We are now in the eleventh year of the longest bull market in history, and every day the major stock indexes continue to make new all-time highs. Why is this? Is it because the economy is doing better today than it has at any other point in history?
Value investor Howard Marks (Trades, Portfolio) does not think so. In his opinion, this record rally is "liquidity-driven,"’ meaning that it has been caused by investors having too much money to spend rather than by a reasonable improvement in underlying economic fundamentals.
And it’s hard to disagree with him - earnings for the S&P 500 have remained largely flat over the course of the last five years, whereas earnings per share have risen due to an increase in buyback activity among the major constituents of the index. Taken together, these factors suggest that investors should have a lower appetite for risk, and yet the opposite seems to be happening. To illustrate this point, the U.S. got closer to all-out war with Iran than it has in decades, and yet the stock market shrugged off this fact as a mere hiccup.
No price too high?
“I think that 'no price too high' is the ultimate sign of a bubble, a widespread error. It’s not what you buy, it’s what you pay for it. Any given stock, or investment, can be good or bad. Bad if it’s expensive, good if it’s cheap.”
That was Marks speaking in an interview with Bloomberg earlier this week. Let’s apply this logic to the market as a whole. Right now, the Shiller price-earnings ratio (also known as the cyclically-adjusted price-earnings ratio), which measures how expensive the S&P 500 is running, is at significantly elevated levels - somewhere around 31.5. For context, the historical average tends to run between 15 and 20. In fact, the only time in history when the Shiller ratio was at a higher level was at the height of the dotcom bubble. In other words, the market is more overvalued today that it was on Black Tuesday (1929), Black Monday (1987) or the at the start of the financial crisis of 2007-08.
“Too much money chasing too few deals” is another Marks-ism that the veteran investor likes to deploy, and I think it’s a good explanation for what is happening right now. The desire to be involved and to do something in the market can often be so overpowering that even professional money managers succumb to it. Indeed, there is an argument to be made that the professionals have even more reason to chase valuations higher, because inaction is so often assumed to be a sign of incompetence, even when restraint is the wiser move.
One investor who has not joined in the feeding frenzy is Warren Buffett (Trades, Portfolio). His Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) has amassed an enormous $128 billion in cash and is waiting for an opportunity to deploy it. If that isn’t a sign that we are in an overly expensive market, then I don’t know what is.
Disclosure: The author owns no stocks mentioned.
Read more here:
- Warren Buffett: Do Successful Investors Have to Be Math Geniuses?
- Stanley Druckenmiller: Invest In Post-Brexit Britain
- Charlie Munger: Be a Generalist in a World of Specialists
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