US stocks are at levels that have preceded past market crashes, Nobel economist Robert Shiller is warning.
Shiller famously used his cyclically adjusted price-earnings ratio (Cape), which averages earnings over 10-year periods, to warn of “irrational exuberance” during the dotcom era. Today’s Cape of 25 has been exceeded on only three occasions – in 1929, 2000 and 2007, severe crashes following each time.
Shiller’s recent New York Times piece on the “mystery of lofty stock market elevations” does not impress bulls. They point to accounting changes and argue stocks deserve higher multiples than in the past, given the biggest S&P 500 sector – technology – is made up of high-margin companies.
Meanwhile, a recent paper says Cape is less predictive than previously thought. The authors prefer an adjusted version of Warren Buffett’s favourite indicator, stock market capitalisation as a percentage of GDP.
However, Buffett’s indicator suggests stocks are even more overvalued than Shiller’s. The current Cape indicates modest but real 10-year returns; using Buffett’s measure, they predict US markets may be around 40 per cent lower in 10 years’ time. The paper is at http://goo.gl/Me4UE3
Berkshire shares top $200,000
Speaking of Buffett, Berkshire Hathaway shares recently breached $200,000 for the first time.
The shares, which have never split, first crossed $100 in 1977, $10,000 in 1992, $50,000 in 1998, and $100,000 in 2006.
However, it hasn’t been plain sailing. Money manager and blogger Ben Carslon notes shareholders regularly suffered large drawdowns – falls of 37 per cent occurred in 1987 and again in 1989-1990, while Berkshire shares halved between 1998 and 2000, and again between 2007 and 2009.
Writing Buffett off, as many have done during the down years, has proved premature, but investors should assume poorer future returns. Firstly, the larger the company, the more difficult outperformance becomes. Berkshire, now valued at $330 billion and with a cash pile of $55 billion, has underperformed indices over the last five years – the first such incidence in its history.
Secondly, Buffett, 84 on Saturday, won’t be around forever. Berkshire will survive his eventual departure but the days of stratospheric returns are over.
Apple proves the naysayers wrong
Few stocks capture the mood swings of Mr Market like Apple, which last week hit fresh all-time highs.
Shares, $100 today, have almost doubled since April 2013. Then, commentators were busy pronouncing the company finished and decrying chief executive Tim Cook as a loser ("Cook continues to urinate on Steve Jobs's grave", said TheStreet.com's Rocco Pendola, describing him as an "incompetent" who was "killing Apple"). These days, everyone is lauding Cook – including Pendola, who says that the upcoming iPhone 6 will crush Android.
What has changed? In reality, not much. Last May, Apple shares soared post-earnings. At the time, this column quoted valuation guru and Apple shareholder Prof Aswath Damodaran, who said nothing in the report changed his valuation of the company. Since then, Apple is up another 25 per cent. Damodaran’s fair-value estimate – $96.55 today, compared with $96.43 in May – has barely budged.
Last year we noted Apple, trading at 7.5 times forward estimates and with $150 billion in the bank, had obvious valuation appeal. Investors eventually cottoned on to that, with the stock also ramping up in advance of the iPhone 6’s expected September debut.
Mr Market is a volatile beast. Remember that, and ignore the storytellers.
Buy the dips for easy-money trades
Stocks may be overvalued but buying the dips continues to be the easy-money trade.
The usual panicked headlines accompanied the 4.4 per cent market tumble that began in late July, but stocks neared new all-time highs last week.
The bull market is pronounced dead every time stocks take a dive. However, there have been 19 pullbacks of more than 5 per cent since the rally began in March 2009, and it has paid to be a buyer on every occasion. That has been especially the case since mid-2012, with pullbacks becoming shorter and less severe.
“Can it be that easy?”, market strategist Jeff Saut last week asked, referring to the quick bounces that invariably follow 5 per cent drops.
For now, yes – as trend traders like to say, if you buy every dip in a bull market, you will be right on all but one occasion.
In numbers:
10
Google last week celebrated 10 years as a public company.
1,300
Google’s percentage rise over that time, with the company now valued at $400 billion.
52,000
Number of people working at Google today, compared with 2,600 in 2004.
8.7
Google's price/sales ratio (PSR) at the time of its market debut, compared to 25 and 34 for Facebook and Twitter's respective flotations.
19
Google trades on 19 times forward estimates, compared with 39 for Facebook and 490 for Twitter.
