IBD Interview Question: How to prepare for market trend question?

Your answer and your reason, talk about the high p/e valuations and the possible interest rate hikes

From a historical perspective, the current P/E of the stock market is approaching the high side, but doesn't look overvalued (http://www.multpl.com). In this interest rate environment, with the economic data that has been coming out recently, this stock market is not overvalued.

That being said, I believe there is one major cause for concern that the growth expectations currently implied by the market will not be fulfilled. Primarily, firms are increasingly spending capital on buybacks, in lieu of investing in organic growth, new technology to increase efficiency, etc. (this http://www.businessinsider.com/contribution-buybacks-eps-growth-2015-11). This is a rash generalization, but based on data in that article, if there were no buybacks in the last 15 quarters (i.e. only using BI's organic NI growth number), current P/E would be 1,022x - maybe a little high. Obviously that number doesn't mean much, but it does go to show the impact of buybacks on the market at the moment, and how their eventual decline will affect the market. Then when we hop back and realize firms aren't growing EPS organically and have dried up all of their cash on buybacks, things could get messy.

Okay that probably doesn't help you, just wanted to ramble for a bit. Seriously though, you just need to have an opinion. If you don't know where to start, just pick a side, try to prove that side right, try to prove it wrong. You'll learn a lot in the process. Also, try to think about things from a theoretical perspective. E.g. the value of a firm, or a combination of firms (the stock market), is equal to Cash Flow divided by (Cost of Capital minus Growth Rate). Think about where each of those items stand now, how you expect them to change in the next 6-12 months, and what that implies for the stock market. For example, "I think rates are going up in [month], which would increase cost of capital for firms, which increases the denominator of above equation, decreasing stock market value. This [has/has not] been priced into the market, and as such I believe the market is [o/uvalued]."

That would be my approach, definitely don't live or die by it, hopefully some others can provide some input as well.

Over/undervaluation is a relative, so would answer in that regard. Is the stock market "expensive" relative to where it was X years ago? Maybe - the average multiple of S&P 500 companies is higher and PE firms are paying higher take private multiples / needing to use higher leverage. What about where you think the market will be in another X years? Maybe not - economic growth blah blah.

They are not looking for anything in particular. This is an opportunity to show them that you follow the markets. Just because the interviewer asks a question (especially questions on this nature) it doesn't mean you have to answer that question specifically. You can say, well it depends on the sector right? Me myself, I follow X sector and blablabla

If you follow no sectors, start following one ASAP.

Thanks, everyone for your great insights!

I had this question for a SA interview. I just focused on my macro view and why I believed that was the case. So, I focused on interest rates, QE2 and the effects once it would end, where I saw gold and crude in the next few months and fiscal and monetary policy changes in the major economies (EU, US, UK, and China).

That seemed to do the trick.

So long as you end each answer by reinforcing how big your cock is, nothing else you say will matter.

I second Walkio, and also this is a really good opportunity to turn the interview into a conversation. As long as you're clear on what you expect have solid reasons for why you believe those things, you should be fine. Make sure you do your research.

the key part is explaining your viewpoint. Having a logical argument for why you predict such-and-such. Actually being right doesn't matter- it's not like they're going to wait and see.

There are 3 ways you can answer these questions in the future (1) learning economic theory and applying it to current situations (difficult) (2) learning economic history and applying outcomes of past events to hypothesize on current situations (easier) (3) stealing someone else's analysis the day before every interview (barron's, economist, blogs, etc) (easiest).

Where are we in the biz cycle? How does this stock move with the biz cylce? I can't see what the treasury curve would have to do with it besides being able to borrow or issue debt at lower cost.

You don't need to know the exact yield. Just know generally whether short and long-term yields are up/down/flat/high/low. That's about the level of detail that's expected across the board (unemployment, GDP, etc.) unless you're interviewing for an econ specific job.

In 15 years, the conservative assumption would be to say that the index would have increased by the risk free rate + the market risk premium. What are these returns? Who knows. For 5 or 10 year periods, the results could be literally anything. You want to answer this question by saying you could estimate a range (increasingly narrow as the time horizon gets longer) of probable values based on a mean return (explained above) and a historical rate of volatility. With a mean and a standard deviation, you have yourself a bell curve. But that's all you have, son.

thanks, jhoratio! very helpful

Its really looking for you to think/touch on three points:

1. As you said, what do you think of the macro picture in terms of where we are in the cycle. Is 20x expensive/cheap/fair etc and why you think that.

2. Should s manufacturing company in general have the same P/E ratio as the average S&P500 stock and just as importantly, is P/E the right ratio to analyze a manufacturing company

3. As you sort of touched on, for a very small company what adjustments would you make