Dear friends,
It’s a Tale of Two Parties, one rather healthier than the other. My students, slowed by a surprisingly cold month and end-of-term stress (Augustana is finishing a Winter trimester that began a bit after Halloween and ends near Valentine’s Day), have taken to launching spontaneous little parties in hopes of gathering that last burst of energy needed to make it through a last set of research presentations and reflective essays. Lionel Ritchie (whose name they barely recognize) captures the late winter moment: “Party, Karamu, Fiesta, Forever. Come on and sing along.” On whole, that strikes me as joyful, appropriate and, ultimately, productive.
The other party rather less so.
“Going so soon? I wouldn’t hear of it. Why my little party’s just beginning.”
Wicked Witch of the West, in L. Frank Baum, The Wonderful Wizard of Oz (1900)
I have never been much of a fan of any parties, but two draw my gravest reservations: (1) those in my honor and (2) those hosted by Wall Street. I’m safe from the former, at least until the end of May, but may be getting dragged into the latter. Two forces have been kept in balance in recent years: the stock market is increasingly overvalued but no one is very enthused about it, so it stumbles ahead without dramatic rises or falls. The first remains true, the second is in jeopardy.
The stock market is overvalued. Unless you believe that stocks are worth precisely whatever someone last paid for them (that is, that they’re never overpriced because someone just saw value in them), the stock market is overvalued. Way. Way, way, and for a long time. The folks at the Leuthold Group track about 30 different valuation measures, several of which focus on the valuations on the median stock in an index. Why median? Because the valuation of the “average” stock mostly reflects the valuations of an index’s largest stocks. By way of example, just five stocks (Apple, Microsoft, Facebook, Amazon and Alphabet) comprise 13% of the S&P 500. Looking at the median stock (the 250th cheapest or 250th most expensive, depending on the direction you’re looking from) avoids that bias.
So, where are we? Quoth Leuthold: “the broad U.S. stock market is more overvalued than at any time in history”(Perception for the Professional, January 2018).
That has, of course, been true for quite a while now. Low interest rates have suppressed interest in fixed-income investing and the move to “passive” investing has kept many portfolios fully exposed to the stock market, where once their managers might have begun reacting (or, admittedly, reacting foolishly) to the market’s moves.
Investors are (finally) starting to get excited. That’s never a good thing. Lisa Beilfuss, writing for the Wall Street Journal, notes, “after sitting out most of the nearly nine-year bull market, individual investors are finally pouring in” (“Retail investors jump into the market,” 1/27-28/2018). Discount brokerages saw surging activity at the end of 2017 and on into January 2018. One analyst warns that FOMO is setting in: Fear Of Missing Out. At Ameritrade, which saw a 72% rise in new accounts established by younger investors, cash flows are being driven by interest in cryptocurrencies and cannabis. E*Trade affirmed, “Crypto and cannabis … volumes have been up big.” Those investments are being financed, at least in part, by peoples’ decision to stop saving money: the US personal savings rate fell in December to its lowest level since the days of the housing bubble. All savings activities combined (college, retirement, savings accounts and so on) consume just 2.4% of disposable income. That’s down by 65% since the modest peak in the aftermath of the financial crisis. That’s helped pay for 14 record highs recorded in the S&P 500 just during January, the most in a single month since 1955. NASDAQ records, 13 of them, match what we saw in December 1999, at the climax of the tech and telecom bubble. When records fall in quick succession, we’re experiencing price acceleration which is, according to three Harvard economists, “the strongest indicator” of an impending peak (Greenwood, et al, “Bubbles for Fama,” 2017).
So where do we go from here? Quite possibly to a party. Stock markets tend to have climactic “melt-ups” in which crazed investors buy anything they can and whatever price it takes. It’s sort of akin to the feeding frenzy of tuna: toss a bit of chum in the water and the fish become so frenzied that they’ll even attack unbaited hooks. By how much might the market rise? In their January report for professional investors (Perception), Leuthold made a simple calculation: if the median stock matched the highest recorded valuation ever, on every measure, then the market would rise 5.1% further.
Oops. The broad U.S. market rose 5.4% in January, pushing through Leuthold’s “crazy but credible” ceiling. Jeremy Grantham, founder of the institutional investment firm GMO, is more optimistic in his pessimism; “we are currently showing signs of entering the blow-off or melt-up phase of this very long bull market” with an eventual S&P 500 top around 3400 – 3700. That is, if historical patterns repeat, the S&P 500 might reasonably (?) be expected to rise 20-25% further.
Woo hoo!
Followed, he fears, by a 50% decline. Leuthold suggests that just returning to our modern “normal” valuations – the median valuations seen since 1990 – would require a 24% decline from here. If the S&P 500 does indeed inflate to the 3400 -3700 range, the decline would be a bit over 40%. Of course, if we again saw the kinds of lows we’ve twice experienced since 1990, the decline would be 64% from here and … well, 73% from Grantham’s hypothetical peak.
Happily, the fact that other people are being stupid is not a reason for us to join them. A soaring market does not justify throwing Bitcoins at marijuana entrepreneurs, nor does the prospect of a falling market justify a panicked flight to cash and stocks of survival biscuits. MFO’s position is always the same: don’t put more money at risk than you can afford to lose, create an asset allocation plan that’s appropriate to your needs and risk tolerance, invest in vehicles that have earned investors’ faith over time … then move on to more important topics, like enjoying life and making a difference in the lives of others.
We’ll try to help. Our March issue will include my annual portfolio disclosure, recommendations for getting a little balance in your portfolio, cash-heavy funds (think of them as light hedge funds, since cash is the ultimate uncorrelated, defensive asset) that managed double-digit returns last year (we call them the “15/15 funds”) and profiles of two funds that consistently get it right. We hope you’ll stick around for the adventure.
Thanks go to . . .
Your generosity continues, and we appreciate it. Many, many thanks go to those who made contributions in January. Some of you subscribed to MFO Premium, some sent us a check, and many made contributions through our PayPal link. We’re grateful for every one. In particular, we’d like to thank Cecil, the Kaspar family, Raal, Gary, Sharon, Mark, Pete, Malcolm, Greg, Michael, Andrew, Dan, OJ (a mighty wave to you, from Chip!), Ted a.k.a. The Linkster, David, Harold, Haim, Tom, Bob C, Marva, Deb, Brian, William, Nate, and the folks at Gardey Financial. We recognize the names of many folks who have, out of a sense of right, supported us year after year; we sometimes sit around, talking about you and wondering how you’re doing. Really. We hope we’re able to make a difference.
Thanks, as ever,
