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Dr. Paul Price
Dr. Paul Price
Articles  | Author's Website |

Don't Get Fooled Again

September 10, 2013 | About:

Market High, but Not Dear

Market Technicians will take one look at the following chart and scream “Look out below!” They expect the current peak to be the precursor to another sharp sell-off.

While the patterns looks similar, the fundamentals of those three tops were very different. The year 2000 pinnacle clearly marked an overvalued and unsustainable frenzy. P/E multiples on blue-chips and tech stocks were excessive. The market’s price/dividend ratio was absurd.

The top of 2008 was more a result of crazy credit markets than outlandish multiples. The Bear Sterns fiasco preceded the Lehman bankruptcy which led to the AIG bailout. The banking system was in jeopardy as money market funds and commercial paper became suspect.

The second-half nearly 50% decline blindsided most investors and fund managers because it did not originate from clearly overpriced conditions.


Today the opposite condition prevails. Nominally high readings on the DJIA, S&P 500 and NASDAQ mask what would be relatively reasonable valuations in a normal interest rate environment. In what is still a ZIRP world, today’s multiples are not really high.

A glance at the market’s current price/dividend ratio shows it sitting near the low-end of where it spent most of the past 16 years.


The end of August numbers told the story accurately. Traders who heeded facts, rather than paying attention to the doomsayers and chartists, were picking up bargains in August, not selling.


It is easy to forget that 10-year Treasuries were yielding 6.2% in 2000 and 4.7% as recently as 2007. Those rates provided relatively risk-free competition for equities. Alternative choices to stocks appear extremely unattractive at present.

The takeaway? Don’t be scared by the S&P 500 at 1671 and a 15,063 DJIA. Valuations are far from expensive in a low interest world.


See more value investing ideas here http://marketshadows.com/value-investing

About the author:

Dr. Paul Price


Visit Dr. Paul Price's Website

Rating: 3.8/5 (18 votes)



LwC - 5 years ago    Report SPAM
Another POV:

Current Shiller PE Ratio: 24.10 +0.16 (0.68%) 11:00 am EDT, Tue Sep 10

Mean: 16.48

Median: 15.89

Min: 4.78 (Dec 1920)

Max: 44.20 (Dec 1999)

Shiller PE ratio for the S&P 500.

Price earnings ratio is based on average inflation-adjusted earnings from the previous 10 years, known as the Cyclically Adjusted PE Ratio (CAPE Ratio), Shiller PE Ratio, or PE 10


Brian Flores, CFA
Brian Flores, CFA - 5 years ago    Report SPAM
Dr. I think you make a valid point, but the real underlying question is: How sustainable is this scenario? ie How long will rates stay the same? What will happen when the IR start going up?

Roark1 - 5 years ago    Report SPAM
What about today's high corporate profit margins? A number of value oriented investors (including the folks at GMO) note that profit margins tend to mean revert over time. This leads them to conclude future returns are likely to be modest from today's levels.

How do today's high corporate profit margins factor into your outlook?
AlbertaSunwapta - 5 years ago    Report SPAM
^ Exactly what worries me. The fuzzy macro stuff that is quite empirically solid. Marty Whitman's focus on companies not needing to go to the market for financing may be the focus to take going forward. Hussman, Grantham, Klarman, Watsa et. al. have expressed some concerns. Hussman and Watsa are both hedging their portfolios. Klarman said he'd be selling into this spring's rising market.

Also, there's ZIRP and there's FX. As in the 1930s I'd say there's a higher risk of competitive exchange rate devaluations occurring in some unexpected way that may blindside Fed policies. Also, when the Fed. Reserve stops buying, who will replace it in the market? Would yields move up in its absence? Going forward any interest rate normalization, in a non-deflationary environment, will probably mean companies then needing financing will see their profit margins squeezed as their costs rise. The window of opportunity in insanely low cost financing may be closing.

Of course, there's also budget deficits etc. but what is a deficit to one person or country, is an income to another. That fact though doesn't reduce the likelihood of knee jerk reactions to spending cuts and the commensurate instability when deficits are eventually addressed.
Vgm - 5 years ago    Report SPAM
Nice piece Paul. Thought-provoking as ever.

I agree valuations on US equities are not stretched for the reasons quoted. Buffett has said as much in recent times.

In this new interview with Howard Marks, he makes two salient points which I think support your thesis. Don't be swayed by the title until you've listened:


1. US equities are in a relatively balanced state (contrast with 2000)

2. The general atmosphere in the financial markets is one of caution, where no-one is acting carefree and unaware of potential dangers (contrast with 2006-7)

Further, he makes the point that the US is growing more strongly than (say) Europe, and the "range of outcomes" is narrower.

In my view, there's too much repetitive doom-mongering from amateurs which lacks rigor, is generic, and is devoid of solid rationality. The comments above by AS are a good example - simplistic meanderings about many topics which add nothing to the discussion.

Our Dr Hussman is nothing if not rigorous and quantitative, but he's driving looking in the rearview mirror. He's been calling CRASH! since 2010.
AlbertaSunwapta - 5 years ago    Report SPAM
^ Sorry if I meandered. I tend to draw my aggregate market views from all over the map. As a result I'm very rarely blindsided on the downside. As for any of my statements being "doom-mongering", I don't see it. In early to mid March 2009 I was picking BRK.a shares as they plummeted at the peak of the crisis to stupid values. That's how optimistic I am. I continued to buy into the spring of 2009. Then again I bought stocks heavily during the screwy fall 2011 downgrade crisis. It wasn't until May this year that I raised cash levels substantially. You can't call that behaviour as doom-mongering. Moreover,I don't need daily up market confirmation or commentary to feel good about my positions. (I'm out of my indexed positions and holding non-"generic" positions.

As for ranking me in with amateurs, that could be a complement, however, my personal amateur equity investment experience is closing in on 38 years. (Professionally I spent over a decade in front of a Bloomberg Professional terminal.)

So VGM, the bottom line is that in the short-term, for traders and the leveraged, Price makes very valid points, however the first posters above took a longer-term perspective and so have concerns about mean regressing profit margins and a discontinuance of the ZIRP and what that will do to market conditions. No one knows or has useful data so we're left with WAGS. And it's not only the amateurs that look a few years down the road. You may recall Prem Watsa, Buffett, the BoE, et. al. all engaging in similar ramblings over the fate of commercial paper securitization, derivatives, etc. Just take a look at that old Fairfax annual report where Watsa was preparing years in advance for the possibility of a "perfect storm".
Vgm - 5 years ago    Report SPAM
AS -- it's not about whether this article is correct, I'm suggesting that we strive to raise the level of our thinking and writing. Your first comment above comes across as a random selection of vague and poorly developed thoughts. They have nothing to do with "aggregate market views", but rather they betray a lack of disciplined thought and absence of rigor. It's typical herd-speak - sounds important but has low or no content on closer examination. I'd like to see Munger read it with a straight face.

The word "amateur" is not related to age or experience. There are plenty of young contributors on GF who present extraordinarily well.

I'm thoroughly aware of Fairfax's (by the way, it wasn't primarily Prem) anticipation of the recent crisis. Howard Marks was onto it too, and others. But as Marks explains in the video I linked above, the current situation is not analogous to that of 2006-7.
AlbertaSunwapta - 5 years ago    Report SPAM
Funny that you say that about Munger. Many years ago it was like-thinking Buffett that sent me two compilations of his old letters, out of pity for my chaotic thinking I presume.

I'd say Mr. Price legitimately denigrates the doom and gloom spewing Chartists however, once a market starts to move, other factors begin to come into play as marginal players good or ill fortune correlates in unexpected ways. As Price says: "The second-half nearly 50% decline blindsided most investors and fund managers because it did not originate from clearly overpriced conditions." That to me is also an accurate statement and it reveals the general lack of rational and rigorous thinking taking place at the time. They couldn't see the forest for the trees. To compound their error, many of those that were blindsided adopted irrationally pessimistic views that persist to today. Still, some of those persistent fears aren't irrational. They are real and ratios and data won't reveal them. That is no reason to ignore potential threats or scenarios that may again blindside the more narrow thinking market players.

For example, as early as 2005 smart money was pulling out of real estate in a big way due to narrow sectoral valuation concerns. A few rigorous thinking real estate pros knew their sector was wildly out of whack. However, they likely didn't see the bigger picture that guys like Watsa saw - the securitization and moral hazard issues. Many didn't even see the valuations as being unreasonable, all other things remaining the same of course. In the derivatives market there were obvious issues but that didn't stop major players from expanding their exposure. I'd guess that Buffett's rather fussy thinking on daisy-chain and correlation risk didn't provide the rigorous thinking they required before they would have someone watch their flank. The folks dealing with AIG, et. al. I guess would have required some very analytical academic research highlighting the risks they were taking before they would change their ways.

The broader market problem was the total lack of interdisciplinary thinking of the sort that Buffett, Munger and Grantham engage in.

Today, we have an economy in recovery being somewhat aided by various interventionist forces. We have trade imbalances and currency issues and political instability. All present great opportunity. It's a pretty good if not very good situation overall. We just can't forget what Taleb pointed out: bad things happen with greater frequency than we lead ourselves to believe. Thus always think about the downside.
Vgm - 5 years ago    Report SPAM
"...out of pity for my chaotic thinking I presume."

Yes. No doubt. A series of vague and woolly thoughts does not constitute thinking, and any conclusions based on them will be erroneous. Rigorous thinking is the "rationality" Buffett and Munger talk about. Bertrand Russell once remarked: "Most men would rather die than think. Many do." It's absolutely true.
AlbertaSunwapta - 5 years ago    Report SPAM
So this is that specificity that you're aiming for in these thread discussions:

"1. US equities are in a relatively balanced state (contrast with 2000)

2. The general atmosphere in the financial markets is one of caution, where no-one is acting carefree and unaware of potential dangers (contrast with 2006-7) "

Or, coincidentally, today we can look at the less vague and woolly thoughts from another fairly successful investor. Here's what Druckenmiller just said:

“I really don’t care whether we go to $70 billion or $65 billion in September,” Druckenmiller said. “But if you tell me quantitative easing is going to be removed over nine or 12 months, that is a big deal.”

The purchases have subsidized all asset prices, he said, and completely stopping them would mean “the market will go down.”


My comments above mentioned the predictability of profit margin mean reversion and stock selection based on cash flow and balance sheet strength (Whitman) to avoid interest rate financing exposure. I also simply asked who will replace the Fed when they stop buying (the end of ZIRP). I also highlighted this fall's (and likely many more for several years to come)... upcoming US budget negotiations and the possibility of a repeat of prior knee-jerk market reactions. Vague and wooly, meandering thoughts, yes. Of course, we need not worry, ZIRP will in reality live forever. :-)

Vgm - 5 years ago    Report SPAM
AS -- LOL! You not only misunderstand, but you misrepresent. Please re-read Russell.

Good luck.
AlbertaSunwapta - 5 years ago    Report SPAM
Please explain.


That was a direct quote from your post.

Anyway, back to the thread premise. Personally, I don't see measures of cheapness or reasonable market value implying a short-term movement towards full valuation. Cheap stocks can become even cheaper and so can markets. At the short-term May market peak, investor concerns over a pulling of the great subsidy arose. I don't know if those fears have disappeared. Owning the market and hoping for continual short-term price recovery and/or further price gains based on leveraging today's artificially low financing rates in my view is risky. Owning specific companies substantially immune from market concerns of course is far less risky.

I do agree with Price that the recent high is very different from the prior two peaks. That should be expected, and market technicians and chartists pointing at peaks and equating them is meaningless. Any prior market level can be substantially overshadowed by the next upward cycle for any number of reasons and the fundamentals driving each cycle can have little to no correlation with the prior peak.

And now a quote highlighting the fuzziness required when thinking of the future but the concern that history sometimes may rhyme... Prem Watsa on hedging...

" And the second is just because we are all here very big fans of Ben Graham, Ben Graham said in 1925 -- in the '30s, he said, after the Crash, after the Depression took hold, that if you weren't bearish in 1925, there was a 1-in-100 chance you'll survive the Depression, 1-in-100 chance. If you weren't bearish long before 1929, meaning 1925, there was a very small chance you survived. So we are very concerned. We don't take this lightly. We're watching this very, very carefully. I mean, if we hadn't hedged, we'd make, I don't know, another $500 million, something like that. Now we can easily buy corporate bonds. We've been in the business for 40 years, and they're stepping away. We think you're not being paid for risk, so we're stepping away from the marketplace. I'll remind you, then, in 2008, 2009, when stock markets were down, we were fully invested. And when spreads were wide, we bought corporate bonds and we bought all sorts of bonds. Today, we think there's a significant amount of risk, and we think you have to be very, very careful. And there's all sorts of unintended consequences in the marketplace because of what's happening in the United States, particularly, but perhaps elsewhere. And so this is our way of protecting ourselves, like we did with our credit default swaps, and just being very, very careful." - Prem Watsa, August, 2013 Transcript source: SeekingAlpha


Vgm - 5 years ago    Report SPAM
"And now a quote highlighting the fuzziness required when thinking of the future"

AS -- please understand that this has zero to do with fuzziness. It reflects a range of outcomes of the kind Howard Marks also talks about. It's good stuff as always from Prem Watsa. I can't think of anyone less fuzzy than Prem.

You just don't get it. It's YOUR rambling unfocussed thoughts I've been referring to and which you need to look at. Not Prem Watsa. He's doing OK :-)

Goodbye. Good luck.

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