Today the SP index closed 2 points higher, (now at 2933) than the previous all-time high, which was in September, 2018. With the PE10 ratio at 31 this ratio shows stocks are priced at double fair value, implying that eventually stocks will crash 50% and stay down for a long time. It may be tempting to short sell stocks but as Keynes said, “stocks can go up longer than you can remain solvent”, so shorting is too risky.
Since stocks are mostly bought by the affluent top 10% of society and these people are doing quite well in their careers then they can take their lucrative earnings and invest in stocks, thus fueling the bubble. But is it right to do so even if you have a good job and can afford to save more from your paycheck if stocks crash?
I don’t think people should buy stocks recklessly simply because they have a salary that allows them to recover if stocks suffered a deep long term crash. There is no guarantee that future living costs or taxes would not go up excessively thus negating the ability to save. If one’s adjustable rate mortgage goes up to the maximum rate and income taxes are raised to 70% (they are at 56% in California) this would make it harder to save after a stock crash. Also a person is at risk of a fundamental career restructuring if his or her occupation becomes outmoded because of new technology and he or she experiences significant employment risks. The risk of suffering a permanent disability resulting in the end of one’s career can also disrupt plans to use a paycheck to rebuild after a stock crash.
Affluent investors should invest with the same degree of caution expected of an investor who has retired and is too old to rejoin the workforce. The prudent way to judge stocks and real estate is to look at a corporation’s long term average income and or cash flows. These data points are created by marketplace transactions, careful decisions by consumers, who buy goods and from decisions by vendors who sell raw materials to companies, along with workers who agree to a certain wage. The data results in annual profit or earnings. This very different from stock prices which can be influenced by artificially low interest rates, central bank buying of stocks, corporate buybacks of stocks using excessive debt, and most importantly from the irrational emotions of a crowd infected with a bubble mentality.
Never forget how in 1634 there was the Dutch tulip bulb mania (a single bulb cost $30,000), in 1720 there was the Mississippi bubble and the South Seas bubble, 1929 was the Great Depression, 1990 was Japan’s stock crash where PE ratios were around 60 or even 100 instead of the reasonable 15, and stocks until a few years ago were down about 75% from the highs. Even today Japan’s Nikkei at 22,200 is 45% below the top of 12-31-1989 despite massive devaluations and central bank purchases of shares with printed money.
Investors should beware that today’s bubble could end up resulting in a similar fate where after nearly 29 years and massive money printing the Nikkei investors still lost 45%. Don’t forget the Nasdaq crash down 80% from 2000 to 2002 – it took 13 years to breakeven after the 2000 top. Nasdaq is only 8% above its 2000 high adjusted for inflation and if adjusted for taxes on phantom gains associated with inflation then investors still lost a small amount of money based on price return, (however, if count Total Return dividends then gains would be very small, since tech stock dividends were minimal a decade ago) in Nasdaq after 19 years
The point is that human emotions can create a bubble and the best defense is to use tools like PE10 (a ten year average of earnings), or Price to Sales or Price to GDP, etc. other advisors have said use EBIT earnings or only cash flow earnings instead of accounting GAAP earnings – fine, that’s OK, the point is to get a long history of routine items in the corporate income statement and average it out, rather than to allow the madness of crowds to be entranced by an unfounded bubble that has no basis in the Accounting profession’s documentation of corporate income.
There are investors who use momentum strategies where the more a stock goes up in price the more they buy in hopes of making a windfall from a bubble. There are passive ETFs that blindly buy a stock in proportion to whatever its price is so if the price is already too high the blind passive system simply buys more making the bubble bigger. These are dangerous and are difficult for investors to know when to get out before the crash.
Investors need independent financial advice about the risks of a Nikkei style crash occurring in the U.S.