On public opinion

Investment Analysis Clubs Saul’s Investing Discussions
#3

Saul, euphoria in the market is expressed - a l’outrance - by Shiller’s CAPE for the S&P standing at 27.1 with a mean of 16.6, implying a 38.7% reduction in market value

This issue has been discussed on a number of boards, including I think this one at some time in the past. There is an inherent difficulty in assuming a reversion to the mean in this measure because the basis of the measure has changed substantially, most notably that it is based on GAAP earnings and standards have changed requiring companies to include a number of things in GAAP expenses which they didn’t use to. This means a systematic reduction in GAAP earnings without the company doing one smidge worse. Thus, if anything, I would expect a reversion to what the mean would have been had current GAAP policies been in effect. To my knowledge, no one has attempted to compute what that would be.

Moreover, I think one has to be systematically about assuming that what once tended to be true will always be true. There is much about today’s market which is fundamentally different from the market in the past. The types of companies today are different. The economy is different. We have tons of ETF and MF that we didn’t used to have. HFT is common. Etc., etc. Including, note, the change in GAAP standards. While some observed ratio like CAPE might tend to remain constant across some of this change, that is, at best, an assumption, not a natural law. I think there is just as good a reason to assume that such observations would exhibit systematic secular shifts in response to that change as to expect it to remain constant.

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#4

Shiller’s CAPE for the S&P standing at 27.1 with a mean of 16.6,

I have no opinion about whether the market is currently over-valued, under-valued, or fairly valued. But the Schiller CAPE, as a metric, is terribly flawed. It has made stocks look wildly overvalued since 2010! Here’s a nice analysis of the many problems with it:

http://www.aaii.com/journal/article/a-cautionary-note-about-…

Even if you still think it’s a great metric after reading about all the problems, here’s a quote from an article Morgan Housel wrote in December:

Since 1871, CAPE has averaged 16.6, which makes today’s market, at 26 times earnings, look overvalued. But since 1957, when the S&P 500 was born (Shiller used a hypothetical version before then), the average is 20. Since 1990, when globalization took off and technology stocks became a bigger part of the index, the average is 25.3. So maybe stocks aren’t so overvalued?

http://www.fool.com/investing/general/2014/12/10/how-to-prov…

Neil

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#5

Isn’t it wonderful that everyone is worried about the market and the economy, and nobody seems euphoric?

Yes it is. I love that most of my co-workers are still afraid of the market. I’ll know to start saving cash if anyone of them starts talking stocks. My guess is that the election next year may cause a rumble.

lovepeace

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#6

Choose your metric. I think the problem is that all of them (I am not talking about those used by long-only fund managers on CNBC (surprise: wow, long-only asset-gatherers deliver upbeat market prediction!) give a similarly bad answer, whether you use Tobin’s Q, market cap./GDP or anything else.

When something happens slowly, it is less easy to notice. Euphoria, in the form of the multiples applied to stocks, have been increasing for 5 years. It’s been fun but presumably we can agree on one thing: euphoria (at QE and low interest rates) cannot be sustained forever.

Once, for established companies, paying close attention to PE charts and reversion to the mean was critical to investment. That may have been abandoned under that old friend ‘It’s different this time’) but I doubt it will be suspended for ever.

But we plug on with our investing but I do think the state of advanced euphoria in the market needs to be, as an old song has it, always on our mind.

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#7

Saul, euphoria in the market is expressed… by Shiller’s CAPE for the S&P standing at 27.1

Hi streina,

Surely you are kidding??? Or perhaps you are too young to remember what euphoria in the market feels like: 1999 for instance, when the markets were rising at an insane rate, Yahoo, AOL etc were going up $20 to $50 per day, when taxi drivers and people at cocktail parties were giving you tips on the next great stock, when analysts at Goldman Sachs etc were saying “true this stock is at 200 times revenues, but comparables are at 400 times revenues, so it’s cheap!” That’s euphoria!!!

Right now, the market is stagnant (up 3% in six months isn’t euphoria). All your friends are afraid of stocks, no one is talking about stocks, except on this board, all you hear from the talking heads is about the impending implosion of China, and Greece, and the Euro, and Europe, and the economy, and the market. Does any of that sound like euphoria to you??? No matter what Shiller’s CAPE is saying???

After all, it’s been saying it for five years, during which the markets have doubled. In fact, six years ago, in 2010, everyone was assuring us that a double dip recession was coming. Two years ago I was having a discussion with Mauser (he can chime in if he’s listening) about an indicator that said a correction was right around the corner. It may have been the CAPE. It’s been a long corner.

We have a slow growth recovery from a very deep recession,with plenty of more room for the economy to grow,
zero inflation,
low interest rates,
no wage inflation,
no booming stock market,
still plenty of unemployment, and
every talking head pessimistic, trying to outdo each other with pessimistic scenarios for the future.

NOTHING AT ALL to indicate euphoria.

A great time to be investing in good, well-chosen stocks.

In my opinion!

Saul

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#8

Well said, Saul.

I know of absolutely no one who just can’t wait to pour their hard earned money into this market.

Jim

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#9

The question is, is there actual euphoria or is there only apparent euphoria in the numbers used for analysis? It seems to me that most of it is the latter since the overall mood is full of predictions of decline and that other signs of mindless action are missing.

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#10

Strelna:

You are wise to be cautious and this post does support part of what you are saying as measured by numerous metrics including Shiller:

http://discussion.fool.com/but-if-you-look-into-the-history-of-f…

However, it also supports what Saul is saying regarding whether we are dealing with an impending collapse as in a bubble. Shiller himself has stated (as referenced) that we are not in a bubble and as you probably know, markets can remain “overvalued” by these metrics for quite some time…many years.

This “emotional” aspect (public opinion) does not suggest an impending collapse.

That said, what should concern folks here is that the Fed plans to tighten and the Fed is what created our stock market gains these past 6 years. When they tighten credit and free money/expansion…the market may be in for a downturn. Historically, what is the impact of rising interest rates on the stock market…look at probabilities.

It does sound to me that Yellen may have learned from past Fed created bubbles and wants to tempor growth slowly so maybe small incremental increases may not shock the market.

Saul can speak for himself but I believe he is always on offense in the market (1-2% margin). Defense may be appropriate here but what defines defense varies from person to person and includes approaches like increasing cash reserves for acquisitions, option strategies, interest based stocks and consumer stocks, etc.

What is your defensive posture now that you are sounding the alarm of caution?

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#11

That said, what should concern folks here is that the Fed plans to tighten

Hi Duma, If they tighten a quarter of a point later this year and again twice more next year, that will move interest rates from “just about zero” to “very close to zero” in the next 18 months. Do you see that having an effect on whether people will put their money in stocks or bonds? really? enough to notice?

With deflation currently more of a worry than inflation, everyone worried about the economy, and an election coming, can you even IMAGINE more tightening than that in the next 18 months? No way!

Best

Saul

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#12

Saul:

I think you are correct regarding the impact of the Fed rate hikes and elimination of treasury purchases “IF” they are gradual and more mild. That is why I mentioned that Yellen intimates she has learned from prior Fed Induced bubbles, that having to slam on the brakes can result is rather devastating consequences to the stock market.

Historically, interest rate succession hikes have been bad for the market even though the market does fine leading up to the hike and even the first year.

All this means that we should pay careful attention to what the Fed is doing…it gave us the stock market gains with its unprecedented treasury purchases and 0 interest rates…it can hurt if it tightens in a Greenspan type fashion…that will shock the market IMO. We don’t exactly know what the Fed is going to do and when…heck maybe even the Fed doesn’t quite know as yet.

Otherwise more minor and very gradual hikes may only reduce returns to the 0-7% range. But philosophically, I see no reason to be overly critical of anyone wanting to be more defensive here in light of the Fed’s plans…unless that defense is a complete capitulation. I don’t think that is what you are doing mind you (being overly critical that is) but it does go against your “all in” style of investing.

#13

After all, it’s been saying it for five years, during which the markets have doubled. In fact, six years ago, in 2010, everyone was assuring us that a double dip recession was coming. Two years ago I was having a discussion with Mauser (he can chime in if he’s listening) about an indicator that said a correction was right around the corner. It may have been the CAPE. It’s been a long corner.

And that’s the kicker that makes me almost completely ignore any macro indicators. The “market” has doubled in the last five years, and many of us have likely done much, much better than that. So the market could lose 40% tomorrow and we’re still MUCH better off having been invested than gone to cash five years ago, three years, or one year ago. And the same thing likely holds going forward. I’m not up 40% like Saul is YTD, but I’m still up many multiples ahead of the “market”.

The opportunity cost of going to cash is just too high. Whenever the next major corrections happens, my portfolio returns the very next day after the crash will be still be leaps and bounds ahead of where they would have been had I listened to the talking heads.

Fletch

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#14

We don’t exactly know what the Fed is going to do and when…heck maybe even the Fed doesn’t quite know as yet.

We actually do know what the Fed will do. Yellen has repeatedly said what they will do but most people don’t listen and just keep asking “Are we there yet” like a little kid in the backseat of a car. The Fed is data-dependent. This means that they look at the data to see what employment and inflation are doing and they will make rate decisions based on the data that we get. The data interpretation is nuanced as they look at much information that leads them to an overall view of employment and inflation. Different Fed FOMC members will have different interpretations of the data and thus the overall view of the Fed will be dependent on the views of the aggregation of the individuals’ views. Yellen has also stated that should would like a slow and steady rate increase over a number of years. Of course, that’s what she says now and that is the preferred approach. However, the incoming data could change all of that and force the Fed into a steeper, more aggressive rate increase trajectory if inflation starts rapidly rising.

My personal view and opinion is that we are currently in an excellent time to be investors. I don’t really care so much at the overall market as I am not invested in “the market”; I am invested in 15 stocks that I believe are in a great position to grow. I watch these companies closely and make adjustments based on what I see and what the respective stock prices of these companies (and other companies that I am watching) do.

Chris

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#15

That said, what should concern folks here is that the Fed plans to tighten and the Fed is what created our stock market gains these past 6 years. When they tighten credit and free money/expansion…the market may be in for a downturn. Historically, what is the impact of rising interest rates on the stock market…look at probabilities.

I’d like to offer a slightly different take on the possibility of tightening. I’m in banking, and what we’ve been hearing from a lot of our clients the last couple of years is that they’ve actually held off from making many major capital investments because of uncertainly of the interest rate environment. We have literally been told that people are waiting to make major investments UNTIL rates have gone up to where many of these decision makers feel is a long term, sustainable level.

Many huge capital projects are not financed on fix rate loans, but rather through complicated and multi-tranched financial syndications that often have floating rate components. People are terrified that they’ll lock into a three or five year construction project with an interest only piece and then have to convert to a term loan in 2019 that is significantly higher than it would be today. No one knows what term rate to model five years out, so no one is willing to take the risk of starting the project today.

So I don’t pretend to be able to predict what rising interest rates will do to the financial markets, but if what many of our clients are telling us is true, the sustained low interest rate environment is actually having just the opposite impact of what the Fed has intended (at least as far is business investment).

A slow and reasonable increase in rates to a long-term, sustainable level may actually have the ironic effect of spurring business investment, which will lead to long-term, sustainable corporate profits. And that, generally, corresponds to strong stock market returns over time.

Fletch

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#16

A slow and reasonable increase in rates to a long-term, sustainable level may actually have the ironic effect of spurring business investment, which will lead to long-term, sustainable corporate profits. And that, generally, corresponds to strong stock market returns over time.

Very interesting post, Fletch! But I have one question: if people are uncertain of the future interest rate environment now, why wouldn’t they still remain uncertain about the future rate environment even AFTER the Fed begins to raise rates? They are data dependent and if the data show, say in a year from now, that inflation is getting out of control then Fed may not be able to stick to their desired gradual rate rise.

Chris

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#17

then Fed may not be able to stick to their desired gradual rate rise.

It seems to me that it is degrees of uncertainty. For a while now people have been worrying that the rates would rise again. Of course, we all knew they would rise again and that there was every reason to expect them to rise gradually, but the on-going “are we there yet, are we there yet” speculation creates tension out of proportion to the likely impact of the actual event. When the rates have started to rise and they are rising very gradually, then, sure, there is always a chance that circumstances will change and they will get adjusted more dramatically, but we won’t be asking the question every 5 minutes and I expect that people will be more inclined to expect things to continue as they are going.

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#18

To reply:

I am 65 and remember the tech. bubble well! It was wild momentum investing and fully enjoyable providing you knew it was a bubble and had your mental stop-loss for the Nasdaq always on your mind. The end could scarcely have been more obvious. But the main point was it was a marvellous time to buy tobacco stocks. I digress.

Up 3% in 6 months is a value change, not a level. Shiller’s CAPE certainly has defects and reservations but its level is a good enough rough and ready guide to me.

No euphoria? World debt is appalling; faith in central bankers is misplaced; the situation in China (including suspension of the free market in stocks) is truly mesmerising and not in a good way; the Eurozone could easily break up; Greece is poised for revolution; half the Middle East is in a Sunni/Shia ferment with Saudi facing up to Iran and nuclear proliferation across the area a certainty; the west has decided to let Islamic State win and it is doing so; interest rates simply have to go up (regardless of economic weakness) to prepare for the next recession; when they do, emerging markets… etc. And I haven’t even started on the Baltic Dry.

Any one of these should sink the market down to Davy Jones’s locker. But its response? Up 3% in 6 months. This is not complacency, it’s something more and if it’s not euphoria, I don’t know what is.

On the question of my defensive response: it’s cash. The time value of money/opportunity cost/whatever seems to me completely acceptable as the premium on an insurance policy. I suppose I am about 25% in cash. That it is gently losing money while you fellows are making a mint fully invested is something I can bear with fortitude. I am definitely not trying to maximise my returns. That’s for another time.

Slightly concerned that I am 75% invested. That might need looking at.

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#19

On the question of my defensive response: it’s cash. The time value of money/opportunity cost/whatever seems to me completely acceptable as the premium on an insurance policy. I suppose I am about 25% in cash. That it is gently losing money while you fellows are making a mint fully invested is something I can bear with fortitude. I am definitely not trying to maximise my returns. That’s for another time.

Your approach is quite reasonable and one that I have also taken. You/we have the benefit of market participation whilst we have the “powder” (using that term will almost certainly sink the market) to pick up discounted shares. There is nothing wrong with that approach and even as the market increases, you are still participating.

Greece is irrelevant IMO…some 2% of of the Euro or thereabouts…greater concern is how many other countries in the Euro are in similar debt/unfunded liabilities situations.

China seems more relevant with haulted shares, real estate meltdown and panic.

But back to the Fed…it does seem that many here are exclusively concentrating on the interest rates and disregarding the reduction/elimination of $85 BILLION in treasuries purchasing MONTHLY. That was a fair amount of liquidity the Fed was pumping in and they did not to my knowledge announce “exactly” what they were going to do in that regard or otherwise…neither did Greenspan when he ultimately slammed on the brakes.

But Strelna, anyone who says they know exactly what is going to happen is most assuredly still drinking the 6 year bull market. We are in uncharted territory which is why IMO, play probabilities…what do stocks do in an increasing interest rate environment and one that eliminates massive liquidity introduced by the Fed like never before.

OTOH…we do not appear to be in a bubble so market participation in some amount seems quite reasonable.

Keep in mind also that your being 65 yo, you don’t likely have the luxury of being way off on your approach…a 70% clipping like Saul experienced in a single year could be quite stressful at 65. People on this board come from all age groups and economic means so there is no single recipe for all.

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#20

I’d like to offer a slightly different take on the possibility of tightening. I’m in banking, and what we’ve been hearing from a lot of our clients the last couple of years is that they’ve actually held off from making many major capital investments because of uncertainly of the interest rate environment.

Eh - banks still loan money to businesses? I thought they just speculate on synthetic financial instruments with their own highly leveraged positions.
:wink:
Ant

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#21

Strelna - it’s a very interesting perspective and younger hotheads should absolutely listen to older and wiser heads.

My thoughts on this to figure out this paradox which has seen us facing a very very tough era for the investing psyche - whereby ever since the GFC hit we have had crises and worries permanently being thrown at us but that has not prevent a bull run from happening…

  1. Corporate balance sheets and profitability levels have been restored and some making companies much more attractive in many ways than pre-crisis

  2. There is nowhere left to go - every other asset class looks much riskier and has hit a genuine bubble and bubble popping scenario (housing, commodities, bonds etc)

  3. Private sector looks so much better than public sector which has terrible fundamentals and is attracting all the investment in town

  4. Cash represents a currency risk - currencies are sovereign default instruments in a way so again stocks appear much safer

  5. There has been genuine innovation in business model productivity supported by fairly transformational influences like the cloud etc

  6. US looks way better positioned than any other market from a macro economic recovery (I’m a brit based in Singapore. Do I want to be in GBP, Euro, Yen, Rubles or any of those zombie economies? - no.)

  7. Highly accommodative policies have supported stock market investing (including ZIRP, QE, TBTF back stops etc).

  8. More than any of the above though - we have been reversing from a massive fall and now only reaching all time highs after 15 years on the Nasdaq for instance. Pretty much most of the gains we have seen in the last 5+ years have been basically recovering lost ground.

Ant

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#22

Ant, completely agree with your list 1-7, which is why I am heavily invested, but not 8. The gains are not due to recovering lost ground, but to multiple expansion.

As a result, the approval and credence given to buybacks, acquisitions and other popular engineering of company figures (but not necessarily productivity) may be misplaced.

Our problem is (as you identify) the market is artificial. Wild distortions of the free market across the globe seems to me to warrant caution while still doing our best to make money.

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