If you don’t read Cullen Roche, you’re missing out:
Nobel winner Robert Shiller is worried, it’s never good when Shiller is worried.
The following chart was posted:
The chart was followed with commentary:
Retail investors have complete mistimed the market, yet again. According to the recent AAII Asset Allocation Survey by retail investors, cash levels in July dropped to the lowest level since 1999 at only 15.8%. Just as this was happening, European markets like DAX 30 have started a free fall of 10% in only a few weeks, while S&P 500 is also experiencing the strongest sell off in months. It seems to be that the same old theme of buying very high and later down the track, most likely panic selling into an upcoming low, will once again be occurring.
The blogger Tiho is correct, the data shows that retail investors held more cash when stocks were at their lowest point in the cycle. But I think some context needs to be added here that is missing. First, this idea that investors were wrong suffers from “hindsight bias.” We now know what the lowest point was in the market cycle, investors in the middle of crisis did not. In fact, for the first time since the Great Depression ordinary people wondered if the United States was about to enter into a depression (some would argue we did) and that in a depression, cash is king.
Cash is king because of the flexibility it would allow the individual if the economy continued to fall and, more importantly, if the market continued to fall. If investors viewed holding stocks as an asymmetric risk, meaning the cost of missing out on a large gain didn’t hurt as much as losing an additional 50 – 80% of their assets, then they made a rational decision. Hindsight bias disturbs not only what could have happened, but how people should react to their potential future possibilities.
The following is a chart of the market environment between 1920 – 1940 and includes the crash of 1929 and the entire Great Depression:
Stocks fell 48% from their high in 1929. People who bought at that low were rewarded with a 48% gain fairly quickly when the market bounced back (though they needed a 108% gain to break-even). Similar to what happened (though not as quickly) in 2009, but these investors didn’t actually turn out to be as lucky as our “totally wrong” 2009 investors as the market then plunged over the next several years by 86%. People lucky enough to buy at that low were rewarded with a 94% increase (this truly was a good time to buy if you were a long term investor!). But that huge increase was met with another dramatic drop in 1933 of 37%. Investors were once again rewarded for buying at this point and holding on, experiencing an increase of nearly 300% – clearly anyone who had held cash was “totally wrong.” Actually, 1937 turned out to be the peak and prices proceeded fall into the next year, losing investors 49%. By the end of 1939 stocks were still half what they were at the height of 1929 and 20% below the level at which stocks had fallen right after the first part of the 1929 crash (all of these numbers exclude inflation/deflation and the effect of dividends).
It was a wild ride and those retail investors in 1929 who held cash at the same point that retail investors held cash in 2009 didn’t turn out to be “totally wrong.” Those investors preserved cash and held on during a tough time in American history. Some retail investors in 2009 realized that the possibility existed that the tough times of the Great Depression may in fact be in front of them and they weren’t willing to risk what could have been a significant downside (as well as a volatile one) with what money they had left. Perhaps the George Santayana quote stuck in their mind “those who cannot remember the past are doomed to repeat it.”
Maybe retail investors aren’t idiots and maybe they aren’t “totally wrong,” perhaps they had good reason to raise cash. We now know how history has turned out (at least so far), but it wasn’t so clear in the depths of 2008 and 2009.
This is not to say that retail investors (or any investor for that matter) should bail out of falling stock markets. It simply means that they should have a plan and know their tolerance for risk. Markets sometimes are great givers, but they can also be great takers and those who have now appeared to be “correct” for buying or sticking it out would have looked like fools during the Depression.
Bottomline – many investors have clearly made mistakes and having such low levels of cash right now is likely one of them, but we should be cognizant that the future holds many paths and just because some chose the path that turned out to be correct, it doesn’t mean it was obvious at the time or that the slightest change in the economic system wouldn’t have made that path “totally wrong.”
Scott Dauenhauer CFP, MSFP, AIF
Quarterly Commentary to follow soon – How is Portlandia and Wall Street related!
For the last few weeks I’ve been inundated with news stories in my Twitter feed about a new app, Yo. I like to be on the cutting edge of technology and finally gave in a clicked on a story about this amazing app. What I found both amused and frightened me. I can sum of the app succinctly, with a single touch you can send someone the word “Yo.” Stephen Colbert does a great job explaining this stunning new technology:
As underwhelming as this concept sounds, the company is being heralded as the future by some, including a columnist for Forbes who says:
Forbes’s Anthony Wing Kosner believes the app has huge potential. “If a ‘Yo’ could also contain a link, the impact would be huge” Kosner says.
He adds: “Consider the meaning of a ‘yo’ with a map location, with a web address, with a song or a YouTube video? The ability to shout out the immediate context is what Twitter is supposed to be for, but who wants to bother crafting 140 characters anymore?”
While not huge, the company has raised $1 million to further develop the app.
In my opinion Yo is among the dumbest things I’ve heard since the height of the last tech bubble, anyone remember Pets.com (by the way, pets.com wasn’t actually a terrible idea)? If Yo is a proxy for the caliber of company getting funded today, we are in trouble. Tech Boom 2.0 will surely end in Tech Bust 2.0.
I do think that this tech boom is different, but it has parallels to the last one (Uber with an $18 billion valuation?). There is no doubt that there are legit companies creating real value and that I have no doubt will be around a decade from now, but it does feel like we are hitting the froth stage of this market. With that said, the froth stage can last longer than anyone thinks (remember the relentless tech stocks of the late nineties?).
Yo is most certainly a fad and a company that will not be around (at least in its present form) in a few years, but does Yo represent the beginning of the end of this second great tech boom?
Only time will tell and I’m not rooting for any bust in tech – it’s my favorite pastime!
Scott Dauenhauer, CFP, MPAS, AIF
I like to think that I can remain an objective observer, but we all have our biases. My research leads me to believe that stocks are overvalued right now (and not by a small amount). Confirmation Bias is when we purposely pursue theories that confirm our beliefs and ignore ones that don’t. In that vein, I’m going to post some data that supports my belief…acknowledging that while I think there is good reason to trust the data, it could just be pure confirmation bias.
Douglas Short over at Advisor Perspectives blog has a monthly post where he highlights Market Valuation, here is his current post:
Note from dshort: I’ve tweaked this commentary to include today’s Federal Reserve release of the Z.1 Financial Accounts for Q1.
Here is a summary of the four market valuation indicators I updated at the beginning of the month.
To facilitate comparisons, I’ve adjusted the two P/E ratios and Q Ratio to their arithmetic means and the inflation-adjusted S&P Composite to its exponential regression. Thus the percentages on the vertical axis show the over/undervaluation as a percent above mean value, which I’m using as a surrogate for fair value. Based on the latest S&P 500 monthly data, the market is overvalued somewhere in the range of 51% to 85%, depending on the indicator, up from the previous month’s 50% to 83%.
I’ve plotted the S&P regression data as an area chart type rather than a line to make the comparisons a bit easier to read. It also reinforces the difference between the line charts — which are simple ratios — and the regression series, which measures the distance from an exponential regression on a log chart.
The chart below differs from the one above in that the two valuation ratios (P/E and Q) are adjusted to their geometric mean rather than their arithmetic mean (which is what most people think of as the “average”). The geometric mean weights the central tendency of a series of numbers, thus calling attention to outliers. In my view, the first chart does a satisfactory job of illustrating these four approaches to market valuation, but I’ve included the geometric variant as an interesting alternative view for the two P/Es and Q. In this chart the range of overvaluation would be in the range of 63% to 99%, up from last month’s 62% to 97%.
The Average of the Four Valuation Indicators
The next chart gives a simplified summary of valuations by plotting the average of the four arithmetic series (the first chart above) along with the standard deviations above and below the mean.
At the end of last month, the average of the four exceeded the credit bubble peak preceding the last recession.
Here is the same chart, this time with the geometric mean and deviations. The latest value of 80% is not far below the two standard deviation value of 82%.
As I’ve frequently pointed out, these indicators aren’t useful as short-term signals of market direction. Periods of over- and under-valuation can last for many years. But they can play a role in framing longer-term expectations of investment returns. At present market overvaluation continues to suggest a cautious long-term outlook and guarded expectations. However, at the today’s low annualized inflation rate and the extremely poor return on fixed income investments (Treasuries, CDs, etc.) the appeal of equities, despite overvaluation risk, is not surprising. For more on that topic, see my periodic update: Market Valuation, Inflation and Treasury Yields: Clues from the Past
In another post tracking the Buffet Valuation indicator, Short posts the following:
Market Cap to GDP is a long-term valuation indicator that has become popular in recent years, thanks to Warren Buffett. Back in 2001 he remarked in a Fortune Magazine interview that “it is probably the best single measure of where valuations stand at any given moment.”
The four valuation indicators I track in my monthly valuation overview offer a long-term perspective of well over a century. The raw data for the “Buffett indicator” only goes back as far as the middle of the 20th century. Quarterly GDP dates from 1947, and the Fed’s B.102 Balance sheet has quarterly updates beginning in Q4 1951. With an acknowledgement of this abbreviated timeframe, let’s take a look at the plain vanilla quarterly ratio with no effort to interpolate monthly data or extrapolate since the end of the most recent quarterly numbers.
The strange numerator in the chart title, MVEONWMVBSNNCB, is the FRED designation for Line 36 in the B.102 balance sheet (Market Value of Equities Outstanding), available on the Federal Reserve website. Here is a link to a FRED version of the chart. Incidentally, the numerator is the same series used for a simple calculation of the Q Ratio valuation indicator.
The “market cap” numerator was updated today through Q1.
For version that’s current through Q1, I can offer a more transparent alternate snapshot over a shorter timeframe. Here is the Wilshire 5000 Full Cap Price Index divided by GDP. I’ve used the FRED data for the stock index numerator (WILL5000PRFC).
A quick technical note: To match the quarterly intervals of GDP, for the Wilshire data I’ve used the quarterly average of daily closes rather than quarterly closes (slightly smoothing the volatility).
What Do These Charts Tell Us?
In a CNBC interview earlier this spring CNBC interview (April 23rd), Warren Buffett expressed his view that stocks aren’t “too frothy”. However, both the “Buffett Index” and the Wilshire 5000 variant suggest that today’s market is indeed at lofty valuations, now above the housing-bubble peak in 2007. In fact, the more timely of the two (Wilshire / GDP) has risen for eight consecutive quarters and is now approaching two standard deviations above its mean — a level exceeded for six quarters during the dot.com bubble.
For good measure, I’ll throw in John Hussman’s weekly Commentary “We Learn From History That We Do Not Learn From History.”
Scott Dauenhauer, CFP, MPAS, AIF