The

VOL. 1, No. 17

Real Returns Report

Non-Consensus, Data-Driven Analysis
MAY 14, 2012

Contents Commentary Value Barometer Equities & Bonds Value Barometer Metals & Energy
Commentary

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Contents From the Archives License/ Disclaimer

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Alex Dumortier, CFA

alex.dumortier@gmail.com linkedin.com/in/alexdumortier

Facebook's IPO: Dislike

Facebook's business clearly has some attractive characteristics, but the company's hugely-hyped initial public offering (IPO) is extremely unattractive to any value-conscious investor (to keno parlor habitus, it may be an interesting diversion, however.) To imagine that Facebook merits a price-to-earnings ratio of 70, one must make wildly optimistic projections regarding growth and profitability and make abstraction of the significant risks and competition the company will face in trying to protect its franchise. Or, as Peter Cauwels of the Swiss Federal Institute of Technology warns:
"Investors should be aware that everything they pay above $30 billion is just an option on future potential and everything above $60 billion is bubble money."

Last June, I predicted that Facebook would end its first day of trading as a public company with a market capitalization of $150 billion. While this is by no means certain, I see no reason to revise that prediction downwards today. At that level, investors might as well set a match to their savings. It goes without saying (but it goes even better said, as the French say) that I strongly recommend that investors refrain from participating in this offering. Value Barometer changes As we continue to expand our coverage of asset class valuations and returns, I've added U.S. high-yield bonds and natural gas to the Value Barometer. Note also that I'm now displaying the arithmetic and geometric averages for each series instead of deviations from the averages (which had the potential to be confusing.) AD 1

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Value Barometer
U.S. Equities
Current value (05/11) Broad Market/ Large-caps Aggregate U.S. equities, Equity q ratio S&P 500, Equity q ratio S&P 500, P/E10 Small-caps Small-caps: Russell 2000, P/E10 29.5 2003 - 2012 32% 30.1 30.6 5.0 0.98 1945 2011 87% 0.66 0.71 0.26 Series length Percentile rank Geometric average Arithmetic average Standard deviation

0.72

1871 2012

51%

0.64

0.69

0.25

20.8

1881 2012

80%

15.2

16.4

6.6

Source: Federal Reserve Board of Governors, Robert Shiller, Russell Indexes, Standard & Poor's, The Real Returns Report

U.S. Fixed Income

Current value (05/10) High-Yield BofA ML High Yield Master II Index, OAS U.S. High Yield Bonds, Trailing 10yr return 600 bps 1996 2012 57% 538 bps 600 bps 306 bps Series length Percentile rank Geometric average Arithmetic average Standard deviation

6.2%

1936 2012

76%

3.6%

3.7%

3.4%

Source: BofA Merrill Lynch, Federal Reserve Bank of St. Louis, Ibbotson Associates, The Real Returns Report

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The Real Returns Report

Value Barometer (cont.)

Precious metals
Current value (05/11) GOLD Real price, USD $1,583.0 1970 2012 96% $640.5 $711.9 $339.9 Series length Percentile rank Geometric average Arithmetic average Standard deviation

Real price, CHF Trailing 10-yr real return, USD Trailing 10-yr real return, CHF SILVER Real price, USD Trailing 10-yr real return, USD

CHF 1,468.7

1970 2012

94%

CHF 767.0

CHF 830.8

CHF 354.3

14.7%

1979 2012

89%

1.5%

1.8%

8.1%

10.9%

1979 2012

92%

0.5%

0.8%

6.9%

$29.9

1970 2012

93%

$12.5

$14.9

$11.3

17.4%

1980 2012

89%

(0.6%)

(0.1%)

9.0%

Source: Kitco, The Real Returns Report, The World Gold Council

Energy
Current value (05/09) U.S. NATURAL GAS Real price, USD Trailing 10-yr real return, USD $2.36 1960 2012 35% $2.87 $3.61 $2.49 Series length Percentile rank Geometric average Arithmetic average Standard deviation

(6.9%)

1970 2012

6%

4.1%

4.3%

7.8%

Source: U.S. Energy Information Administration, The Real Returns Report, The World Bank

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Notes Equity q = Market value / Net worth (estimated at market prices) This is a variation on Tobin's q. When it is calculated over all U.S. equities, it is a quarterly series since it depends on data from the Federal Reserve's Flow of Funds report. However, it's possible to calculate the ratio mid-quarter, as I have done, by adjusting the market value to reflect changes in equity market indexes. Here, I used the Wilshire 5000 full capitalization index, which is the broadest measure of U.S. equities' market capitalization and performance. P/E10: Also known as the cyclically-adjusted PE (CAPE) or "Shiller PE" after Robert Shiller of Yale. The P/E10 uses the average of the prior ten years' earnings, on an inflation adjusted basis, as its earnings input. The rationale behind this is the observation that earnings are too volatile on a year-to-year basis to provide reliable information on a company's (or a market's) true earnings power. By using a ten-year average, the P/E10 smoothes out earnings volatility and allows investors to better identify legitimate changes in risk premiums. The figures in this table are derived from Professor Shiller's data (available from his web page), which include series of monthly average prices for the S&P 500/ S&P Composite Index.

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From the Archives

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The Real Returns Report

The Real Returns Report by Alex Dumortier is licensed under a Creative Commons AttributionNonCommercial-NoDerivs 3.0 Unported License. Permissions beyond the scope of this license may be available at longrunreturns.blogspot.com.

Disclaimer: This research is based on current public information that we consider reliable, but we do not represent it is accurate or complete, and it should not be relied on as such. This research does not constitute a personal recommendation. The price and value of the investments referred to in this research and the income from them may fluctuate. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur. Certain transactions, including those involving futures, options, and other derivatives, give rise to substantial risk and are not suitable for all investors.

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