How to Spot a Market Cheerleader
Why do I bother going through this exercise if I think his data is so
worthless? Because it is a prime example of the contortions that
market cheerleaders and advocates of a buy and hold philosophy do to
justify their beliefs. If the data doesn't justify your belief, then
find something that does. If current P/E ratios don't work, then
create 5 year smoothed ratios, using earnings levels from previous
years that won't be repeated for many years. Don't tell your readers
that it usually takes 5-6 years for companies to get back to new
earnings highs after a recession.
Now, could the market decide to rise from here and never return? Of
course, anything is possible. But History, as Grantham will now tell
us, says it is not likely.
Jeremy Grantham took the stage after Siegel spoke, and immediately set the tone with the remark, "Investors are not smart."
Grantham is not a congenital bear. He simply looks for investment
classes which are below trend and buys them and sells them when they
get above trend. Sometimes he buys too early and sometimes he sells
too early, but he believes in the dictum that markets always come back to trend. I have often stated that markets are a mean, lean, reversion machine. Grantham is right. Markets always come back to trend.
He presents us with the benefits of his research into bubbles. He has
looked at every bubble for which he could find data. His research goes back years and years and includes stocks, bonds, commodities and
currencies. He has found 28 bubbles. He defines a bubble as a 40-year
event in which statistics went well beyond the norm, a two-standard-
deviation event. Every one of the 28 went back to trend, no
exceptions, no new eras, not a single one that we can find in history.
He then argues the broad U.S. market today is still in bubble
territory, as it has not come back to trend.
[Let me repeat for emphasis: with no exceptions, bubbles and markets
will come back to trend.]
He notes that many markets and bubbles not only come back to trend,
but go down right on past the trend line.
What is trend for the US markets? He gives us four measures. Based
upon dividend yield, the market is overvalued by 50%. Based upon
Tobin's Q (the market value of a firm's assets divided by their
replacement value) the market is too high by 31%. The price of stocks
to the 10 year average of real earnings is too high by 31% and as a
function of market cap to GDP the market would need to come down by
45% to get back to trend.
The trend line for P/E is slightly under 15. Grantham thinks you could see this trend rise to 17.5 over time, as he does agree the markets are now more liquid and we live in somewhat safer times. But this would mean the market would need to drop substantially to come back to trend. How much depends upon whether you use core earnings, pro forma earnings, and forward or trailing earnings. But they all suggest the need for a substantial correction.
Notice that Grantham uses a 10 year average of real earnings instead
of Siegel's 5 years of reported earnings. The longer time frame takes
out the effect of the very high four years immediately prior to 2001,
and thus does not "curve fit" the data to fit a desired outcome.
It is important for Siegel and other cheerleaders, if they want to
maintain any type of credibility, to look for some way to suggest that stocks are fairly valued, as Grantham's next data shows. If you can't find a reason that stocks are at fair value, then you would logically be forced to acknowledge the effects of trend reversion. |
