Oh dear. Oh dear. My BS detector is flashing red. Alert! Alert!
The Economist this week is doing something no investment writing should ever do.
Too late…they’ve done it!
The ‘Buttonwood’ column is trotting out the Shiller ‘CAPE’ ratio to flag a potential big draw down in US stocks.
To quote:
‘America’s stock market is in an unusually precarious position…Take valuations first. The cyclically adjusted price-earnings (CAPE) ratio…is now higher than it was in the late 1920s.
‘The ratios current level has been exceeded only around the turn of the millennium and in 2021. Both occasions preceded market crashes.’
Yawn. Blah blah. Next. Have a nice day. Goodbye.
You see…no indicator, in my experience, has a worse track record at helping investors.
I ought to know. I’m not kidding when I say I’ve been reading the same warning, seemingly every year, for about 10 years.
The potential lost opportunity from those who avoided US stocks because of the CAPE could run into the billions.
US stocks have delivered outstanding returns over the last 10 years.
What a decade it’s been.
We’ve had the rise of social media, an energy revolution in US oil and gas, a US housing boom…and now the explosive potential in artificial intelligence.
The CAPE ratio can tell you diddly squat about any of this.
Indeed…
The vaunted CAPE ratio was higher than history said it ‘should’ be for most of this time.
Naturally, any time US stocks went down sharply it appears that the CAPE ‘predicted’ the falls.
The CAPE ratio did no such thing. A broken clock is right twice day.
Fund manager Ken Fisher happened to address this issue just the other day. Here’s what you need to know:
‘The CAPE Shiller PE looks at ten-year normalized price earnings ratios calculated in a particular way, and shows that ten years after that, stocks tend to have below average returns.
‘And that’s been true. Not negative returns, but below average returns. That’s true.
‘The fact is, if you take that same CAPE Shiller PE data and instead look at subsequent one, three, and five year returns, it’s got a correlation to stocks of zero. Once you get that, you realize that it’s not a very good forecasting tool.’
In other words, you can take a wild guess at what the world looks like in ten years, or you could look at what’s happening right in front of us right now.
I know what’s easier!
None of us know for sure what’s going to happen tomorrow…
Perhaps China invades Taiwan…and investors panic, sending stocks diving.
Or perhaps AI sends productivity soaring…and investors load up with margin debt to bid stocks to extreme levels.
Or perhaps…
You get the idea. The future is unknowable.
But one ratio cannot synthesise into your entire investment strategy.
The CAPE ratio looks at aggregate prices and earnings. OK.
What about cash levels? Margins? Buybacks? Growth rates? Interest rates? Government deficits? Fed policy? Oil prices?
You can see from this alone that the market is very complicated. The CAPE ratio has nothing to say about any of this.
However, history is clear on one point: the market rewards the optimistic. Shares deliver long term.
Former fund manager Peter Lynch once said that investors have lost far more money trying to avoid stocks falling than if they just rode through the dud periods when they do.
That’s because it so difficult to get your timing right.
Check out this recent quote…
A recent fund manager report said:
‘Since late 2023 investors have been wrong-footed. High interest rates, high inflation readings, global turmoil and economic unease prompted retreat among the many “expert” commentators. How wrong they have been, as local and global share markets move higher.’
Yep. How wrong they were.
Not us here at the Fat Tail Daily, of course…
at least on Wednesdays
All last year I said to buy stocks while they were depressed, in a funk, looking like duds. I didn’t know that the CAPE ratio said at the time, and didn’t care.
Today stocks have a spring in their step again.
You see…it pays to hang around the optimists among us.
Peter Lynch was right. And he made his comment about 30 years ago. Ha!
The Economist can cite the CAPE ratio to avoid US stocks – and by implication, Aussie ones as well – all it likes.
If you like, I could give you another dozen reasons right now to go along with that.
For example, there are big government deficits, war in Ukraine, high oil, high mortgage rates, a Presidential election looming, gold spiking, Biden’s incoherent rambling, Trump’s brain farts, and on and on we could go…
But you know what?
The market knows all this already!
These issues are ‘in the price’.
Our job is to try and find mispriced opportunities.
What is the market missing that could send stocks soaring? What is something other investors don’t know?
That’s the helpful thing to consider, and NOT the CAPE ratio. Go here for more.
Best,
 |
Callum Newman,
Editor, Small-Cap Systems and Australian Small-Cap Investigator
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