Tag Archives: valuations

Valuations: The route taken matters

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By John De Goey, CFP, CIM

Special to the Financial Independence Hub

The other day I had a lovely exchange with some friends on Twitter about advisor behaviour considering current market valuations.   Every time I write about this, I need to begin with the caveat: this is NOT about forecasting or market timing.  I can’t do it.  You can’t.  No one can do that if reliability is properly considered.  What follows is not about predictions.

It is about what, if anything, can be done – either proactively or reactively – considering high market levels and what that might mean for investors.  To be clear, I will admit that “what that might mean” is my code for “if markets take a really big tumble.”

By now, you’ll know that I have been concerned about the frothy levels of market valuation south of the border for over a year.  The fact is that the Shiller CAPE for the S&P 500 has been above 30 for about four years now.  In early February, it hit 35 for the first time since the dot.com bubble at the turn of the millennium.  Based on valuation alone, markets are much higher today than they were at the start of the GFC [Great Financial Crisis], for instance.  I think we should be worried, but most of my colleagues don’t seem to be.

At these levels, returns next decade could be poor

The thing about CAPE is that although it is a poor tool for short term market timing (i.e., it is essentially useless in picking ‘tops’), it has, over the years, proven to be a highly reliable predictor of returns over the next decade or so.  When valuations are this high, the ensuing decade is pretty much always ugly.

Despite this, all I ever seem to hear about is how the good times are rolling and it would be folly to ‘fight the fed’, that ‘the trend is your friend’ and that investors seem to be more confident than ever before.  Like they say in the movies… “it’s pretty quiet out there … a little TOO quiet.”

People like Jeremy Grantham at GMO have taken to suggesting the coming returns for North American stocks and bonds are likely to be negative (!) over the next seven years at least.  Who has THAT in their financial plans?  Perhaps more to the point, what if there’s not a single, monumental point where markets fall off a cliff?  If markets drop by 1% or 2% every year for the better part of the coming decade, how will people react … and who will be genuinely prepared?

A Thought Exercise

Here’s a thought exercise.  Continue Reading…

The Long View: Follow the Herd?

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By Jeffrey Schulze, CFA, Director, Investment Strategist with ClearBridge Investments, a Specialty Investment Manager of Franklin Templeton

(Sponsor Content)

There are times to follow the herd and there are times to stray away from the pack. Investors must learn this lesson. Sometimes, it can be beneficial to follow a larger group, but there are moments when it can make sense to chart one’s own course. In the early and middle stages of an economic expansion, running with the herd can be a beneficial and safe proposition.

As the U.S. recovery unfolds, some investors may be tempted to break off, worried about the formation of a bubble. Indeed, many investors are concerned that the market may be overheating, based on metrics such as the forward earnings of the S&P 500 Index.

Importantly, an increase in equity multiples is not uncommon during the early stages of an economic expansion. Following recessionary troughs, market returns tend to be driven by price-to-earnings (P/E) multiples during the initial market rally (approximately nine months) as investors anticipate an eventual earnings rebound. As the recovery matures over the subsequent two years, the opposite dynamic occurs, with multiple compressions on the back of stronger earnings growth. Put differently, earnings typically make a significant contribution toward stock returns during this second phase of the rally and declining P/Es become a modest drag on returns (see Exhibit 1 below).

Exhibit 1: Multiples vs. Earnings Data as of Dec. 31, 2020. Source: JP Morgan.

As we move through 2021 and eventually into 2022, we expect this same pattern to unfold; however, multiples may remain elevated.

Higher multiples not uncommon early in Expansion

Valuations are elevated in part because investors correctly sniffed out the budding U.S. economic recovery. Unprecedented stimulus actions (both monetary and fiscal) short-circuited the typical bottoming process, as policymakers formulated a response that rapidly ended the economic crisis and fueled an upturn in financial markets.

ClearBridge Investments has been tracking the scope of this improvement, and we see an overall expansionary green signal since the end of the second quarter of 2020. In our view, it has become clear that a durable U.S. economic and market bottom has formed, with the S&P 500 up 67.9% from the lows and a third-quarter GDP rebound of +33.4%, as of December 2020. Continue Reading…

Define “Bubble”

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By John De Goey, CFP, CIM

Special to the Financial Independence Hub

The word “bubble” is bandied about often to explain quick and often unwarranted run-ups in securities prices.  If you use the word in that context in a general conversation about economics, most people will have a quick, intuitive understanding of what you’re talking about.

Interestingly, two of the most prominent financial economists have radically different definitions of the term.  In fact, one of them goes so far as to suggest that the word “bubble” is itself a misnomer that is all but meaningless.

A half dozen years ago, Professors Robert Shiller of Yale and Eugene Fama of the University of Chicago shared the Nobel for their contributions to the understanding of asset pricing.  Many people have since speculated that the people in Stockholm who award the prize chose to give it to the two men concurrently in order to avoid implicitly “taking a side” in the debate about what constitutes bubbles.  While I respect and admire both men immensely, you need to understand that they are rivals of sorts.  The Nobel people likely wanted to recognize both without getting involved in a political and sometimes dogmatic battle of wits.

For about a generation now, I’ve been using products based on Fama’s research as the primary set of core holdings for my clients.  Based on a recent conversation with one of that company’s representatives, that’s about to change.  Basically, the company threatened to stop working with me simply because I told them I was inclined to subscribe to Shiller’s definition of a bubble.

Irrational exuberance

I’m currently reading the third edition (2014) of Shiller’s groundbreaking book “Irrational Exuberance.”  He gets straight to the point.  In the preface, he writes:

Maybe the word bubble is used too carelessly.  Eugene Fama certainly thinks so.  Fama, the most important proponent of the “efficient markets hypothesis,” denies that speculative bubbles exist.   In his 2014 Nobel lecture, Fama states that the word bubble refers to “an irrational strong price increase that implies a predictable strong decline.”  If that is what bubble means, and if predictable means that we can specify the date when a bubble bursts, then I agree with him that there may be little solid evidence that bubbles exist.  But that is not my definition of a bubble, for speculative markets are just not so predictable.

Obviously, it’s all fine and well for Shiller to say what a bubble isn’t, but it should be obvious that it behooves him to go on to offer what his own definition might be.  He provides a concise explanation (definition?) in chapter 1:

Irrational exuberance is the psychological basis of a speculative bubble.  I define a speculative bubble as a situation in which news of price increases spurs investor enthusiasm, which spreads by psychological contagion from person to person, and, in the process, amplifies stories that might justify the price increase and brings in a larger and larger class of investors, who, despite doubts about the real value of the investment, are drawn to it partly through envy of others’ successes and partly through a gambler’s excitement.

Basically, I agree with Shiller on both counts … that Fama’s point is fair if one’s definition implies predictability, but that Shiller’s point (and definition) is more practical.  I certainly do believe that bubbles exist and I make absolutely no claim to be able to predict anything about when, how or why they will burst. Continue Reading…

Stock market investment advice for worry-warts

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patmckeough
Patrick McKeough, TSINetwork.ca

 By Patrick McKeough, TSI Network.ca

Special to the Financial Independence Hub

Many investors spend a lot of time worrying about the wrong things. In particular, they worry about things that are unpredictable. Even if they happen, these things may have only an indirect impact on their long-term profits. As a result, they have little time to pay attention to things that have a direct impact on the value of their investments. Our stock market investment advice will help you become a worry-free investor.

For instance, at times they may mull over every tidbit of economic information that comes out, and how it differs from its predecessor of a week or a month earlier. They hope to detect a pattern—a sign that the economy is mending and headed for a return to steady growth, say, or perhaps deteriorating and doomed to plunge into a new recession.

Others look for patterns or omens in domestic or international politics, or in demographic data, or in the price of gold. This can eat up an awful lot of time and no stock market investment advice out there can save you the time you’ll waste.

These investors often feel they can cut their investment risk by selling some or all of their stocks in times of high risk, and buying them back when risk is low. This never works well for long. After all, risk as portrayed in the media, and genuine market risk, are two different things. No matter how you try, it’s hard to pinpoint market turning points, if only because you have to outguess so many other smart people who are trying to do the same thing.

Why stocks imitate the traffic on freeways, not elevators’

Continue Reading…

Templeton Growth manager overweight Europe, has zero Canadian exposure

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James Harper photo_2015
James Harper, Templeton Growth Fund

I’ve always enjoyed interviewing the managers of the Templeton Growth Fund (TGF), one of the most famous global mutual funds in the world and the basis for the famous “Mountain Chart” (shown below.)

TGF also happens to be one of a handful of mutual funds our family still owns, along with numerous ETFs and individual stocks, so when Franklin Templeton brings in its fund managers for its annual media lunch in June or July, I’m always happy to take advantage of the access.

On Wednesday, I taped an interview with the new portfolio manager of Templeton Growth, British-born James Harper, normally based in Nassua and a veteran of 22 years in the business, the last eight with Franklin Templeton. He took over the fund on April 21st of this year. Like his predecessors, Lisa Myers and George Morgan, Harper has a refreshing take on the valuations of stocks around the world.

Fund underweight U.S. stocks: “becoming fully valued”  Continue Reading…