Updated for 2020 and beyond.
Of course we are in a bubble! When you’ve got people with no professional financial experience giving investment advice, you better believe we’re in a bubble. Online investing advice by non-finance professionals is the modern day version of shoe shine boys giving stock tips prior to the crash of 1929. Always understand the background of those who give investment advice before considering their counsel.
Even after 20 years of investing and working in the finance industry, I always feel uncomfortable giving any sort of investment advice because I’ve had way too many losses partly thanks to multiple boom and bust cycles. Furthermore, everybody’s risk tolerance and money making abilities are different. The best thing we can do is have an appropriate asset allocation to ride out the waves.
The good thing about bubbles is that the greater fool game can last for much longer than expected because we humans are GREEDY, GREEDY, GREEDY!
The largest criers of the word “BUBBLE!” are those who have the least amount at stake. Perhaps they sold their real estate, stocks, or businesses before 2012 and are now kicking themselves. Maybe they are still graduate students with a lot of student loans to repay. Or maybe they are retirees or early retirees who can no longer take full advantage of a heated economy. Whatever the case may be, when the largest complainers of a bubble start getting back in, you know danger is imminent.
Let’s at least all agree that we’re in the second half of a bull market and the bubble will eventually burst. Maybe we’ll only correct by 15%-20%, unlike 2009’s 50% ass-kicking. But eventually, that year or three of pain will come!
WHEN WILL THE BUBBLE BURST?
I predict the bubble will burst on October 18, 2016 at 12:48pm. Heck if I know! Your guess is as good as mine. When the bubble bursts, there will be plenty of private companies at crazy valuations going bust because they still won’t be profitable and nobody will give them any more money. We have pre-product, pre-revenue startups being valued for $8 – $12 million dollars all the time nowadays. Furthermore, plenty of private companies are trading at 15-25X revenue with the expectations of never ending triple digit growth. The private equity market is completely out of control compared to the public equity market. It’s been eye-opening these past two years consulting in startup land. Once the private equity market collapses, it will pull down every other asset class with it. At least the Fed will think about cutting rates again. If we can hold on through the downturn, and continue to dollar cost average, we should be fine in the long run, especially since most of us don’t have access to such private equity companies. The goals for all of us are to: 1) Recognize when we are in a bubble. 2) Maximize our returns during a bubble. 3) Slowly minimize risk and exposure the larger the bubble grows. 4) Try to exit as much as possible before pandemonium sets in. 5) Have enough cash once the bubble bursts to buy everything in sight. Remember, you must convert some of the funny money into real assets or fantastic experiences. Otherwise, when the bubble bursts, you might be left with NOTHING but regret!CHARTS SHOWING BUBBLISCIOUS VALUATIONS
REAL ESTATE
Whoah! San Francisco median home prices have skyrocketed by 100% since 2012. The median household income in San Francisco is about $80,000 while the median home price is now $1.7 million. In other words, the median house costs 21X the median income when banks only lend at most 5X one’s gross income (used to be 3X, but rates have come down to more affordable levels).
But who cares about the banks? They don’t lend to good creditors anyway! More people are buying with cash, and more people are coming from “low per capita GDP” nations like China with bucket loads of dough. The San Francisco housing market is a bubble for local residents. Good thing San Francisco faces a strong international demand curve. But when the US bubble bursts, foreign money will disappear.
The real estate charts for Los Angeles, San Diego, Manhattan, DC, New York, Paris, Hong Kong, London, Singapore, Miami, Sydney, and so forth all have similar trajectories. The median home price to median income multiples are also at nose bleed levels.
STOCK MARKET BUBBLE
Shiller CAPE P/E Ratio
MAYBE WE AREN’T IN A BUBBLE?
There is no way any of us will be completely unscathed from a bubble collapse because none of us will be able to perfectly time our exit to 100% cash. I think there’s a good chance this bubble continues to grow for the next three years as companies like Uber, AirBnB, Pinterest, and Slack go public. They’ll have a lot of money for acquisitions, which will fuel the private market frenzy even more. Let’s look at another interesting chart to compare today with the internet bubble of 2000. I remember almost investing $20,000 into my college alum’s now defunct company called DormNow. Those were the glory days when Yahoo stock would jump 10% a day!
Thank goodness we’re no longer valuing companies based on “eyeballs.” I still remember my company’s old Internet Analyst, Anthony Noto (now CFO at Twitter), producing an Internet report with googly eyes on the cover. Then there was Henry Blodget who was pumping Amazon to $400. It was nutso and people made a boatload of money! Even I got lucky and made a 40 bagger with one ridiculous company named VCSY that went bust shortly after.
The chart above shows how reasonably valued some of the largest NASDAQ companies are today vs NASDAQ companies in 2000. Apple trading at 15X earning with $150+ billion in cash doesn’t sound like a company that’s ever going bust. In fact, the likes of Apple and Berkshire Hathaway could be our saviors if there’s another correction.
The issue I see is mutual funds, who have expertise in public market investing, seeking 10% returns by participating in late stage private financing for bigger gains. They are investing in what they don’t know and being too cavalier with their assets.
THE BUBBLE WILL BURST EVENTUALLY
When the bubble bursts, I pray everyone has a diversified net worth to hold them through for at least two years. And if you end up losing your shirt, don’t worry. The bubble was fun while it lasted! There will always be another bubble to profit from. It’s the American way. Here’s what I’m doing to help buffer myself from a collapse: * Raised my after-tax savings rate to 70% from 50% now that my master bathroom project is done (post coming) in order to increase liquidity and build a war chest in case opportunities arise. Goal is to get to $100,000+ in cash by June 1, 2015, and $200,000 by Dec 31, 2015. * Looking for new online business partnerships so that no one revenue stream takes up more than 30% of total revenue. Client concentration risk is the downfall of many companies. * Write more bearish articles that help people during downturns in order to diversify traffic on Financial Samurai in case a downturn happens. Part of being a good publisher is properly forecasting the future of what people might be talking about. * Completely pay off a rental income property mortgage that will free up $1,308 in monthly cash flow, and increase my cash flow by ~$2,000 in the eyes of a mortgage underwriter due to their funny math of discounting rental income by 25% if one has a mortgage. I’m essentially preparing myself for one last attempt at refinancing a primary mortgage just in case interest rates start collapsing again. * Continue to buy equity via structured notes with 20-30% downside barriers or buffers as part of my monthly investing contribution as opposed to buying naked equity. * Constantly review my net worth allocation online to make sure my stock market exposure as a percent of my overall net worth is no more than 30%. I’m currently overexposed to real estate with a ~40% weighting due to my home purchase in 2014. All I can do to decrease exposure is to pay down mortgage debt, save more cash, and grow my business as I never plan to sell any property given they are cash cows. It’s easy to do an investment checkup and a holistic overview of your finances once everything you’ve aggregated all your accounts in one place.RECOMMENDATIONS TO BUILD WEALTH
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Good Article! Based on your poll about 74% think this bubble ends between now and 3 years, which I’d agree with. Having been through the Dot.com and Real Estate bubbles in the 2000’s I’d have to say this one scares me the most. The reason being the fed has nothing but QE to backstop this burst with. Where previously we were able to take rates to zero during the 2000 bubble, and a mixture of zero rates and QE in 2008 to soften the blow. The fed has increased balance sheet to 3 trillion, I guess technically they can increase to as much as they want as long as the dollar stays the reserve currency. I guess we shall all wait and see what happens but I do agree with your hedging strategies.
One note, I think the PE ratios of these large companies are deceptive, you have companies like Apple, IBM, GE, etc. selling bonds to finance stock buybacks, to reduce float and therefore meet or beat earning numbers. I guess part of ZIRP has created this current enviroment(Sell 30 year notes at 3% to finance buybacks that juices your stock and executive comps). So when we look at PE I would guess you would want to factor in how much debt they took in.
Derek –
Too funny.
I thought about tackling the whole log-scale topic as well in my earlier notes, but judged it as too advanced. ;<)
I think I've figured out that the trick to this site is to just peek in to see how the "talking heads" crowd operates.
They actually don't want to have a real discussion.
Although I agree that U.S. stock valuations are high, I would caution that using a linearly scaled chart for stock prices is very misleading, particularly when it is framed as evidence of a bubble. Using a linear scale, you are assuming an increase from 100 to 200 is the same as a change from 1700 to 1800 which certainly is not the case; one is a 100% increase and the other is less than 6% increase. A chart with a logarithmic scale is much more appropriate.
Sounds good. Do you therefore believe we are in a bubble and expect deflation? Or do you believe that with a logarithmic scale, we are therefore not in a bubble? Please share some of the investments you are making to reflect your outlook. Thx!
Thanks for the lesson in math, but you do realize your point is moot! Since the market moved from 500 or so to just over 1500 in 2000, just under 800 to 1600 in 2008, and finally from 666 to over 2100 now. Your point might make sense if we were talking about movements from the 1920’s bull run.
I love the current valuations in the stock market right now. I think they reflect a healthy optimism regarding the world. We are on the cusp of having billions more people connected to the Internet, which will revolutionize the political and economic systems. I would imagine that with each new entrant to the Internet tech stocks will greatly benefit.
I hope you are right! But just in case you’re not, I’m trying to make and save as much as I can this year, and I encourage everyone to do the same while maintaining a consistent investment frequency.
Fundamentally, I agree that we’re in a giant asset bubble, but I struggle to come up with something that would actually result in the bubble deflating. The problem is that central banks seem to turn on the cheap money faucet at the slightest hint of an economic slowdown. ZIRP, QE, Abenomics and now PPSE aren’t creating much, if any, real growth, but it’s enough to kick the can down the road and prop up the financial markets. My guess is that we’re just going to bumble along for the next few years with stagnant growth until there’s a real crisis, at which point being in cash vs. being in equities won’t make much of a difference.
Nice analysis Sam. We’re probably in a bubble and so long as we recognize the risks, things will be OK.
My concern is that if a significant number of the new non-service industry related jobs (middle to upper middle class) in the past four years were due to fracking, we may be in for a bumpy ride. San Francisco home prices may not be affected by the drop in oil prices, but the new, high paying jobs from Texas to North Dakota may be evaporating. Maybe the overall economy is strong enough to weather that, but I’m trying to figure out if there’s a real estate opportunity in Colorado coming soon?
You’re probably right about Texas, ND and other oil producing areas being screwed for a while. There has to be a cut at the margins with such a drastic drop in oil prices.
Do you think Colorado real estate is poised to decline from the knock effect of weaker oil prices? I like CO, and if so, I’ll be there with you, looking.
those 2015 PEs of the tech company — where is that PE of Google from @19?
PE referencing 2014 earnings seems to be hovering about 28-29 now, while PE forward i would expect at low to mid 20s…?
This post seemed a bit all over the place on bubbles. San Francisco real estate and private tech startups very well may be in a bubble, but that doesn’t really apply to the broader population. The major tech companies have relatively moderate pricing metrics and real estate in much of the country has recovered from the bust, but isn’t particularly expensive. US stocks would seem to be somewhere between correctly valued to slightly expensive, and if you go international valuations are lower.
I would have to look, but I think I’m around 60-65% invested at this point. I let my 401k keep making it’s monthly contribution, but my Roth and brokerage money is piling up in cash.
There are bubbles all over the place. San Francisco is used as an example for places like LA, New York City, London, Hong Kong, Paris and other international cities. The charts all look the same.
The broader population WILL get crushed if the bubbles burst in major cities and in the large private startups. We are all interconnected. These industries provide thousands of jobs that will go away. Funding will go away. Consumer confidence will decline. Spending will decline, and we have a nice bust until things get cheap enough and recover once again.
Stock markets are global and interconnected as well.
Adam, what industry do you work in?
The way you mentioned 2012 exiters calling it bubble and showing 7 year cycles to hint towards selling a part, I hope you’re not one the 2015 exiter ruing in 2016 or 2017
Great discussion! At 49 years old, I think much differently about this topic than I would have even 5 years ago.
I do think, in aggregate, that the stock market is overvalued. My equity allocation is now around 50%. I actually increased it by 5% during the Ebola fear but decided to take that easy money off the table a few weeks ago. My allocation to equities 2 years ago was 65 percent. A gradual decline. Also, my international equities have increased from 20 to 30 percent of my overall equity position. I did that this year. We only have 5 percent in bonds – all short term corporate. 30 percent is cash with an equal split between a money market at 1 percent in a taxable account and a 2% yield in a GIC in my 401k. Another 2.2 percent is in private real estate (through Fundrise and 1 other firm) and the rest is equity in my house.
I plan to increase the private real estate investments to 5 to 7 percent. I am ready for a market correction and will gladly buy if that happens. However, if the TTM PE goes above 21.50, I will take another 5 percent out of equities.
I feel good where I am but have been told by pros that I should have way more in equities. No thank you. Have the courage to stick to your guns.
The trend has definitely entered parabolic territory. It’s funny you publish this today as I just wrote a post this weekend that will go live on Thursday detailing how I have been selling into strength and building my cash stash for the inevitable fall in prices.
Like you mentioned we have had an incredible run these last 6 years. So over the past 6 months I have been selling positions to raise cash. Luckily all of my equity investments are in pre-tax accounts so taxes are not even a thought.
As of last week I am sitting in about 60% cash in an aggregated equity portfolio (all retirement accounts). All remaining longs have calls sold against them (I only by 100 share increments, or 10 if they have mini options).
I have also been getting a little short delta in my portfolio selling call-spreads on the SPY. We may not crash this year, but I don’t think we are going to go very far either. So I am selling call-spreads on top of the market and puts that when you add the premium collected from both my effective entry price is about 10% off of all-time highs (on the SPY etf).
The cash stash will only continue to grow as I make contributions and hold out for better prices. No one knows when the crash will come, but I think it is fair to say that the risk/reward now favors the downside.
I shared this with Mr. 1500 on one of his recent posts on 3/26/15:
As I write this the S&P 500 is 2,054 (current index reading), here are a few things to ponder based on what the options market is pricing in.
1 – There is a 60% probability that the S&P 500 touches 1,850 by year end, which would represent about a 10% correction (or about 204 points) from the current reading above (and a 13% correction from all-time highs).
2 – There is a 35% probability that the S&P 500 touches 2,250 by year end, which would be about 9.5% higher (or about 196 points) than the current index reading above.
So the expected return if you are committing new capital looks like this:
Expected Return = (35% x 196) – (60% x 204) = 68.6 – 122.4 = -53.8
Expected ROI = (2054 – 53.8)/2054 – 1 = approx -2.6% (that’s a negative return)
I know my bank is only paying me 0.5% interest on my cash and making extra payments on my mortgage is saving me 3.675% interest. That sure seems like a better return than -2.6%…and that’s why I am not investing new capital at this time.
As you can see from the example above the options market is pricing in a much higher probability that the market will trade down 10% vs. trading up 10%. I actually think that the probability is a bit higher than 60% that we will trade down by 10% by the end of the year. But I have no control over the probabilities; I can only make a plan based on the numbers.
Cheers!
GYFG
Nice, job doing your research and taking a stance. If all assets are overvalued, this will make getting to your $10 million but a lot more difficult. Like have multiple Pistons break and being only left with job income.
Time to moonlight and build something on the side!
I totally agree and am working on that as we speak.
It’s great to have a goal, but I can only focus on things that I have control over. The market is going to do what it’s going to do.
I think those charts say a lot, and even if you don’t know much about finance, visually it’s hard to argue that we’re not in some sort of bubble.
I just got rid of my stock investment loan as a small step to prepare for a downturn, and really wish I had the patience to hold more cash! But I really don’t want to sell down many of my stock holdings, so I’ll just hang on for now and try to save up a little cash in preparation for the eventual downturn.
There are plenty of industries experiencing the opposite of a bubble right now, like mining services companies here in Australia, and some of them appear dirt cheap. Will be interesting to see whether a bursting bubble ends up wiping out some of these businesses, or whether they’ve already hit rock bottom and can survive despite a broader market correction.
I just hope any correction is short and sharp – I’d rather assets become cheap quickly rather than drag along for 7 or 8 years as a slow, burning pain!
I completely agree with everything except for one part, which is that I think you’re using “private equity” too loosely. From the article, it seems like you’re referring to venture capital, early stage companies., etc. But private equity funds are also buying very boring, well-established companies with solid CAGRs for reasonable EBITDA multiples. I agree that the early-stage tech companies are getting crazy valuations, but private equity encompasses much more than that.
Regardless, great article. I agree with 99% of it.
You’re right. I’m referring to private equity tech/internet startups in particular. I’ll clarify that in the post.
Sam, what is your take on buying property now then in this bubble? Moving out of state, selling current house(making some $ of that) and buying? Who knows how long this will last and like you have said return on renting is always 0. Just would hate to lose 20% if market changes next year.
Thank you
It just gets too complicated for me. The older I get, the more I want to simplify. Dealing with tenant issues as an out of state landlord is a headache. Perhaps I would hire a property manager to maintain for me.
I buy property for LIFESTYLE first so the yearly fluctuations in my primary residence isn’t that big of a deal. Losing 20% will be bad, but what I’ve noticed is that rents are stick on the way down, and slippery on the way up, at least here in SF. For example, during the 2008-2010 crash, I didn’t lower rent one bit b/c they were locked into a one year lease. When the lease came up, it had been 3.5 years already, so I actually raised rent.
It’s not a bad idea to sell my first rental property, but it is a 2/2, and demand for 2/2 is out of control in SF. The mortgage will be $0 by June, and the rent is $4,000 a month.
The Federal Reserve has set a lending rate at 0.0-0.25% for more than six years now. Does everyone know what ZIRP is? The P/Es and valuations everyone is measuring are all predicated on years of zero cost-of-money for both government and corporations. Every year the government (at all levels) spends more than it takes in, that gap/deficit is a “stimulus”.
The last few years of actual numbers show a 30-35% excess in expenditure to revenue. Somebody is getting the benefit of that spending, and nobody is paying for it today. Every. Single. Year. Some questions to consider, as we evaluate the possibility of a “bubble”…
Why have US equities tripled in the last six years? Why has oil barrel prices declined 64% in the last seven years? Why has gold declined 33% in the last four years? Why has the FDIC closed over 1,300 banks (16% of the total) since 2008? What would happen to real estate if current 30 year mortgage rates (3.5%) returned to 2008 rates (6.25%)? Why has the Wilshire 5000 index gone from 7,700 represented stocks in 1999 to 3,700 today?
Lastly, my observation is that there is a disconnect between the real economy (the one we all experience), the reported economy (i.e. unemployment and inflation rates), and the market economy (i.e. stock and real estate markets) which in times past has been used as a predictor for the future economy. If I didn’t want to buy US equities at S&P500 1,500, I don’t want to buy today at 2,000. I actually know my “ouch point.”:-)
Sam, my own “shoeshine boy” moment was experienced just last month. A college friend contacted me about becoming an early investor in a new equities mutual fund he is helping to roll out as CFO; the selling point is that the ‘hood ornament’ is a prominent person for the last 35 years particularly in the bond space. I had to say ‘no thanks’, as I’m not sure 2015 is the time the world needs a new mutual fund headed by someone who made his name in another asset class. Hope that gave you a smile!
So Bill Gross is peddling mutual funds to retail investors while Mohamed El-Erian is concurrently telling the media he’s almost entirely in cash. Sounds about right; and tells me pretty much everything I need to know.
This bull run has surprised me as well. I’ve got a ton of cash locked up in a CD, which is at least earning a 4% interest rate. But, in retrospect I should have went all in in the private and public equity markets.
If we can return 8% in 2015 in the S&P 500, I think that’s a win. Rocky times ahead during an interest rate adjustment period. I’m focused on generating revenue independent of the market.
8 percent for this year would be fantastic. Equities don’t end with the S&P 500. Non US equities have lower PE’s. Doesn’t mean they are guaranteed to outperform but having them helps diversify.
@MD, I will wish you good luck with your international equities. EAFE has gained 22% in the past 5 years while the S&P500 (70% of total US equities) has gained 77%. Hang Seng about the same. The Euro has lost 38% against the dollar in the last four years. Emerging Markets have been stinking up the place for years, and MSCI world market index has far underperformed the US equity markets (as mentioned above, because the dollar is so strong and earnings are so much better for US stocks). Not to mention the crazy risk in foreign stocks. Saving my best for last, stocks in the S&P500 are the largest capitalized stocks and all are international. So if you are looking for exposure to consumer and business markets outside the US, you still get that but without the currency, accounting practices, and litigation risk.
The reason I buy them (through an index fund) is precisely because they are down. History has shown that out of favor regions eventually revert to the mean. All the risks you typed are accurate. At 30 percent of my equity position, I still think they are s good bet for the long term.
Any thoughts on student loans as a bubble?
I think there is a higher education bubble where tuition prices are out of control, especially since information is becoming commoditized. You can take online courses for free at some of the best financial institutions. You can also read websites like mine for free, who are actually doing instead of only teaching or practicing theory.
This bubble will self-correct as people realize the return on their education isn’t worth it. Prices must come down for those institutions who do not provide more value.
I suspect there will be massive government support to prevent a student loan collapse.
Read: Should I Go To Public School Or Private School? Depends On Your Level Of Fear And Guilty
Disclaimer: I work in higher education.
A major problem with things like MOOCs replacing higher ed institutions is that they have such terrible “graduation” rates. By that I don’t just mean that people don’t tend to stick with them through the equivalent of 120 credit hours of courses. Well under 10% of people who sign up for a single MOOC course finish it. Imagine telling your typical (or even a top 10%)18-year-old that instead of going to college she should just sign up for 40 of those classes over a 4-year period. That’s like telling a1970’s teenager that instead of going to college he should just make ample use of his library’s inter library loan program (which will allow him to read pretty much any book carried by the state’s university libraries).
The people who do finish MOOCs tend to be people who already have a college education. I think MOOCs are really valuable tools, but you need a specific skill set to make good use of them. Part of that skill set is academic (e.g., reading and numerical proficiency); part of it is self-discipline and motivation. Very few 18-year-olds have both.
Now, I do think that a higher ed bubble is coming, but I don’t think it’s about the alternative paths you mentioned replacing college. I think it’s about:
1. For-profit and some lower-tier non-profit schools being exposed for what they are (vultures that spend all their money advertising an education that they cannot and will not deliver).
2. The end of the college arms race that leads to fancy dorms, extensive student activities options, and the administrators and junior administrators needed to oversee all of these things. (and)
3. (I hope) Poorly prepared high school students being informed if they lack the skill set to succeed in college, even considering the way (some) colleges are pretty good at helping develop that skill set.
Interestingly, I think there are analogues between the above points and the housing bubble: 1 is like predatory lending; 2 is the McMansions; 3 is liar loans (only it’s not the students who are lying; it’s the people who are telling them that college is for everyone).
It’s interesting, b/c the SON of the University of Phoenix founder sold his mansion in Pac Heights for like $25 million to David Sachs, of Yammer. I wonder how much the father is worth!
Selling education for profit to people who end up not being able to utilize the degree is pretty predatory. I wonder why the government doesn’t regulate more. Oh yeah, the government actually gives money to veterans to go to University of Phoenix Online for a degree.
MOOCs goes to the CORE of education, to learn for knowledge and skills, and not for a degree. As we know, getting places often requires hookups, so that is where MOOCs and other places fail.
Point of information, the completion rate of Junior College courses is ridiculously low. I have read/heard several estimates, between 20% – 30% complete for credit. The difference between “free” and $46/unit isn’t much, but if you think students don’t value that cheap education now just imagine the drop-rate when they have paid zero for the privilege of learning.
In California CSU 4-year schools, you may already know that 2/3 of incoming students (purportedly the top 12.5% of high-school students in the state) require at least one course of remedial mathematics or English.
An anecdote: I have a family friend who is 27 and attending CSU on a Veteran’s bill. He has been getting his living expenses and tuition/books paid by he government for two years, and he has completed five of 20 courses. He smokes weed with his friends and hangs out with teenage girls. To him, this is ‘living the dream’ and “someone else”*wink* is paying for it.
So many bubbles is hard to know where to start. Or perhaps it’s less about the bubbles and not about the trust, or lack thereof.
Do you trust the data reported by the government about the unemployment rate? How about inflation? Do you think the Federal Reserve is concerned about your financial health or about Goldman Sachs’s?
Eventually, you just have to place your bets and take your chances. But the unknown unknowns seem a lot more prevalent than usual since 2008.
What I’ve learned over the years is that it doesn’t matter whether what the government economic reports are true or not. The market will accept them as truths and react accordingly. There’s an investing derivative in place in order to make money.
My driver’s ed teacher used to have this saying, “you can be dead right”. Just because the light is red, doesn’t always mean people will stop.
The stock market is clearly expensive right now. But that doesn’t necessarily mean it’s going to crash.
Markets have this funny way of going up for way longer than they should. And unfortunately, the same inertial rules are in place for the ride back down.
Along the way in my career, I was VP of M&A for a Fortune 100 company. In this role I was responsible for setting prices on possible acquisition candidates. In other words, I know how to do the math.
But what is more difficult is determining the moment when the math matters.
My S&P-500 valuation model determined that the market became statistically too expensive circa late 2013.
At this point I began slowly paring back from my sweet spot allocation of 60% equity. As of last week, I am now all the way down to 36%. I plan to hold here until something material occurs. (Historically, this might take a while).
I’ve been searching for the “reason” that prices don’t correct (when they “should”). After all, its not like we’re going to run out stocks. (So it’s not about scarcity).
Perhaps you got it right, Sam. It could all simply be driven by the greater fool theory, aka Greed.
My only advice to your readers is to take a sober look at the inflation adjusted value of the S&P over the last 100 years. It provides a very different look than the non-inflation adjusted version (of course).
From this chart we find 5 episodes where the price of the S&P fell to 50% or lower from its peak.
3 of these rough patches dragged on for over 20 years before the previous highs were re-established.
The thing with inflation-adjusted from an investors standpoint is that there’s a difference between losing money, and losing purchasing power (negative real returns/interest rate). Losing purchasing power is obviously better than losing money.
There’s no use fighting the power like the Fed or the Government. It’s much more productive to recognize current stages we are in and invest accordingly.
Sam – Meet Unlucky Fred
In 1968, Unlucky Fred invested $1 in the stock market. This was enough to buy a cheeseburger at that time.
By 1982, (14 yrs later) sadly the purchasing power of Unlucky Fred’s investment was worth only 40 cents.
This meant he went to bed hungry that night as he could no longer afford a cheeseburger with what his investment was now worth.
(You need to look at an inflation adjusted chart of the S&P-500 to understand why).
Incidentally, his financial advisor told him, don’t worry.
“Losing purchasing power is obviously better than losing money”
Wow, Fred is so unlucky! Have you met Lucky Lucy who is now a multi-millionaire for investing 20% of her earnings in the S&P 500 for the past 40 years while making a median wage? Check her out.
It’s fine if you’d rather lose money on an investment than lose purchasing power. Not making or having as much money can be frustrating. Watching others make more in a bull market while you started selling in 2013 can be maddening. But don’t despair!
You’ve just got to keep the faith that your finances will get better with continued saving, investing, and an asset allocation appropriate to your risk tolerance. Comparing yourself to others is a sure way to misery and bitterness.
Haha, touché! Weird how ee would rather lose a dollar, than keep a dollar even though it may not keep up with inflation.
What you said your post about people who cry bubble the most is true. It must be killing EE to lose ground as others get much more wealthy than him in this market!
Huh?
Didn’t say anything about comparing to others, losing faith, et al.
Just pointing out that the “nominal” value of a dollar is meaningless.
Just ask a Mexican who went through the overnight devaluation of the Peso in 1994. He still had the same number of Pesos (e.g. Nominal value). The problem was he could now only buy 1/3rd of what he could before the devaluation (e.g. purchasing power).
You do get this, right?
I do. Can you elaborate on why you’d rather lose, for example $100,000 in an investment, than keep $100,000 and have it lose purchasing power to inflation? If you lose $100,000 in an investment, not only do you not have $100,000 anymore, you are still losing purchasing power with your other money in this inflation scenario.
Are there any specific securities you are shorting so you can profit from the collapse? If so, can you share with the community? Thanks!
Sam – I am genuinely concerned about the information you communicate on this blog.
I honestly can’t tell if you just don’t understand some of the basics, or you just type faster than your brain can process.
So level with me:
Do you understand the difference between real dollars and nominal dollars? And if you do, why not always communicate with charts that correct for inflation?
Do you understand that if our country goes $20T in debt, we really do have to pay it back?
Do you understand that the stock market has blown away the real-estate market for the last 100 years?; and that the real estate market does well to simply pace inflation?
Do you understand that it’s absurd to have 20% of Americans paying 85% of our taxes while the guy sitting in our president’s chair gives endless sermons that the “rich” need to pay their fair share?
Do you understand how damaging it is to our economy for people to believe its not worth the effort to make over $200k per year?
Do you understand that it’s silly for you to state as fact that short term interest rates will rise; but long-term rates will magically stay flat? (with no rationale provided)
Do you understand that it does NOT make sense to stay short on the yield curve if you expect short term rates to rise? And that if you really do believe long-term rates will stay flat, do you understand you should go buy a bunch of long-term bonds (they are apparently on sale!)
Do you understand how strange it is for you to say that the MARKET determines interest rates independent of what the Fed does? Never mind the fact the Fed just added $4T to its balance sheet with QE 1, 2 and 3; The whole point of this was lower to interest rates! (and it worked).
Do you understand that you are living in the middle of a bubble (in so many ways) in San Francisco?
P.S.
My goal is to help people that honestly want the help; and are willing to do the hard work to sort through all the misinformation that abounds in the finance world.
I don’t have a site. I don’t make any money. I simply share my knowledge where it’s needed.
My only request of you is that you don’t add to the misinformation and confusion.
Sincerely,
EarlyRetired
What about solutions? Share with us some specific actions you’re taking so that we might profit.
Not sure doubling is very good since 2009 given the market went down 50%. That means you’re back to even 7 years later.
I love your comments, so keep them up!
Sam – I’ll make you a deal.
If you answer my questions, I’ll answer yours.
So how about it? Quit trying to wiggle, and answer my questions?
So first to your questions:
As for doubling since 2009 not being “enough”, I fear that I’ve already come off as bragging too much while trying to legitimize my sources…,
But trust me, twice what I had in 2009 (when I didn’t lose that much in the interim) is an amount I am extremely happy with. Hence, my desire to help others.
Specific actions?:
I’ll repeat my extremely simple plan since you again asked:
Reduce equity exposure to the bare bottom of your range. Be patient.
(Near zero percent interest rates have resulted in earnings that are way over-stated. Think through how interest expense flows through an income statement for instance;
Also think about how zero cost stock buybacks have over heated just about every valuation metric you care to track.)
Keep the balance as liquid as possible with minimal exposure to rising interest rates. Even 5 yr CD’s earning 2.5% (with minimal EWP’s) are not terrible when inflation is near zero.
Sam, It’s your turn—Don’t be shy.
The questions I’ve repeatedly asked over the last week or so are neatly summarized above for your convenience.
earlyretired – absolutely love reading your comments. Thank you!
Creating a fictitious scenario to prove a point is a strawman’s argument.
Do you work in finance or are you just trying to argue for argument’s sake?
+1 enjoying this thread
Thanks Gary and Webbersworld.
Just logged back in to continue the conversation….
But disappointed to see that Sam (aka Jan above) continues to avoid answering even one of my questions.
Wouldn’t we all rather debate my questions in an environment like this as opposed to betting with our pocketbooks in the real world?
I really don’t want to hurt his feelings. This is a great forum.
Lets be patient. Maybe he will still respond?
Seems like you’re pretty salty that you sold so much stock in 2013. Even though this article discusses we are in a bubble, you disagree because you think we’re in a bigger bubble? You seem to be arguing just for arguments sake. Why the condescending attitude?
Finance is the great equalizer. You lost selling so much in 2013, and everybody else who held on until now wins since we’re at record highs.
Fascinating interpretation of what I actually said!
But since you asked, I’ve more than doubled the value of my portfolio since 2009.
The stock market was similarly over-valued in 2007 (see Shiller chart for one of the clues). Accordingly, my equity exposure was minimal by the time we reached the lows of March, 2009. With a ton of liquid cash on hand, I enjoyed some of the best buying opportunities in a generation.
Seeing the same pattern emerge in late 2013, I began an orderly process of again slowly reducing exposure to equities….
I don’t know if you are part of the group on this Blog that wants to bring down the successful; or part of the other half that wants to learn from them. But just in case you are in the latter, I recommend that you do the same.
Wow!, Paranoid much? No one really cares.
Sam,
You total changed the way i look at my finances and pure inspiration for all my planning for last couple of years.
Can you give me more info about this?
Continue to buy equity via structured notes with 20-30% downside barriers or buffers as part of my monthly investing contribution as opposed to buying naked equity
I have close to 200K in FD’s and not sure how to diversify this money? I never bought any structured notes in my life and really want to explore what are the other options? I do have around 300K in my 401K and SIP in Betterment.
Thank You.
-Reds
Check out these posts on structured notes. They are essentially derivative products that help product you on the downside by giving up some of the upside.
https://www.financialsamurai.com/understanding-structured-derivative-products-cdsnote-as-an-investment/
https://www.financialsamurai.com/example-of-how-a-structured-note-works/
From the last market recession I’ve learned that the first thing to do is to not panic, stay the course and look for bargains. I mentally picture how I would feel if the market drops 50% in a few days. That exercise has helped me to prepare for the worst besides diversifying. Great post!
Meh. I’m in an accumulation phase. I buy, and keep buying, at my asset allocation. Worrying about bubbles is worrying about noise. Stocks crash? Great — I get more shares for my monthly purchase. But I’m not changing my monthly dollar-cost averaging amount out of fear of a crash (since it’s at the optimal level that works with my budget/priorities right now).
Indeed. If you don’t have much money, you want a massive crash. Yet, when the massive crash comes, you might be scared shitless of investing any money because your job may be at stake. It’s an interesting scenario!
Or you may have no job. Its easy to say you will just Dollar Cost Average through a bubble burst or recession so you have nothing to worry about – but that assumes you will have money coming in in which to DCA.
Pardon me if I quibble a bit about terms but to me Dollar Cost Averaging (DCA) and Re-balancing are two different things.
DCA is something you do with a DRIP, for example I own Emera (EMA-T) and every 3 months they take $500 from my bank account. What matters to me, ins’t the stock price but the dividend it gets raised every 3-4 years. Matter of fact I prefer a flat to declining stock price.
Re-balancing is what I do in my LIRSP (locked in RRSP) I own 4 ETFs 25% in each of the following
Canadian bond fund
Canadian Dividend fund*
Vanguard Whole US market
International ETF
Generally speaking once a year or so I will rebalance them back to 25% . I’m not too worried about a bubble (2008 excepted when everything dropped) as rebalancing ensures that I sell high and buy low.
I’m a Canadian living in Europe so I have the additional hassle of dealing with currency, sending Euros to Canada is wonderful, bringing dollars back to pay bills (in retirement just a few short years away) hurts!
*I went with a dividend fund rather than a whole market fund as the CDN market is quite tiny compared to our neighbors south of the border.
Sounds good to me. Thanks for reminding others about rebalancing and dollar cost averaging.
I’ve found over the years that having a consistent contribution methodology can do wonders. Hence why I believe everybody can accumulate a million in their 401k if they keep maxing out over the decades.
We don’t have to be in a bubble to see a 20% (or even 30%) pullback in equity prices.
Obviously the definition of a bubble varies by person, but I generally consider it to be a situation where valuations cannot be justified by even the most optimistic economic assumptions. In a bubble, prices are driven soley by the idea that someone else will be willing to buy at an even higher price.
That may be the case in private equity, but it is still possible to rationalize current stock prices.
That’s true, but if we correct 20%, I think that’s mainly b/c we were in a bubble based on the common vernacular of folks in finance. 10%, not as much, but it will sure feel like the world is coming to an end at -10%.
The private valuations in tech/internet startups is out of control. I hope it continues for 3 more years as an option holder in a fintech company, and landlord in SF.
Can you explain more ” structured notes with 20-30% downside barriers”
Sure, here are a couple posts on structured notes and how they work:
https://www.financialsamurai.com/understanding-structured-derivative-products-cdsnote-as-an-investment/
https://www.financialsamurai.com/example-of-how-a-structured-note-works/
There is always a bubble somewhere – and conversely a bear market somewhere. Stock Market (US) and Real Estate (SF) both looked high to me, but they also need to be compared to the alternatives and the relation to interest rates and taxable consequences.
I hope everyone knows that cash is also not a risk free position and can be in a bubble itself…..
ALWAYS enjoy reading your blog and first time I have posted.
Thanks Dave. What are some of the risks to cash you are alluding to in America?
I do think SF real estate market is in a bubble. Don’t think stock market is in a bubble yet. Look at the PE ratios of the companies below:
Apple (PE 17)
Toyota (PE 13)
CBS (PE 12)
Berkshire (PE 18)
Aetna (PE 19)
Microsoft (PE 17)
Goldman Sachs (PE 12)
Exxon (PE 11)
Think that anyone that is staying in cash is probably just wasting time. When the real bubble happens they would either still be in cash or converted cash to equity at higher prices than today. Best play is to just dollar cost average through it all and not worry about a bubble.
Can’t really speak to the private equity market since most have been locked out of it.
I agree with AAB. When you look at many of the large companies out there, I don’t see the bubble. Yet when I look at the total value of the market, it does look awfully high. It seems like there are some companies that are dramatically overvalued (billion dollar start-ups), yet established companies seem to be in a normal range.
I hope that any correction coming will be minor and last only a few quarters.
I agree with you on the stock market. I think people misconstrue business cycles as bubbles too often and the media runs with it… because, well, the media. Cash is a negative yield play, stay away. Far away.
Article would have had more weight last september. Howeve, the longer the market goes sideways the less bubbly overall it gets, as it’s effectively growing into the valuations. Look at some of the forward pe for companies that were in the mid to high 20s a few months ago….reasonable.
Yes, there are frothy sectors, but also down sectors. No one is forcing you to buy tesla over exxon. Peoples psyches have been scarred by two back to back bubbles and this influences their thinking.
When you look at the long term chart of the s/p over time iirc it actually shows us being about average right now. this is a long slow recovery that is just trudging forward and likely good for a couple years more without some extrinsic factor causing a panic (could happen 5 mins from now). Though I expect average corrections to occur regularly even 20% is far from average post ww2.
Agreed. Agree, with the following statement “When you look at the long term chart of the s/p over time iirc it actually shows us being about average right now.”
It’s even slightly below average if anyone takes the time to do the math.
I assume its no coincidence that you happened to cherry pick the 3 largest market cap companies in the S&P: Apple, MS and Exxon. By any measure — TTM PE or Schiller as above, the S&P as a whole is expensive by historical standards.
Stock buybacks, fueled by cheap money, and other balance sheet gimmicks are making the big fish in the S&P appear artificially cheap. If the funny money starts drying up, so will the paper earnings.
Lol @ Cherry pick
Why not buy one of the three you say I cherry picked rather than move to cash? All three are buying back shares :)
The day that Sam posts a poll regarding bubble and the majority say we are not in a bubble then we probably are in a bubble. Lol
Personally, think we will be much higher than this within 6 years, so I don’t want to sell my shares in 2015. You don’t so we differ.
Alledged story
Magic Johnson once briefly coached the Lakers and didn’t do so well as a coach. He would get upset with his point guard Nick Van Excel at the time because Magic would say to Nick, “Dont you see that guys open?”. Nick couldn’t see the play the same way Magic saw it. Nick was a decent PG in his career. Magic was a great player, not so great at coaching.
Moral
Everyone see’s things differently and that’s okay :)
Yep… that’s why we have markets!
So, what do you think is going to drive us higher in the next 6 years?
Will economic growth pick up? Inflation? Multiple expansion? Continued cheap money and stock buybacks? All of the above?
Simple math – the answer to this question is sort of in my response to Zaphod above.
Take a good look at graph of S&P that Sam posted and run the numbers. Don’t look at the fact that we are at all time high or any of that mess. Block that out.