I’ve posted Entry #520 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called Overvaluation That Is Not Quickly Addressed Becomes Locked In to Stock Prices.
Juicy Excerpt: I am not aware of any other field of endeavor in which we identify risk in the manner in which we do in the stock investing field. If someone bought a house in a flood area, their property insurance rates would reflect the risk that they were taking on by doing so. If twelve months later, no flood had materialized, no one would say that they were due a refund on grounds that there had never been any risk to speak of.
We are at bubble-level prices today regardless of whether we see a price crash within the next year or not. A positive outcome will not mean that the bubble did not exist, only that it was averted. Investors trying to perform an effective risk analysis need to be sure to make this distinction. We are in a bubble today. Period.
Are you at all upset that you have missed out on the great Trump rally?
No.
Anything that comes from a CAPE above 16 is irrational exuberance. Temporary, not real. Not my particular cup of tea. I go for the gains based on real economic growth, the stuff that lasts.
If we all worked together, we could do away with irrational exuberance. I think we should do that, the way we try to do away with drunk driving and cigarette smoking and heart attacks and cancer. I can’t feel good about anything that causes as much human misery as the no-market-timing thing.
Rob
“Anything that comes from a CAPE above 16 is irrational exuberance.”
The idea that there is a single correct valuation for the stock market is irrational.
It’s not.
We do not have perfect knowledge of the correct value for the market It could be that the U.S. economy has changed in some fundamental way so that the future average annual return will be 7 percent real. Or it could be that the future annual return will be 6 percent real. If either of those things is so, 16 will not continue to be the fair-value CAPE indefinitely into the future.
But the CAPE that applied in January 2000 was 44. That’s freakin’ nuts, Evidence. That’s so far from anything that makes even a lick of sense that it’s scary to contemplate. Buy-and-Holders were treating that CAPE value as if it were real, they were telling investors of the time that there was no need for them to lower their stock allocations because of the insane CAPE value that applied. Pleae give me a freakin’ break.
“16” is our best estimate of the fair-value CAPE, based on 150 years of historical return data. If someone wants to make a case for 17 or 15 being better numbers because of some opinion they have about how productive the U.S. economy will be on a going-forward basis, I have no argument with that. But I have a very big argument with anyone who says that 44 was a reasonable number in January 2000 and who says that investors did not need to lower their stock allocation when prices reached that insane level.
Reasonable people do not continue to drive their cars at 60 miles per hour when there is a heavy blanket of snow on the highway. Crazy people who do that get killed. If someone takes issue with a driver who cuts his speed to 20 miles per hour in those conditions and makes a makes a case that going 25 miles per hour is a better choice, I am not going to get upset about that. But I am definitely going to disagree strongly with anyone who says that, since we do not know with absolute certainy that 20 miles per hour is the right choice in those conditions, we should all always drive at 60 mile per hour no matter how dangerous it becomes to do so.
We can’t always know things with perfection. But once we learned from Shiller’s Nobel-prize-winning research that it is dangerous as all get-out to refrain from recommending market timing at all times to all investors, we should all have joined together to do all that we could to spread the word.
Rob
“We do not have perfect knowledge of the correct value for the market ”
You have made two mistakes
1) There is no such thing as “the correct value for the market”
2) Even if there was it wouldn’t be a single value at all times.
I disagree with you on both points, Evidence.
And I wish you all the best that this life has to offer a person.
Rob
I should add that I obviously do not believe that the market has the same value at all times. Economic productivity pushes its value by by 6.5 percent real per year. It’s been doing that for 150 years now. But, if the nominal value of the market increases by 40 percent one year and you treat those gains as real, you are kidding yourself. Gains of 6.5 percent a real and the other 33.5 percent of the gains are the product of irrational exuberance, not something that you can count on to finance a retirement.
Rob