Monday, March 7, 2011
Bubbles are Back
In Why Stocks Tanked (It's Not Just Libya), Brett Arends explains why we might be in the mist of another bubble. Already? Are we a bunch of fools? But how can we be sure? What if the bubble lasts for a few more years? And what are you going to do if you decide not to play the bubble?
Well the answers to these question are: 1. Yes, we are probably already in overvaluation territory. It certainly looks like many stocks are far from being bargains; especially given the uncertainty out there these days. 2. Yes, we are a bunch of fools who have no idea what the future holds for us. 3. The bubble probably has a while to go; barring an accident such as a $150 barrel of oil due to wars in the Middle East. 4. The best strategy is to invest in the Super Firms, a concept I introduced last year. These firms have not overperformed the market during the last two years and are still relatively cheap.
Just look at this measure of stock valuation, Tobin's Q (Click on the picture to enlarge) to convince yourself that historically we are approaching a peak. It's not very reassuring.
Here is Brett Arends' article recently published in the Wall Street Journal:
"It's not just about Libya. There's another reason the stock market just took a hit. Everyone had become way too bullish and way too complacent.
"Pride, as they say, goeth before a fall. When everyone's bullish, who is left to come in?
"We're slap-bang in the middle of another mania.
"How crazy have people become? Last week a portfolio manager I know told me about a conversation he'd just had with one of his clients. This manager runs a conservative practice. His clients are solid, sensible types—some old money, and some new money that thinks a bit like old money. One of his clients, a partner in a small private firm, had called him up and said, casually, that he and his partners were discussing this year's bonus pool. "We're thinking about putting it all in Apple stock for the year. What do you think?" he asked.
"The portfolio manager thought the guy was kidding. "No, we're serious," the client replied.
""Why not?" he went on. "I mean, it's not like Apple's going to go down. It's a sure thing."
"Yikes. You see this type of stuff when animal spirits are soaring.
"No wonder IPOs are back on the menu. The time to take your company public is when the investors are rushing around with their checkbooks open.
"A few days ago, while everyone was watching events unfold across the Arab world, an intriguing document came across my desk. It was the monthly Bank of America/Merrill Lynch survey of the world's top investment managers.
"Bank of America spoke to 270 institutional investment managers—with a thumping $773 billion in assets—around the world and asked them for their views on the markets.
"In a nutshell? They were about as euphoric as they have been since the late 1990s. "Institutions have record equity and commodity overweights, very low cash levels and the strongest risk appetite since Jan '06," reports Bank of America. Cash had fallen to 3.5% of assets—a dangerously low level. BofA research says that in the past, when it has fallen that low a stock market "correction" has usually followed in a matter of weeks.
"Our old friends the hedge funds are back to where they were before the crash. According to the BofA report, hedge funds are betting as heavily on booming share prices as they were in July 2007, and the last time they were playing with this much borrowed money was in March 2008. Ah, the happy memories ...
"There are no certainties in the markets, but the Bank of America/Merrill Lynch survey is among the better indicators. On the occasions when it has shown sentiment at extreme levels, it has often proven an excellent "magnetic south," pointing you in exactly the wrong direction. If you had sold when everyone was crazy bullish, and bought when everyone was crazy bearish, you would not have done badly over the years. After all, the big institutions are the ones that bet the big money. If they are already loaded up to the gunwales with equities, who's going to be the next buyer?
"It isn't just the institutions, either. The individual American investor, who has been selling stocks for most of the past couple of years, has suddenly turned tail and started buying again. Portfolio managers will tell you their clients have been back on the phone since the start of the year, eager to get in on the action. The Investment Company Institute, a trade organization for mutual funds, reports big inflows of new money into stock-market funds since early January. Indeed, inflows into U.S. stock funds have been running at levels not seen—but for a single brief spike in 2009—since well before the crash.
"Sentiment is one thing. Valuation is another. And Wall Street is frankly expensive by most measures. The dividend yield on the overall market, according to FactSet, is a measly 1.5%. The last time it was this low for any length of time was during the great bubble years of 1997 to 2001. According to data tracked by Yale University economics professor Robert Shiller, the market overall is priced at about 24 times cyclically-adjusted corporate earnings. That is very high; the average is about 16. Last week I screened the stock market for good dividend stocks: blue-chip companies whose shares are selling cheaply and which offer decent yields. The ranks are pretty thin these days. Everything has boomed.
"White-shoe fund company GMO has just published its latest investment forecasts. From today's levels, it says, investors are looking at pretty slim long-term pickings. Indeed, it thinks typical investors in U.S. equities will be lucky to make money, after inflation, over the next seven or so years.
"None of these indicators are dispositive. Nothing in the investment world is ever more than about 80% certain. Last week I spoke to a brilliant hedge-fund manager I know, and he was a raging bull. But then he's trading on short-term moves, and he's been buying things like distressed European financial stocks, where the bold (or foolish) may yet find bargains. It's a dangerous game.
"For anyone looking to make long-term investments, the situation right now offers plenty of grounds for caution. And it's not just because of Libya."