Below are my comments in an email on recent market valuation:
Are stocks expensive, yes. Is it a bubble no. Will there be a correction? Of course. When? Who knows. We are in the 8th year of a bull market rally. In the past there was a correction every 18 months on average. Look where we are today. Nobody predicted that. No one. The stock market reached a new high yesterday, again making a mockery of what savvy economic commentators though they know about the world. It’s absolutely ridiculous. Consider how things looked one year ago. The world economy seemed hopelessly trapped in a cycle of low growth and inflation. Markets recoiled at the mere possibility that the Fed would raise interest rates. Now, interest rates and inflation forecasts have risen substantially from last year; financial markets are shrugging off — or even rallying at the possibility of — imminent Fed rate increases; and it is all taking place during the Trump’s presidency. Now there are signs that the “new normal” will become the “old normal”. Good luck trying to make sense of all that.
Now back to market valuation. The famous Shiller CAPE ratio chart is often brought up to explain the next crash. Bears like to cited this chart when predicting the next big crash. The last two times CAPE ratio was this high was 1929 and 2000. You know how that ended. It’s true and it’s a powerful chart that really sinks in. Well there’s a few things that are not mentioned.
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1) The Shiller ratio has been a record high for a few years now. It’s been brought up to predict the next crash but still waiting. There’s a popular saying in the business: “I predicted 9 of the last 5 recessions”.
2)Back in 1929 and 2000 the the risk free ratio was at least 5%. That mean a treasury bond, the safest investment of all, would guarantee you least 5%. Today you are getting nothing, or negative return because of inflation. The reason why the stocks are persistently expensive is that there’s no other option to park your money. Where else are you going to put your saving? Bonds are on the block to get slaughtered if interest rate ever normalized. Why would I loan money at somebody for less than 1% or even negative rates? Then you have gold. Very speculative and how to you value gold? It looks good on your wife what else are you going to do with? The return on gold since 1800 is 0.5%, on stocks 6.7%, and 3.5% for bonds. These numbers are from Professor Jeremy Siegel are Wharton. Because of persistently low interest rate, people are stuck with stocks.
3) The CAPE is backward looking. It divides the S&P with the last 10 years of earnings. It would be more accurate if you divide it with the expected earnings. I know it’s predicting but you can have a range. It would come down a bit.
4) Professor Robert Shiller said he would still buy stocks because interest rates are super low. He also said that you are not looking at the chart correctly. It wasn’t met to be a marking timing mechanism. You have to look at it like its continual.The lesson there is that if you combine that with a good market diversification, the important thing is that you never get completely in or completely out of stocks.
But to hell with all that, too much explanation, let’s just tell people that it’s doom time again. If you are managing money, I think you need to explain a little bit more. You owe that to your clientele.
Charts has the tendency to over simplifying things. You can’t just wait there until it comes down to PE 6x or something. Stocks just don’t drop because the chart said so. You need a catalyst. A recession would do it but it looks like the U.S. is doing well and that should help Canada. My money is on rising interest rates. Rates will need to go above 2% or more for people to get out of stocks. People are sitting on dividend yield of 3% for now, so why get out. My worried is how are we going to pay all that debt back once interest rate rise? We have taken on a lot of debt but its costing nothing. But that can’t last forever. All that need will need to be renewed one day and it might be a much higher rate. Budgets are already strained and nobody is asking how are we going to pay it back. But again, what do I know.
Right now stocks are on fire because of Trump. Which has me worried. It seems like the market only listened to the good stuff Trump had to say and ignore the bad stuff. The good stuff: tax cuts, regulation cut, and massive infrastructure spending. The bad stuff: possible trade war, protectionism policy, disrupting diplomacy etc…. And Trump’s personality is very volatile. But he has a good business team in board so that’s reassuring.
Stocks could be high for a while.The last couple major dips (5-10% drop), like in August 2016, Jan-Feb 2016, Brexit…was only a blip on the radar. The stocks came roaring back. there are too many specialized funds that take advantage of the dips. While you are trying to make sense of what’s happening stocks are back up. The best move was doing nothing.
The market anticipates very big things from the Trump administration. However market anticipations are often wrong. Trump will not get everything he wants and the market could take it the wrong way. But there is also some real improvement in the economic data underneath the shifts, reflecting economic forces that have been underway for years. And this resetting of expectations is evident in market data beyond the always erratic stock market.
Every decade or so there’s a massive storm like in 2000 and 2008. This is the key to real returns. It’s to buy when nobody wants everybody is selling. When there’s “blood on the street”. That’s easy to say (or write). You need nerve of steel to do that. It wasn’t evident in 2008-2009, after stocks were down 50% that the smart thing to do was to buy stocks. After weren’t we on the brink of a financial collapse? There will be another downturn one day to profit from.
Article by Brian Langis