I am a big fan of Carl Icahn. I don’t follow his 13D filings as there is usually an immediate pile on effect when he announces a buy or sell .But he is very plain spoken and doesn’t care much what others think of him. On CNBC yesterday he said that he thinks the market, especially the high yield market was overheated. He added that “I think the public is walking into a trap again as they did in 2007. "I think it's almost the duty of well-respected investors, like myself I hope, to warn people, to tell people, that really you are making errors. It's almost déjà vu. Many companies are selling at huge multiples and reporting earnings that are "sort of fudged" due to various accounting methods. I do think you are going to have a dramatic pullback, certain things may happen."

Economist Ed Yardeni recently chimed in on is blog about market levels. He said that PE ratios may not in fact be too high based on inflation levels He said that “In my ongoing research on valuation, I constructed a quarterly P/E series for the S&P 500 based on reported earnings from Q4-1935 through Q3-1988, and operating earnings since then. Its average is exactly 15.0. It was 18.5 during Q1-2015. It has been this high before and sometimes gone higher. A reversion-to-the-mean valuation model is bearish based on this measure of the P/E since it is currently higher than its mean. Over 30 years ago, Jim Moltz, my mentor at CJ Lawrence during the 1990s, devised the Rule of 20. It states that for equities to be fairly valued, the P/E ratio plus the inflation rate has to be around 20. In April, the CPI inflation rate was minus 0.2% y/y, implying that the fair-value P/E should be 20.2, well above the trailing P/E. On the other hand, the core CPI was up 1.8% y/y, suggesting that 18.2 is the right valuation number. “ This would imply a fairly valued market that might even have some more upside to reach the overvalued level that might be vulnerable to a sell off.

However he then added “In addition to tracking the trailing P/E, I also monitor market-capitalization-to-sales and price-to-sales ratios. During Q1, the Fed’s Financial Accounts showed that the ratio of the market capitalization of all equities traded in the US (excluding foreign issues) to nominal GDP rose to 1.69, the highest since Q3-2000. The comparable ratio for the S&P 500 rose to 1.87 during Q1, also the highest since Q3-2000. The ratio of the S&P 500 to its forward revenues per share rose to a cyclical high of 1.82 in early June. Stocks are seriously overvalued according to these measures.”

By the way if you are not following Mr. Yardeni’s blog at http://blog.yardeni.com/ you should be. I have followed him for more than 2 decades and he is one of the few economists I respect.

As you may recall Stanley Druckenmiller also give us a warning about financial markets earlier this year when he said ““The problem with this is when you have zero money for so long, the marginal benefits you get through consumption greatly diminish but there’s one thing that doesn’t diminish, which is unintended consequences. “I know that it’s so tempting to go ahead and make investments and it looks good for today, but when this thing ends, because we’ve had speculation, we’ve had money building up for four to six years in terms of a risk pattern. I think it could end very badly.”

While I am a horrible market timer and our cash position is more a function of lack of opportunities than a grand call on my part I find it worrisome that three very successful folks who have not only survived but thrived in the markets for decades are expressing this level of concern about market levels. I think to some large degree at this point that, outside of the community banks, we ae may be picking up pennies in front of a bulldozer. There is no way to know when the bulldozer might flatten you but odds degree each time you run out to grab the shiny little coin. As I said in yesterday’s video we can argue all day about the market being fairly valued or overvalued. We cannot ,however, have any sort of discussion about the market being undervalued enough to be one of Charlie Mungers exceptional opportunities.

I can’t tell you when stock prices will finally crack, it will probably take a good push form outside forces and the high yield market break suggested by Mr. Icahn and Jeffrey Gundlach could be the catalyst. I do wish it would go ahead and happen because I miss the IQ points I have shed as the market has climbed steadily higher. I was a damn genius from 2008 to 2013 as the market crashed and recovered but outside the small banks I have not been all that smart the past two years as deep value strategies have lagged rather badly. My day will come and I can’t wait to be really smart again.

I have seen this cycle many times during my career. After a bear market value strategies deliver explosive gains and continue to do so for several years and then come back to market matching levels and then lag as the bull gets gray and begins losing hair. I have no reason to think this time will be any different. I am encouraged that some very smart folks that have both big wallets and battle scars are starting to think we are getting closer to the next phase of the cycle. At 54 I figure I have maybe two or 3 more of these round trip market adventures until I may want to think about cutting back and that should be enough.

I leave you with the thoughts of my old friend Hetty who once advised “More money is made in the end by an over-supply of caution than by indiscriminate recklessness. I am not advising timidity. Quite the contrary. Be very sure that you are right first, then go ahead, and don’t be scared.” Right now it is time to exercise that over supply of caution and when everyone else is scared it will be time for us to “go ahead.”

Have a Great Week!

Tim

Song of the week: As deep value investors https://www.youtube.com/watch?v=CxYRbzGi8Rg . unitl then patience and discipline are the rule of the day