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When A Good Indicator Goes Bad: The Shiller CAPE Ratio
This is a very good read and another example of why 'true-isms' can produce inaccurate results, when economic changes, dividend practices, goodwill, and other big factors are not adjusted. I am certainly not saying the current market is woefully undervalued. But I think we have all learned that there have been some huge changes to what is 'normal' in the last 15 years.
Agree with you there, AndyJ. I don't think all that much in general of our new Nobel Prizewinner, but CAPE was never sold as anything but a long term indicator (meaning at least 10 years). It's nothing that Benjamin Graham didn't do, but over 7 years instead of 10. The idea was to get completely through the business cycle and thus avoid the distortions in P/E that come from measuring it during boom years vs. bust years. I think that the general idea is sound, and the 'discovery' that valuations haven't mattered recently when you're well into a bull market run seems to be the most easily forgotten discovery in human history.
They used to say that you could only have one bubble per generation because investors, having been caught up in one, would never forget it, but it seems that P. T. Barnum ("There's a sucker born every minute") and H. L. Mencken ("Nobody ever went broke betting on the stupidity of the American Public") may have had a point.
It seems there is a tendency in finance to consider empirical results as natural laws. Some of these work for a while as a self-fulfilling prophecy. If enough people believe and act on an indicator, the indicator remains valid. Happens with TA all the time, not because of any natural laws. Something works until, it doesn't work any more.
Markets are continually evolving "organisms" subject to massive paradigm shifts. The generational inflow of money into retirement plans in the 90s completely changed the valuation equation because average risk overhang went up. The increasing prominence of indexing instruments increased correlations between stocks and decreased price discovery for individual stocks in the index. Increased use of derivatives have made even some fundamentals moot.
There is no new normal any more than there was an old normal. There is just a snapshot at any time of what the markets respond to. Attempts to divine some laws that guide the markets and worse predict seem like exercises in religion to explain the unknown than science.
Perhaps. Stocks are still claims on the future earnings of companies. But we rarely think of them that way anymore. Just look at the statistics on average hold time for a stock or a mutual fund. They are going to have to start measuring both in DAYS.
Oh, I understand the "new market" all right. Despite the innovations, its a Jesse Livermore market. Different players, but same market. This one wont go to the moon either. And we haven't reached a "permanently high plateau" even if it feels that way some days.
History isn't repeating. But it will likely rhyme.
Comments
Decidedly not short this market, but after five years of a run up I am very wary.
In my opinion we have one more cyclical bear market to go before the secular bear is over.
Interesting times we live and invest in.
Good luck to all and Merry Christmas!
Agree with you there, AndyJ. I don't think all that much in general of our new Nobel Prizewinner, but CAPE was never sold as anything but a long term indicator (meaning at least 10 years). It's nothing that Benjamin Graham didn't do, but over 7 years instead of 10. The idea was to get completely through the business cycle and thus avoid the distortions in P/E that come from measuring it during boom years vs. bust years. I think that the general idea is sound, and the 'discovery' that valuations haven't mattered recently when you're well into a bull market run seems to be the most easily forgotten discovery in human history.
They used to say that you could only have one bubble per generation because investors, having been caught up in one, would never forget it, but it seems that P. T. Barnum ("There's a sucker born every minute") and H. L. Mencken ("Nobody ever went broke betting on the stupidity of the American Public") may have had a point.
Markets are continually evolving "organisms" subject to massive paradigm shifts. The generational inflow of money into retirement plans in the 90s completely changed the valuation equation because average risk overhang went up. The increasing prominence of indexing instruments increased correlations between stocks and decreased price discovery for individual stocks in the index. Increased use of derivatives have made even some fundamentals moot.
There is no new normal any more than there was an old normal. There is just a snapshot at any time of what the markets respond to. Attempts to divine some laws that guide the markets and worse predict seem like exercises in religion to explain the unknown than science.
Oh, I understand the "new market" all right. Despite the innovations, its a Jesse Livermore market. Different players, but same market. This one wont go to the moon either. And we haven't reached a "permanently high plateau" even if it feels that way some days.
History isn't repeating. But it will likely rhyme.