I don’t call the market, especially for no pay. But for the past year or so I have been pushing the view that equities are roughly fairly priced to deliver very subpar returns. I like the distinction between attractive and not demonstrably overvalued. In a low return world, multiples should be high. Or put the other way, high multiples are not necessarily “wrong,” but they do imply low returns looking forward.
But equities keep grinding higher and trailing returns look fair to middling, rather than low. For the one year return, the proper adjective would depend a lot on when you look. Today, the one-year change in the S&P500 is just over 2%, which I guess makes a total return of 4 to 5%. That is not high. But nor is it really so subpar. It sure beats cash, and with a different base effect, the one-year return could be quite a bit higher. Some might say that the low return thing has been premature and that the simpler story is that equities have remained in a “bull market.”
Confronted with such a forecast error, a popular approach on Wall Street would be to pronounce equities in a bubble. On this conception, the definition of a bubble is when the price of an asset class goes up, even though you figured it wouldn’t. This may sound odd and solipsistic. But check your inbox or your deleted box for comments from equity bears. Clearly, I have identified their definition of a bubble. Throw in that the Fed caused this by “distorting” the market, and you have 1/3 of market commentary. You could probably even code an algorithm to write their weekly.
For the past n years, we here at Euro Global Capital Alpha Hedge have been documenting the dangerous equity bubble, which continues to inflate. And just as we warned, valuations have continued to surge, in response to the Fed’s manipulation of the yield curve and total suspension of natural price discovery. Just this week, the 10-year Treasury yield ABCd to xx%, while the
trailing Shiller PE multiple in the S&P DEFd to yy. When will the serial bubble blower, XYZ, wake up from his/her socialistic/liberal stupor and let the market work? Can’t he/she figure out that all this financial repression is leading to income inequality, something about which we all care so deeply?
I prefer Richard Thaler’s* definition of a bubble. Richard Thaler is the author of one of the two best financial market presentations I have ever attended. (The other one was Jeremy Siegel making a case of Bonds for the Short Run at the top of the tech bubble. If you think Siegel is just a stopped clock bull, you have not done your history.)
Back in 1999 or maybe 2000, I forget which, I saw Thaler give a talk at the Chicago Booth School. He was very clear that a bubble is not when you or I think the price is too high. A bubble exists when people are willing to own an asset class because they believe other people with less knowledge than them will push the asset class from expensive to more expensive. A bubble is when the price is set by people investing on the basis of the greater fool theory. The beauty of this definition is that it takes something that could be subjective (I think it is overvalued) and makes it in principle objective (I have evidence that owners do too).
He then presented survey evidence showing that fund managers believed that equities were both overvalued and would continue rising during the coming year. He also showed that this dichotomy was more extreme the more tightly the asset class was defined on tech. For example, it was true of the S&P, but even more true in the case of the tech index itself.
Maybe Thaler got lucky. I know some academic purists don’t like survey data. But he gave an entire (correct) market call without referring to his own opinions. To me that is a feature. And it puts him in a class far above the stopped clocks who just pronounce everything they don’t like as being in a bubble.
So I will avoid doing that. Equities are looking a bit better than my base case. I am not changing my base case, but nor am I ANGRY or YELLING AT YOU WITH ALL CAPS AND EXCLAMATION POINTS AND CASTING ASPERSIONS ON THE FOOLS!! I reserve my wrath not for equity bulls but for the dummies who believe in heli money. Sorry.
Two weeks ago, a pal said, “buybacks for the win.” Shoulda listened. Bygones.
* I am pretty sure Dr. Thaler does not pronounce his name Taller, but it would be cool if he did. That is old world for dollar. You may have noticed him narrating with Selena Gomez in The Big Short. I wonder what Thaler is saying about the market now.