Find someone who sees a certain future, and we will find a dreamer every time.
Five long years from the bear market bottom of 2008-09, asset pricing in most risk markets is downright garish again and a few participants are expressing some concern. This week some have been announcing a defensive shift: moving some capital to what they describe as more “conservative” “value” sectors (ie., the ones that typically fall 25 to 40% in bear markets) and away from the more “aggressive growth” sectors (that typically fall 40 to 70%). Others are explaining why they have chosen to raise cash levels to a shocking 5%(!) See: Investors pile into cash. What practical “liquidity” or “buying power/security” 5% cash offers, while 95% of their portfolio remains strapped to plunging markets, is never explained of course.
To keep this nascent trend in proper context: just last month in July, investor surveys recorded a record bull-bear spread, with 60% of advisers saying they were bullish of ongoing gains in stocks and just 15% expressing concern with downside risk. In classic late-to-the-party-style, over the past 12 months retail investors have been piling into stocks and high yield bonds at a level not seen since the market peaks of 2000 and 2007.
The irony here is striking. Many of the same investors, advisers and commentators who were dumping assets at 50%+ discounts in 2002 and 2009 have recently been buying at some of the highest valuations ever in market history while expressing great confidence and comfort.
All of this is text book cycle stuff. Browsing today through an original copy of the US News and World Report dated July 27, 1964 (exactly a year before I was born), I come upon an article entitled, “Today’s Problem for Investors”, to wit:
“The stock market in relation to company earnings and dividends are high. The bull market itself is old. Questions are being raised about how much longer and the rise in business activity and profits will continue.”
Capital continued to pile into stocks for about another year after this article driving valuations to a secular peak before launching the secular bear that would punish undisciplined capital from late 1965 all the way to 1982.
In retrospect, looking back well after losses hit, the mainstream were able to point out peak valuations at the market tops of 1965 and 1987, 2000 and 2007. In real time however, they were clueless. Take today and March 2000 as recent examples. Pretty much everyone now, looking back, (ok, leaving aside some crazies like Jeremy Siegel) will admit that stock valuations were a disaster waiting to happen in the late 90’s. Yet today, very few express similar concern even though median stock valuations are higher now than they were at the peak in 1999-2000. Believe it. Today the median stock is trading at 20x forward estimated earnings. In January 2000, it was trading at 16x. And this is not even getting into a discussion about how unrealistic the jubilant “E” forecasts of that equation are likely to pan out going forward. Another historically reliable measure: the median stock today trades at 2.5x “book” or net asset value, compared with “just” 2.2x at the start of 2000.
But the financial sales crew recommending drastic moves like ‘taking a little off the table’ (the craps table that is) and raising cash to ‘heavy defensive’ levels of 5%, are not citing over-valuation concerns as motivation. That’s not it at all. Their concern is with what they see as increased “uncertainty” courtesy of mid-east conflicts and looming pandemics.
But for those humble few who are aware of just how full of risk life always is, the future today is not more uncertain–just always uncertain. It is not uncertainty that is new in financial markets, but how we price the room for disappointment that defines our outcome.
Today priced to perfection, financial assets have no room for disappointment; therein lies the clear and present danger. None of us control the future, but the good news is that we do have control over whether, when and to what extent we expose our life savings to price risk.