Question: When Bubbles Burst, Do Asset Prices Go Below Instrinsic Value?

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Park
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Question: When Bubbles Burst, Do Asset Prices Go Below Instrinsic Value?

Post by Park » Wed Dec 05, 2018 10:31 am

I thought that I read somewhere of a study (GMO?), that found when a bubble bursts, asset prices overcompensate and go below their intrinsic value.

I can't find it, so I thought that I would index the collective wisdom of the forum regarding this.

cadreamer2015
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Re: Question: When Bubbles Burst, Do Asset Prices Go Below Instrinsic Value?

Post by cadreamer2015 » Wed Dec 05, 2018 10:32 am

What is intrinsic value? How is it determined?
De gustibus non est disputandum

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raven15
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Re: Question: When Bubbles Burst, Do Asset Prices Go Below Instrinsic Value?

Post by raven15 » Wed Dec 05, 2018 10:33 am

I wonder how far bitcoin will drop before it meets its intrinsic value! :confused
It's Time. Adding Interest.

megabad
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Re: Question: When Bubbles Burst, Do Asset Prices Go Below Instrinsic Value?

Post by megabad » Wed Dec 05, 2018 12:19 pm

Park wrote:
Wed Dec 05, 2018 10:31 am
I thought that I read somewhere of a study (GMO?), that found when a bubble bursts, asset prices overcompensate and go below their intrinsic value.

I can't find it, so I thought that I would index the collective wisdom of the forum regarding this.
Sorry, I cannot find the article based on the info listed. As above, I do not believe in intrinsic value. I believe in market value. Asset value is exactly what the market says it is. Can there be a bubble? You bet. Can values drop suddenly very low? You bet. Greenspan has several quotes in articles around that talk about "intrinsic value" but I don't think this is what you mean, nor do I necessarily view economics the same way he does.

senex
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Re: Question: When Bubbles Burst, Do Asset Prices Go Below Instrinsic Value?

Post by senex » Wed Dec 05, 2018 12:36 pm

cadreamer2015 wrote:
Wed Dec 05, 2018 10:32 am
What is intrinsic value? How is it determined?
One definition is a combination of book value plus the present discounted value of conservatively estimated future cash flows. By that definition, I believe that assets routinely drop below intrinsic value during panics, even if any particular case is arguable based on what constitutes a "conservative" discount rate etc.

A counter-argument is that if it were easy or objective to calculate intrinsic value, then many people would do it, making easy money. Thus we begin the spiral into arguments about investor psychology, efficient markets, etc.

Charlie Munger (Buffett's partner) often talks about panics in his early career when "monopoly newspapers were selling at 3-4x earnings," as if those were no-brainer buying opportunities -- and indeed, he made way above-market returns for decades by buying below "intrinsic value." So there is probably something to his idea besides luck. (A Buffett article called "The Super Investors of Graham and Doddsville" discusses the possibility that he and Charlie were just lucky).

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nedsaid
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Re: Question: When Bubbles Burst, Do Asset Prices Go Below Instrinsic Value?

Post by nedsaid » Wed Dec 05, 2018 1:12 pm

Park wrote:
Wed Dec 05, 2018 10:31 am
I thought that I read somewhere of a study (GMO?), that found when a bubble bursts, asset prices overcompensate and go below their intrinsic value.

I can't find it, so I thought that I would index the collective wisdom of the forum regarding this.
Answer is probably. Intrinsic value is in the eye of the beholder, this is hardly an objective measurement. Also some investors are better at valuing assets than others, Warren Buffett comes to mind. So again, the answer is a qualified yes.
A fool and his money are good for business.

zengolf2011
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Re: Question: When Bubbles Burst, Do Asset Prices Go Below Instrinsic Value?

Post by zengolf2011 » Wed Dec 05, 2018 3:43 pm

I think it's common for asset prices to fall below any reasonable estimate of "intrinsic" value during financial crises. Panic selling takes on a life of its own completely decoupled from hard asset values , as does frenzied buying in the run-up to bubbles. In 1932, Benjamin Graham wrote an article for Forbes listing 20 leading companies of the time whose stock was selling for less than their cash assets. In other words, one could buy the company at its prevailing market capitalization, take the cash assets, throw the rest of the company away, and realize a profit. He indicated there were dozens more companies in similar shape. This is not just a phenomenon of the Great Depression. Corporate raiders have made fortunes doing just that in more recent times.

TheNightsToCome
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Re: Question: When Bubbles Burst, Do Asset Prices Go Below Instrinsic Value?

Post by TheNightsToCome » Wed Dec 05, 2018 4:00 pm

I remember Grantham's description of his work (from interviews and articles published early in this century) covering the 20th century in many asset classes across many international markets. As I recall, GMO (his company) defined a bubble as a two standard deviation rise above the very long-term price trend for each asset class.

GMO found 28 such bubbles in the 20th century and 27 of them eventually fell below the long term price trend (from a peak more than two standard deviations above it). The late 90s stock market bubble was the 28th and the research was published around the time of the stock market peak.

In general, the subsequent under-valuation was roughly proportional to the preceding over-valuation.

btenny
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Re: Question: When Bubbles Burst, Do Asset Prices Go Below Instrinsic Value?

Post by btenny » Wed Dec 05, 2018 4:30 pm

In some cases and some times absolutely. In Arizona I have witnessed fire sale prices on homes and property during and after major recessions three times in the last 50 years, in 1974, in 1987 and in 2008. Each time it was obvious that things were being sold for extremely low prices well below intrinsic value. There were other crashes in other years but these crashes were major buying events for real estate if you had money.

1974 Oil Embargo
https://www.thebalance.com/opec-oil-emb ... is-3305806

1987 Savings and Loan crisis and Stock Market crash
https://en.wikipedia.org/wiki/Black_Monday_(1987)
https://en.wikipedia.org/wiki/Savings_and_loan_crisis

2008 Sub Prime Loan Crisis
https://en.wikipedia.org/wiki/Subprime_mortgage_crisis

During these recessions lots of stuff was on sale at cost below replacement. For example in 2010 you could buy a nearly new nice home in Chandler or Gilbert Arizona for significantly less than it cost to build it just a few years before. Yep they were selling repossessed homes for $200K or less that cost $250K or more to build and sold new for $350K. They were nice homes in good neighborhoods. The issue was they were bought by people who could barely afford the mortgage and then lost their jobs. These homes are located near the technical industry area of Phoenix so there are lots of places to work. Tons of small investors knew this area would recover fast so they bought up 2-3 homes each and became land lords. Today these homes sell for $400K or more.

Similarly stocks were on sales during all three of these recessions and smart investors did very well there too.

Good Luck.

btenny
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Re: Question: When Bubbles Burst, Do Asset Prices Go Below Instrinsic Value?

Post by btenny » Wed Dec 05, 2018 4:40 pm

Right now I think we are in a crash in oil prices. This crash started in 2014 and is still going. I think there are bargains to be purchased in oil stocks and similar things. But I am unclear what the intrinsic value or great price is.

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Watty
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Re: Question: When Bubbles Burst, Do Asset Prices Go Below Instrinsic Value?

Post by Watty » Wed Dec 05, 2018 5:04 pm

With real estate the price of a building can drop below what it would cost to build the building.

That does not mean that it is necessarily a good deal since the housing market in an area like Detroit may not recover anytime soon.

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serbeer
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Re: Question: When Bubbles Burst, Do Asset Prices Go Below Instrinsic Value?

Post by serbeer » Wed Dec 05, 2018 5:48 pm

Watty wrote:
Wed Dec 05, 2018 5:04 pm
With real estate the price of a building can drop below what it would cost to build the building.

That does not mean that it is necessarily a good deal since the housing market in an area like Detroit may not recover anytime soon.
Oh yes, as I discovered after purchasing new home, conventional sale, not foreclosure or short sale, that according to insurance company estimated rebuild value (through both automated system and human appraisers they sent down) is 1.8 times of what I paid for the house, so that's what I must insure it for. Played with several web calculators and amount was even higher. And mind you, when I purchased, I paid for both land and house, while rebuild value is based on price of the house alone.

So not in burst bubble but already intrinsic value of my land + house is probably 2x more than what I paid for it. And I know I will never be able to sell it for anywhere close to intrinsic value too.

Park
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Re: Question: When Bubbles Burst, Do Asset Prices Go Below Instrinsic Value?

Post by Park » Thu Dec 06, 2018 9:00 am

TheNightsToCome wrote:
Wed Dec 05, 2018 4:00 pm
I remember Grantham's description of his work (from interviews and articles published early in this century) covering the 20th century in many asset classes across many international markets. As I recall, GMO (his company) defined a bubble as a two standard deviation rise above the very long-term price trend for each asset class.

GMO found 28 such bubbles in the 20th century and 27 of them eventually fell below the long term price trend (from a peak more than two standard deviations above it). The late 90s stock market bubble was the 28th and the research was published around the time of the stock market peak.

In general, the subsequent under-valuation was roughly proportional to the preceding over-valuation.
https://www.businessinsider.com/jeremy- ... yet-2015-6

"Every 2-sigma event is followed by an equal and offsetting 2-sigma reversion," he said, adding that the pattern occurred in 28 out of 28 of the major bubbles GMO has studied throughout history. "And they all went back half a year quicker than they went up,""

There have been appropriate comments in this thread about my use of the word intrinsic value. But this is what I was looking for. Based on how GMO defines bubble, the fact that all bubbles that GMO has studied have an equal and offsetting mean reversion is relevant. It's not easy to make money from bubbles. And that may be a reason why quantitative value strategies will continue to work in the future.

Edited to include the following: the above is consistent with being able to time the market at extremes of valuation.

TheNightsToCome
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Re: Question: When Bubbles Burst, Do Asset Prices Go Below Instrinsic Value?

Post by TheNightsToCome » Sat Dec 08, 2018 6:55 pm

Park wrote:
Thu Dec 06, 2018 9:00 am
TheNightsToCome wrote:
Wed Dec 05, 2018 4:00 pm
I remember Grantham's description of his work (from interviews and articles published early in this century) covering the 20th century in many asset classes across many international markets. As I recall, GMO (his company) defined a bubble as a two standard deviation rise above the very long-term price trend for each asset class.

GMO found 28 such bubbles in the 20th century and 27 of them eventually fell below the long term price trend (from a peak more than two standard deviations above it). The late 90s stock market bubble was the 28th and the research was published around the time of the stock market peak.

In general, the subsequent under-valuation was roughly proportional to the preceding over-valuation.
https://www.businessinsider.com/jeremy- ... yet-2015-6

"Every 2-sigma event is followed by an equal and offsetting 2-sigma reversion," he said, adding that the pattern occurred in 28 out of 28 of the major bubbles GMO has studied throughout history. "And they all went back half a year quicker than they went up,""

There have been appropriate comments in this thread about my use of the word intrinsic value. But this is what I was looking for. Based on how GMO defines bubble, the fact that all bubbles that GMO has studied have an equal and offsetting mean reversion is relevant. It's not easy to make money from bubbles. And that may be a reason why quantitative value strategies will continue to work in the future.

Edited to include the following: the above is consistent with being able to time the market at extremes of valuation.
From Andrew Smithers:

"Chart two compares two long-term investment strategies. One is the “buy-and-hold” approach, with the other investors going liquid when the stock market is 70 per cent overvalued and reinvesting when it falls back to fair value. The long-term benefits from managing the portfolio by selling during overvalued markets are to improve the return and lower the volatility of that return. From 1871 to 2013 the improvement in the return is just over 1 per cent a year in real terms and the volatility of the annual returns falls from 18 per cent to 15 per cent, so that there is an even greater improvement in the risk adjusted return – the Sharpe ratio is about 30 per cent better."

Smithers provides caveats, including:

"It is essential to stick to an agreed strategy. Investors suffer all too easily from “decision regret”. The gaps between selling and reinvesting can be long. Selling at the end of 1905 proved to be a good decision, but it required investors to be out of the stock market for 12 years and it was nine years between the decision to sell at the end of 1999 and to reinvest at the end of 2008. Not only were these long waits, but the market went on rising after the sales were made and went on falling after the decision to reinvest. (This was even true in the first four months of 1930, when the stock market rose 20 per cent from its end-1929 value.)"

See the article here: https://outline.com/AFBr44

TheNightsToCome
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Re: Question: When Bubbles Burst, Do Asset Prices Go Below Instrinsic Value?

Post by TheNightsToCome » Sun Dec 09, 2018 4:45 pm

Park wrote:
Thu Dec 06, 2018 9:00 am
TheNightsToCome wrote:
Wed Dec 05, 2018 4:00 pm
I remember Grantham's description of his work (from interviews and articles published early in this century) covering the 20th century in many asset classes across many international markets. As I recall, GMO (his company) defined a bubble as a two standard deviation rise above the very long-term price trend for each asset class.

GMO found 28 such bubbles in the 20th century and 27 of them eventually fell below the long term price trend (from a peak more than two standard deviations above it). The late 90s stock market bubble was the 28th and the research was published around the time of the stock market peak.

In general, the subsequent under-valuation was roughly proportional to the preceding over-valuation.
https://www.businessinsider.com/jeremy- ... yet-2015-6

"Every 2-sigma event is followed by an equal and offsetting 2-sigma reversion," he said, adding that the pattern occurred in 28 out of 28 of the major bubbles GMO has studied throughout history. "And they all went back half a year quicker than they went up,""

There have been appropriate comments in this thread about my use of the word intrinsic value. But this is what I was looking for. Based on how GMO defines bubble, the fact that all bubbles that GMO has studied have an equal and offsetting mean reversion is relevant. It's not easy to make money from bubbles. And that may be a reason why quantitative value strategies will continue to work in the future.

Edited to include the following: the above is consistent with being able to time the market at extremes of valuation.
In November, the market was almost 3 standard deviations above its long-term trend based on data presented here: https://www.advisorperspectives.com/dsh ... erformance

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