Saturday, May 25, 2013

the market is (still) overvalued

It's that time again.

A growing group of pessimists are asking whether the stock market is back to bubble territory. Some are even comparing it to 1999. They say stocks are being inflated by the Fed. That they're disconnected from the reality of a weak economy. That they're overvalued and bound to fall.

Could they be right? Of course.

They make a forceful case with charts and ratios and historical data.

But they have been making the same argument for four years now, and they have been wrong all the way. Clearly, the world is more complicated than the pessimists assume.

Consider that the S&P 500 has risen as much as 60% since these quotes went to press:
"The S&P 500 is about 40 percent overvalued" -- October, 2009
"US Stocks Surge Back Toward Bubble Territory" -- January, 2010
"On a valuation basis, the S&P 500 remains about 40% above historical norms on the basis of normalized earnings." -- July, 2010
"Is The Stock Market Overvalued? Almost Every Important Measure Says Yes" -- November, 2010
"The market is as overvalued now as it was undervalued [in early 2009]," said David A. Rosenberg, chief economist and strategist for Gluskin Sheff, an investment firm." -- March, 2010
"Andrew Smithers, an excellent economist based in London, is telling us that we're way too optimistic, that fair value for the S&P 500 is actually in the 700-750 range. Smithers, therefore, thinks the stock market is about 50% overvalued." -- June, 2010
Sure, you might say these calls were just early. But let me put forth a truism in finance: When an average business cycle lasts five years, there is no such thing as four years ahead of the game. You are just wrong.

Some of the bubble arguments haven't changed in the face of a 50% rally. Take the cyclically adjusted price/earnings ratio, or CAPE. In 2010, the S&P 500, which traded near the 1,000 level, had a CAPE valuation of around 22, which many pointed out was about 40% above historic norms. Today, trading above 1,600, the S&P 500 has a CAPE of about ... 23. Even as the market exploded higher, the degree to which the market is supposedly overvalued hasn't changed that much, since companies have been busy investing in their operations and boosting earnings. That's why being four years early means being four years wrong.

Some people predicted the financial crisis in 2008. And good for them. But many of them also predicted a financial crisis in 2007, 2006, 2005, 1997, 1995, 1992, 1985, 1970, and so on. They are perma-bears who get ignored during booms and lionized during busts, even though their arguments rarely change. It's the classic broken-clock-is-right-twice-a-day syndrome.
Author Daniel Gardner wrote earlier this year:
In 2010, [Robert] Prechter said the Dow would crash to 1,000 this year or in the near future. The media loved it. Prechter's call was reported all over the world. Which was nice for Prechter. 
Even better, very few reporters bothered to mention that Prechter has been making pretty much the same prediction since 1987.
It was similar for investor Peter Schiff. There's a great YouTube video -- worthy of some 2.1 million views -- of Schiff predicting a market crash circa 2007. That was an excellent call. But here's another video of Schiff in 2002 predicting all kinds of gloom that never happened. Sadly, that video received only a handful of views. Gardner writes in his book Future Babble:
[Schiff predicted the 2008 crisis,] but it's somewhat less amazing if you bear in mind that Schiff has been making essentially the same prediction for the same reason for many years. And the amazement fades entirely when you learn that the man Schiff credits for his understanding of economics -- his father, Irwin -- has been doing the same at least since 1976.

What do I think?  Well, AAPL has a P/E of 10.6.  MSFT has a P/E of 17.7 (forward P/E of 10.8).  Berkshire Hathaway has P/B of 1.4 (higher than low of 1.1 in 2011).  CSCO has a P/E of 13.1.  I would say these stocks aren't overpriced.  The current P/E of VFINX is 14.28.  While not cheap, that still sounds quite reasonable.

The argument is that current earnings are inflated.  I can see that the growth rate will slow, but I still see overall eps increasing from here, if only moderately.

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