måndag 8 december 2014

Stocks are ridiculously expensive - so what? 4 OTHER things to do with your money than gamble in a loser's game

Who cares about your "multiples" and valuation measures grandpa?

OK, so we can all agree that stocks are more than 100% more expensive than typically (that is if we use historically relevant, and price margin neutral, measures such as MarketCap/GDP [150% above] or Price/Sales).

So what? They were 50% above the historical average a while back, and stocks have gone up since then. What's to keep valuations to go to 150% of the historical norm? Yellen will keep printing money, won't she?

Some valuation measures from Hussman
vs. the historical average

So, what do you suggest I do? Just sit on it?

And what else can you do with your money? You're not getting more pay and most things you need are becoming more expensive. You can't retire on zero interest, right?

Wake up! It's a new paradigm, old-timer

There are soooo many arguments sloshing around for why this time is different. And if not that, you just "don't fight the Fed" and of course remember that "the trend is your friend".

That's how most people view the stock market these days: money printing rules all, there are no alternatives anyway and follow the trend - as if fundamentals and value creation really have nothing to do with stocks. Besides, everybody else is buying... I mean, what better argument can there be than that everybody else is doing something? (sic)

Know the odds before you gamble. Do it for fun if you like

I'm not saying you should short this market. I'm actually not saying you should do anything at all. I'm just saying you should choose your investments carefully. Either you know what you are doing, know the risks, have adjusted your exposure accordingly, or you are just gambling. If it is the latter, you at least should know against what odds you are gambling:

  1. Stocks are the most expensive they have ever been (on some measures; other have valuations at 15% below the all time peak in year 2000). Just check out a couple of Hussman's weekly letters if you want more details.
  2. Trend uniformity has imploded (e.g., fewer stocks lead the market to all time highs)
  3. Junk spreads are widening
  4. Micro internals show mini flash crashes every day
  5. There is hardly any real stock market turnover left - it's all robots trading with robots, picking pennies
  6. Other assets are signaling distress or manipulation: oil, gold, currencies
  7. Average returns after all time highs are rarely good even if stocks keep sett ing new all time highs for a while. If you have lived to see a new all time high and then an additional 10-20% upside from there, history tells you to sell.

Oh, I almost forgot, then there are the fundamentals too

And that's before even looking at fundamentals (or the Fed). The above is part and parcel of "the trend is your friend" arguments and the pattern above is not a trend you want to rely on (a disciplined and informed trading strategy or single stock investment strategy might still work - if you know exactly what you are doing)

Just don't forget fundamentals such as: growth has not improved (it has worsened) since 2000 or 2007, debts are higher since then, interest rates are lower (can't be lower than zero - the effect of money printing vs negative rates is unclear though), the catching up that the BRIC countries did in 2000-2007 (and in 2007-2014) has progressed much further and there is not much more juice left in that engine. Actually the infrastructure boom in China that helped both Brazil and Russia was debt financed and is mostly over. The general growth boom that fueled oil prices and the Russian bonanza also seems to be a thing of the past.

Over time, the stock market has done a good job valuing profits and cash flows. On average, or rather like a stopped clock, showing a benchmark around which the stock market swings like a drunken lunatic. Anyway, unless you really think this time and for the foreseeable future we really live in a new paradigm, rest assured that fundamentals will assert themselves again.

House prices can never fall, yeah right!

Average house prices will never fall, they said. IT stocks are to Buy and Hold forever, they said. Are you going to trust them again when they say Money printing will make stocks rise forever?

Debts feel like a free lunch, until they make you lunch

In addition to the above, spending and profits are much higher compared to income and sales vs. historical averages. The reason is everybody is relying on debt and more debt. However those are debts that will never be repaid but will have to be restructured at some point. When debts go into reverse markets typically crash (a debtor fails to pay, and the next person in line fails too, market interests rise to compensate for risk and losses, more people fail and more institutions make losses. In the end even some banks fail. The higher the debt and the lower the interest rates are, the closer the Minsky Moment of a depressionary deleveraging is.

Money printing in itself doesn't cause markets to rise - it's the belief they do that does

The only thing that is holding this house of cards up is the belief that money printing will work to push up asset prices, no matter what it does to the economy.

Some hope for higher inflation to either kick-start the economy, deflate debts or simply make real assets more worth in terms of money. Others think that low interest rates will prevail for so long, that even just 1% return per annum from stocks over a decade or two is better than any alternatives. Nota bene that these are diametrically contradictory arguments.

Sure, there has been a leakage from bond investors and cash holders into the stock market but there is no mechanistic relationship between Quantitative Easing and rising stock markets. Also, don't forget that the Fed lowered rates frantically throughout the TWO 50% falls that ocurred in just the last decade.

Even if money printing worked, it also means stocks will yield sub-par returns for a quarter century

A 5%-points lower interest rate than normal for one year only means stocks or other assets could be reprised upward by 5% in that year. Stocks however are 100-150% overpriced, meaning they discount interest rates that are 5% below norm for 25-30 years going forward. It also means that stock market returns will be 5%-points lower per year than usual for those 25-30 years. That's what discounting means.

OK, so what's new here? Really? In one short word: Internals. Markets are breaking apart internally, despite making new highs every week. Industries, non market cap weighted indicies, smal caps, oil, gold, volume, bond spreads... Everything is screaming "get out!" but the trend and the inclination to buy the dip has become so strong that markets keep going up, despite already having lost their foothold.

So what can you do?

You can always wait.

You can always choose to look like an idiot now rather than afterward.

You never have to get rich on stocks (and you certainly don't have to or need to get poor on them either). You can always focus on your work on your house on your skills. Focus on what you can control and constantly build on instead of gamble in a loser's game. Remember, if you don't know who is losing at the poker table, it is you.

  1. Either just sit on the money (bonds or bank account - if you trust the bank or the government) or... 
  2. invest in your own business or something else than the average stock - something you understand
  3. Even a little gold or bitcoins might be better, or...
  4. if you can find cheap but potentially productive land somewhere you actually want to be (just don't buy unproductive and unattractive land or overspeculated real estate)

4 kommentarer:

  1. Given the likelihood of future hyper inflation, how would equity prices respond during a recession when international money supply continues to increase?

    From what I see, equities appreciate via inflation despite no real growth, or go bust heading to bankruptcy.

    1. So many variables, so few useful predictions.. ;)

      In Weimar 1923, in modern day Venezuela and Zimbabwe stocks skyrocketed but you would have Bern better off buying gold, at times real estate, and always anything outside the country.

      Stcks will rise with nominal profits over time +/-90% or so. Hence inflation propels stock prices. But inflation also erodes the real economy, i.e. real profits.

      Unless inflation is extreme, stocks will fall (crash even) sooner or later if they started out expensive. IF inflation is extreme you want to leave the country anyway.

      In Lords of finance, L.A. describes how various asset classes in Germany took turns being the best way to protect wealth (gold, stocks, real estate, currency) but any missed turned or trade could cost you more or less all.

  2. I guess I'll spend my cash hiring more talented writers then...

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