cells that shut down the immediate pathogen attack and long-lived memory T cells that provide protection against future attacks. But how do T cells decide whether to form cells that kill pathogens now or protect against future infections?

We are a team of bioengineers studying how immune cells mature. In our recently published research, we found that having multiple pathways to decide whether to kill pathogens now or prepare for future invaders boosts the immune system’s ability to effectively respond to different types of challenges.

Fight or remember?

To understand when and how T cells decide to become effector cells that kill pathogens or memory cells that prepare for future infections, we took movies of T cells dividing in response to a stimulus mimicking an encounter with a pathogen.

Specifically, we tracked the activity of a gene called T cell factor 1, or TCF1. This gene is essential for the longevity of memory cells. We found that stochastic, or probabilistic, silencing of the TCF1 gene when cells confront invading pathogens and inflammation drives an early decision between whether T cells become effector or memory cells. Exposure to higher levels of pathogens or inflammation increases the probability of forming effector cells.

Surprisingly, though, we found that some effector cells that had turned off TCF1 early on were able to turn it back on after clearing the pathogen, later becoming memory cells.

Through mathematical modeling, we determined that this flexibility in decision making among memory T cells is critical to generating the right number of cells that respond immediately and cells that prepare for the future, appropriate to the severity of the infection.

Understanding immune memory

The proper formation of persistent, long-lived T cell memory is critical to a person’s ability to fend off diseases ranging from the common cold to COVID-19 to cancer.

From a social and cognitive science perspective, flexibility allows people to adapt and respond optimally to uncertain and dynamic environments. Similarly, for immune cells responding to a pathogen, flexibility in decision making around whether to become memory cells may enable greater responsiveness to an evolving immune challenge.

Memory cells can be subclassified into different types with distinct features and roles in protective immunity. It’s possible that the pathway where memory cells diverge from effector cells early on and the pathway where memory cells form from effector cells later on give rise to particular subtypes of memory cells.

Our study focuses on T cell memory in the context of acute infections the immune system can successfully clear in days, such as cold, the flu or food poisoning. In contrast, chronic conditions such as HIV and cancer require persistent immune responses; long-lived, memory-like cells are critical for this persistence. Our team is investigating whether flexible memory decision making also applies to chronic conditions and whether we can leverage that flexibility to improve cancer immunotherapy.

Resolving uncertainty surrounding how and when memory cells form could help improve vaccine design and therapies that boost the immune system’s ability to provide long-term protection against diverse infectious diseases.

Kathleen Abadie was funded by a NSF (National Science Foundation) Graduate Research Fellowships. She performed this research in affiliation with the University of Washington Department of Bioengineering.

Elisa Clark performed her research in affiliation with the University of Washington (UW) Department of Bioengineering and was funded by a National Science Foundation Graduate Research Fellowship (NSF-GRFP) and by a predoctoral fellowship through the UW Institute for Stem Cell and Regenerative Medicine (ISCRM).

Hao Yuan Kueh receives funding from the National Institutes of Health.

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President Biden Delivers The “Darkest, Most Un-American Speech Given By A President”

President Biden Delivers The "Darkest, Most Un-American Speech Given By A President"

Having successfully raged, ranted, lied, and yelled through…

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President Biden Delivers The "Darkest, Most Un-American Speech Given By A President"

Having successfully raged, ranted, lied, and yelled through the State of The Union, President Biden can go back to his crypt now.

Whatever 'they' gave Biden, every American man, woman, and the other should be allowed to take it - though it seems the cocktail brings out 'dark Brandon'?

Tl;dw: Biden's Speech tonight ...

  • Fund Ukraine.

  • Trump is threat to democracy and America itself.

  • Abortion is good.

  • American Economy is stronger than ever.

  • Inflation wasn't Biden's fault.

  • Illegals are Americans too.

  • Republicans are responsible for the border crisis.

  • Trump is bad.

  • Biden stands with trans-children.

  • J6 was the worst insurrection since the Civil War.

(h/t @TCDMS99)

Tucker Carlson's response sums it all up perfectly:

"that was possibly the darkest, most un-American speech given by an American president. It wasn't a speech, it was a rant..."

Carlson continued: "The true measure of a nation's greatness lies within its capacity to control borders, yet Bid refuses to do it."

"In a fair election, Joe Biden cannot win"

And concluded:

“There was not a meaningful word for the entire duration about the things that actually matter to people who live here.”

Victor Davis Hanson added some excellent color, but this was probably the best line on Biden:

"he doesn't care... he lives in an alternative reality."

*  *  *

Watch SOTU Live here...

*   *   *

Mises' Connor O'Keeffe, warns: "Be on the Lookout for These Lies in Biden's State of the Union Address." 

On Thursday evening, President Joe Biden is set to give his third State of the Union address. The political press has been buzzing with speculation over what the president will say. That speculation, however, is focused more on how Biden will perform, and which issues he will prioritize. Much of the speech is expected to be familiar.

The story Biden will tell about what he has done as president and where the country finds itself as a result will be the same dishonest story he's been telling since at least the summer.

He'll cite government statistics to say the economy is growing, unemployment is low, and inflation is down.

Something that has been frustrating Biden, his team, and his allies in the media is that the American people do not feel as economically well off as the official data says they are. Despite what the White House and establishment-friendly journalists say, the problem lies with the data, not the American people's ability to perceive their own well-being.

As I wrote back in January, the reason for the discrepancy is the lack of distinction made between private economic activity and government spending in the most frequently cited economic indicators. There is an important difference between the two:

  • Government, unlike any other entity in the economy, can simply take money and resources from others to spend on things and hire people. Whether or not the spending brings people value is irrelevant

  • It's the private sector that's responsible for producing goods and services that actually meet people's needs and wants. So, the private components of the economy have the most significant effect on people's economic well-being.

Recently, government spending and hiring has accounted for a larger than normal share of both economic activity and employment. This means the government is propping up these traditional measures, making the economy appear better than it actually is. Also, many of the jobs Biden and his allies take credit for creating will quickly go away once it becomes clear that consumers don't actually want whatever the government encouraged these companies to produce.

On top of all that, the administration is dealing with the consequences of their chosen inflation rhetoric.

Since its peak in the summer of 2022, the president's team has talked about inflation "coming back down," which can easily give the impression that it's prices that will eventually come back down.

But that's not what that phrase means. It would be more honest to say that price increases are slowing down.

Americans are finally waking up to the fact that the cost of living will not return to prepandemic levels, and they're not happy about it.

The president has made some clumsy attempts at damage control, such as a Super Bowl Sunday video attacking food companies for "shrinkflation"—selling smaller portions at the same price instead of simply raising prices.

In his speech Thursday, Biden is expected to play up his desire to crack down on the "corporate greed" he's blaming for high prices.

In the name of "bringing down costs for Americans," the administration wants to implement targeted price ceilings - something anyone who has taken even a single economics class could tell you does more harm than good. Biden would never place the blame for the dramatic price increases we've experienced during his term where it actually belongs—on all the government spending that he and President Donald Trump oversaw during the pandemic, funded by the creation of $6 trillion out of thin air - because that kind of spending is precisely what he hopes to kick back up in a second term.

If reelected, the president wants to "revive" parts of his so-called Build Back Better agenda, which he tried and failed to pass in his first year. That would bring a significant expansion of domestic spending. And Biden remains committed to the idea that Americans must be forced to continue funding the war in Ukraine. That's another topic Biden is expected to highlight in the State of the Union, likely accompanied by the lie that Ukraine spending is good for the American economy. It isn't.

It's not possible to predict all the ways President Biden will exaggerate, mislead, and outright lie in his speech on Thursday. But we can be sure of two things. The "state of the Union" is not as strong as Biden will say it is. And his policy ambitions risk making it much worse.

*  *  *

The American people will be tuning in on their smartphones, laptops, and televisions on Thursday evening to see if 'sloppy joe' 81-year-old President Joe Biden can coherently put together more than two sentences (even with a teleprompter) as he gives his third State of the Union in front of a divided Congress. 

President Biden will speak on various topics to convince voters why he shouldn't be sent to a retirement home.

According to CNN sources, here are some of the topics Biden will discuss tonight:

  • Economic issues: Biden and his team have been drafting a speech heavy on economic populism, aides said, with calls for higher taxes on corporations and the wealthy – an attempt to draw a sharp contrast with Republicans and their likely presidential nominee, Donald Trump.

  • Health care expenses: Biden will also push for lowering health care costs and discuss his efforts to go after drug manufacturers to lower the cost of prescription medications — all issues his advisers believe can help buoy what have been sagging economic approval ratings.

  • Israel's war with Hamas: Also looming large over Biden's primetime address is the ongoing Israel-Hamas war, which has consumed much of the president's time and attention over the past few months. The president's top national security advisers have been working around the clock to try to finalize a ceasefire-hostages release deal by Ramadan, the Muslim holy month that begins next week.

  • An argument for reelection: Aides view Thursday's speech as a critical opportunity for the president to tout his accomplishments in office and lay out his plans for another four years in the nation's top job. Even though viewership has declined over the years, the yearly speech reliably draws tens of millions of households.

Sources provided more color on Biden's SOTU address: 

The speech is expected to be heavy on economic populism. The president will talk about raising taxes on corporations and the wealthy. He'll highlight efforts to cut costs for the American people, including pushing Congress to help make prescription drugs more affordable.

Biden will talk about the need to preserve democracy and freedom, a cornerstone of his re-election bid. That includes protecting and bolstering reproductive rights, an issue Democrats believe will energize voters in November. Biden is also expected to promote his unity agenda, a key feature of each of his addresses to Congress while in office.

Biden is also expected to give remarks on border security while the invasion of illegals has become one of the most heated topics among American voters. A majority of voters are frustrated with radical progressives in the White House facilitating the illegal migrant invasion. 

It is probable that the president will attribute the failure of the Senate border bill to the Republicans, a claim many voters view as unfounded. This is because the White House has the option to issue an executive order to restore border security, yet opts not to do so

Maybe this is why? 

While Biden addresses the nation, the Biden administration will be armed with a social media team to pump propaganda to at least 100 million Americans. 

"The White House hosted about 70 creators, digital publishers, and influencers across three separate events" on Wednesday and Thursday, a White House official told CNN. 

Not a very capable social media team... 

The administration's move to ramp up social media operations comes as users on X are mostly free from government censorship with Elon Musk at the helm. This infuriates Democrats, who can no longer censor their political enemies on X. 

Meanwhile, Democratic lawmakers tell Axios that the president's SOTU performance will be critical as he tries to dispel voter concerns about his elderly age. The address reached as many as 27 million people in 2023. 

"We are all nervous," said one House Democrat, citing concerns about the president's "ability to speak without blowing things."

The SOTU address comes as Biden's polling data is in the dumps

BetOnline has created several money-making opportunities for gamblers tonight, such as betting on what word Biden mentions the most. 

As well as...

We will update you when Tucker Carlson's live feed of SOTU is published. 

Tyler Durden Fri, 03/08/2024 - 07:44

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