Stock Bubble? History Argues the Contrary

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sapphire96
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Stock Bubble? History Argues the Contrary

Post by sapphire96 »

There has been discussion of the dramatic rise in the US stock market and how a bubble is forming. I would like to make the proposal that evaluations are not that far from normal historical deviations and should not influence a person's asset allocation.

Chart A is the S&P 500 since 1933 (excludes dividends). I have calculated an exponential average of the price returns throughout this period (up to 2017, when I first created the tracking file) and have extrapolated that average forward to today; this is the red line. Traditionally, if the S&P 500 (blue) is above the red line, it implies the price is higher than where it should be on average; this can, in turn, imply the likelihood of decreased expected future returns. Better future expected returns would be implied if the S&P 500 was below its expected average price. We can see a few prolonged periods of when the S&P 500 was below and above its expected average price.

Note, however, just because the S&P 500 is above or below "where it should be," does not stop the market from rising. If anything, the transition from above to below average (and vice versa) is often sudden (1-3 years) and you can have many years of steady growth between these sudden changes. To better illustrate this, I took the S&P 500 price as a percent of the exponential average to generate a premium percentage (Chart B). We can see more clearly these above and below implied average periods. The tech bubble sticks out like a sore thumb, but note how today's evaluations are no where near the late-90s. In fact, note the period of 1955-1970: that period of "above average" prices lasted steadily for 15 years and our current evaluations are nearly identical to the beginning of that period.

Granted, past performance is not a guarantee of future results. However, the past is our best indicator of the future, and as far as I can see, current evaluations are above average but not to the degree of a bubble. I would not be surprised if in 10 to 15 years we have a transition to below average pricing, but that seems far off. Considering this, investors should not change their asset allocations when markets rise or fall since they ultimately do not know when the transition "back" will occur.

Edit: grammar and spelling.

Chart A - S&P 500 Price with Exponential Average since 1933.
Image

Chart B - S&P 500 Percent Over Exponential Average.
Image
Last edited by sapphire96 on Sun Mar 21, 2021 11:30 am, edited 1 time in total.
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Re: Stock Bubble? History Argues the Contrary

Post by nedsaid »

This is an excellent post and your graph provides nice long term perspective. Younger investors should not sweat any of this and just keep making systematic investments into the stock market.
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Re: Stock Bubble? History Argues the Contrary

Post by JoMoney »

Why the 1933 start date? Seems odd to pick a year that's a known stock market low point as the start date for your growth line.
Doesn't seem to be have been a point that was "average" relative to growth starting in other years.
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Re: Stock Bubble? History Argues the Contrary

Post by HootingSloth »

It would be great to see these same charts with the trend fixed by, say, a 1937 start date and 2009 end date as a robustness check that addresses JoMoney's point. How much does your qualitative assessment depend on the period chosen?
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Re: Stock Bubble? History Argues the Contrary

Post by nedsaid »

88 years is not a bad sample.
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Re: Stock Bubble? History Argues the Contrary

Post by sapphire96 »

JoMoney wrote: Sun Mar 21, 2021 10:42 am Why the 1933 start date? Seems odd to pick a year that's a known stock market low point as the start date for your growth line.
Doesn't seem to be have been a point that was "average" relative to growth starting in other years.
1933 was picked as the starting point because before this, the modern exponential average (which used 1950 through 2017 data points to generate) does not hold as the growth rate was much flatter. I recognize 1933 was a low point, but this appeared to be a visual end of the best fit line - otherwise, the modern best fit line would have gone below zero in the 1900s.

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Re: Stock Bubble? History Argues the Contrary

Post by sapphire96 »

HootingSloth wrote: Sun Mar 21, 2021 10:49 am It would be great to see these same charts with the trend fixed by, say, a 1937 start date and 2009 end date as a robustness check that addresses JoMoney's point. How much does your qualitative assessment depend on the period chosen?
So for giggles, I just created an all-time exponential average. It would imply a few things...
1873-1897 had elevated prices with no growth.
The 1925-1929 "bubble" was never a bubble.
The US never got back to average until the 1960s, but barely.
Prices have been elevated since 1990 - the tech bubble never fully popped.
The bottom of the Great Financial Crisis crash had evaluations back to average.

The question I think arises was there a fundamental economic shift in the US starting in the 1930s that created a new exponential average growth line and does this create the possibility of a lower (or higher?) exponential growth line for the future.
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Re: Stock Bubble? History Argues the Contrary

Post by sapphire96 »

nedsaid wrote: Sun Mar 21, 2021 10:54 am 88 years is not a bad sample.
I can top that with 150 years. :twisted:
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Re: Stock Bubble? History Argues the Contrary

Post by willthrill81 »

Estimating where stocks 'should' be on the basis of historic growth rates alone is not a bad approach. But some would argue that it is ignoring potentially valuable information. Adding information, such as from valuations, has not resulted in a poorer estimate of forward returns; rather, it has resulted in a superior estimate of forward returns.

However, even models that incorporate valuations as a dependent variable have still had substantial prediction intervals. Some argue that these intervals have been so large as to not be actionable in a meaningful way. I'm not sure that I subscribe to that notion myself though.

What I don't recall seeing is a model of something like CAPE divided by expected real 10 year yields. Some of the lowest CAPE values ever were in the early 1980s, when interest rates were very high. Conversely, we're basically seeing the second highest CAPE values in history, but expected real interest rates are also near record lows.

So I'm not convinced that U.S. stocks are in a bubble, though I do strongly suspect that returns will be below average for the next 10 years or so.

It always makes me cringe when I hear people, especially so-called financial advisors or pundits, planning on getting 7% real returns over their specific investment horizon. There have been many historic periods where real returns were significantly lower.
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Re: Stock Bubble? History Argues the Contrary

Post by nedsaid »

sapphire96 wrote: Sun Mar 21, 2021 11:57 am
nedsaid wrote: Sun Mar 21, 2021 10:54 am 88 years is not a bad sample.
I can top that with 150 years. :twisted:
I suppose if your graph started in 1871, someone would say that you cherry picked the starting point.

If you could post a graph starting in 1926, that would quell some of the criticism but I suspect that the graph would look much the same.

Edit: I saw you beat me to it, you posted a graph going back to "only" 1873.
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Re: Stock Bubble? History Argues the Contrary

Post by nedsaid »

sapphire96 wrote: Sun Mar 21, 2021 11:57 am
So for giggles, I just created an all-time exponential average. It would imply a few things...
1873-1897 had elevated prices with no growth.
The 1925-1929 "bubble" was never a bubble.
The US never got back to average until the 1960s, but barely.
Prices have been elevated since 1990 - the tech bubble never fully popped.
The bottom of the Great Financial Crisis crash had evaluations back to average.

The question I think arises was there a fundamental economic shift in the US starting in the 1930s that created a new exponential average growth line and does this create the possibility of a lower (or higher?) exponential growth line for the future.
What we might be seeing is the effect of the post Civil War period and reconstruction. A pretty good argument can be made that the American South took 100 years to really recover from the effects of the war. There are still folks hopping mad over Sherman's March to Atlanta, you can see evidence of the path of destruction even now with satellite photos. Not sure if there is GDP data from the former Confederate states in the aftermath of the Civil War, if my thesis is correct, the South might have been a drag on total US economic growth for over 50 years.
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Re: Stock Bubble? History Argues the Contrary

Post by JoMoney »

sapphire96 wrote: Sun Mar 21, 2021 11:57 am ....
The question I think arises was there a fundamental economic shift in the US starting in the 1930s that created a new exponential average growth line and does this create the possibility of a lower (or higher?) exponential growth line for the future....
There have been several shifts, notably in dividend payout ratios/retained earnings. Since your chart is price only, any growth an investor saw from current income/dividends is left out. A chart on bond prices ignoring coupon interest payments would look dreadful.
Jeremy Siegel looks at the different dividend payout regimes in Stocks For The Long Run. You might also look at his trend line that incorporates Total Return and Inflation.
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Re: Stock Bubble? History Argues the Contrary

Post by Forester »

S&P 500 has grown at 7% a year versus the same CAPE valuation in summer 1998 which all things being equal is what one would expect. I assume US returns will be OK-but-mediocre over the next twenty years, and the global market cap portfolio, which should be the default benchmark, will be just fine.
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Re: Stock Bubble? History Argues the Contrary

Post by nisiprius »

I think we're in a stock bubble, and I am personally trying to take no action at all based on that belief.

One confusing thing is that I really do think we are seeing clear signs of some kind of mania as evidenced by GME, SPACs, NFTs, etc. etc. However, the total dollar amount is trivial compared to the total size of the market. Robinhood is the bucket shop for the 21st century, but VTI is not one of the things being gambled on.

I don't like starting at 1933. Basically, if you believe that the history of the stock market is discontinuous, then history shouldn't be used to argue anything. Jim Otar published an interesting chart:

Image

I don't know how seriously to take it. I do think it suggests that when we look at a century or so of data, we are looking at eight independent data points, not a hundred. It does fit with one traditional view of the stock market, which is that it is an episodic sequence of separate "markets," last around a decade or so, each with its own independent "personality" and characteristics.
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Re: Stock Bubble? History Argues the Contrary

Post by ljford7 »

nisiprius wrote: Sun Mar 21, 2021 1:14 pm One confusing thing is that I really do think we are seeing clear signs of some kind of mania as evidenced by GME, SPACs, NFTs, etc. etc. However, the total dollar amount is trivial compared to the total size of the market. Robinhood is the bucket shop for the 21st century, but VTI is not one of the things being gambled on.
This is what I think some people fail to recognize. There are parts of the market that are exhibiting bubble like behavior, but that doesn't mean the entire market is in a bubble.

I would also add electric vehicle stocks to the list. Their valuations are ridiculous and it is going to be shocking (to some people) what happens to them once the big auto manufactures start to flood the market with electric and self driving vehicles (it is going to happen sooner then later).
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Re: Stock Bubble? History Argues the Contrary

Post by ljford7 »

sapphire96 wrote: Sun Mar 21, 2021 10:28 am Chart B - S&P 500 Percent Over Exponential Average.
Image
This is a really neat chart. The dotcom bust (recently) shows how much the market was out of alignment at the time. What did you us to make the chart?
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Re: Stock Bubble? History Argues the Contrary

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willthrill81 wrote: Sun Mar 21, 2021 11:58 am
What I don't recall seeing is a model of something like CAPE divided by expected real 10 year yields. Some of the lowest CAPE values ever were in the early 1980s, when interest rates were very high. Conversely, we're basically seeing the second highest CAPE values in history, but expected real interest rates are also near record lows.
Isn't Vanguard's "fair value CAPE" an attempt to incorporate interest rates into the over / under value assessment of CAPE 10?
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Re: Stock Bubble? History Argues the Contrary

Post by Steve Reading »

nisiprius wrote: Sun Mar 21, 2021 1:14 pm I think we're in a stock bubble
Cliff Asness' pet peeve #2 is how loosely people use the word "bubble":
the term bubble should indicate a price that no reasonable future outcome can justify. I believe that tech stocks in early 2000 fit this description. I don’t think there were assumptions— short of them owning the GDP of the Earth—that justified their valuations. However, in the wake of 1999–2000 and 2007–2008 and with the prevalence of the use of the word “bubble” to describe these two instances, we have dumbed the word down and now use it too much. An asset or a security is often declared to be in a bubble when it is more accurate to describe it as “expensive” or possessing a “lower than normal expected return.” The descriptions “lower than normal expected return” and “bubble” are not the same thing.
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@OP: Thanks for the graph and perspective!
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Re: Stock Bubble? History Argues the Contrary

Post by willthrill81 »

watchnerd wrote: Mon Mar 22, 2021 10:10 am
willthrill81 wrote: Sun Mar 21, 2021 11:58 am
What I don't recall seeing is a model of something like CAPE divided by expected real 10 year yields. Some of the lowest CAPE values ever were in the early 1980s, when interest rates were very high. Conversely, we're basically seeing the second highest CAPE values in history, but expected real interest rates are also near record lows.
Isn't Vanguard's "fair value CAPE" an attempt to incorporate interest rates into the over / under value assessment of CAPE 10?
I've not looked into how they calculate it, so I don't know.
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Re: Stock Bubble? History Argues the Contrary

Post by watchnerd »

willthrill81 wrote: Mon Mar 22, 2021 10:40 am
watchnerd wrote: Mon Mar 22, 2021 10:10 am
willthrill81 wrote: Sun Mar 21, 2021 11:58 am
What I don't recall seeing is a model of something like CAPE divided by expected real 10 year yields. Some of the lowest CAPE values ever were in the early 1980s, when interest rates were very high. Conversely, we're basically seeing the second highest CAPE values in history, but expected real interest rates are also near record lows.
Isn't Vanguard's "fair value CAPE" an attempt to incorporate interest rates into the over / under value assessment of CAPE 10?
I've not looked into how they calculate it, so I don't know.
I haven't found a detailed disclosure on how it works, either. It is proprietary, after all.

What they've said, that I've found, is too broad to DIY it at home.
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Re: Stock Bubble? History Argues the Contrary

Post by burritoLover »

If you decide a metric shows that we're not in a bubble and you shouldn't do anything, then you are arguing that the same metric showing a bubble (by your analysis) means that you should do something. You can't have it both ways.

These are interesting discussions but this and other data is effectively useless in determining any action or inaction. Since there is no reliable way of determining if a bubble exists or not, you might as well take the default position of doing nothing.
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Re: Stock Bubble? History Argues the Contrary

Post by watchnerd »

I don't think it requires one to think that we're in a bubble to think that stocks are expensive at the moment.

And I don't think it's illogical to make minor adjustments to one's AA if one thinks stocks are expensive.

We reduced on stock allocation by 10% (from 70% to 60%) in February because our IPS says that's allowed under valuation circumstances.

From an ROI perspective, I don't feel bad about doing 'something else' with that 10%.

That 'something else' will probably be to take those monies out of our risk portfolio entirely and use it to add to our TIPS/STRIPS LMP ladder at the July TIPS auction and/or to beef up the collection of short TIPS we would use to bridge us from early retirement at 55 to IRA withdrawal age at 59.5.

Is that valuation-based market timing?

Sure.
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Re: Stock Bubble? History Argues the Contrary

Post by jarjarM »

watchnerd wrote: Mon Mar 22, 2021 10:58 am
willthrill81 wrote: Mon Mar 22, 2021 10:40 am
watchnerd wrote: Mon Mar 22, 2021 10:10 am
willthrill81 wrote: Sun Mar 21, 2021 11:58 am
What I don't recall seeing is a model of something like CAPE divided by expected real 10 year yields. Some of the lowest CAPE values ever were in the early 1980s, when interest rates were very high. Conversely, we're basically seeing the second highest CAPE values in history, but expected real interest rates are also near record lows.
Isn't Vanguard's "fair value CAPE" an attempt to incorporate interest rates into the over / under value assessment of CAPE 10?
I've not looked into how they calculate it, so I don't know.
I haven't found a detailed disclosure on how it works, either. It is proprietary, after all.

What they've said, that I've found, is too broad to DIY it at home.
This is the article that described how they calculate the fair value CAPE via a VAR model.

https://mebfaber.com/wp-content/uploads ... ecasts.pdf
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Re: Stock Bubble? History Argues the Contrary

Post by watchnerd »

jarjarM wrote: Mon Mar 22, 2021 12:24 pm
watchnerd wrote: Mon Mar 22, 2021 10:58 am
willthrill81 wrote: Mon Mar 22, 2021 10:40 am
watchnerd wrote: Mon Mar 22, 2021 10:10 am
willthrill81 wrote: Sun Mar 21, 2021 11:58 am
What I don't recall seeing is a model of something like CAPE divided by expected real 10 year yields. Some of the lowest CAPE values ever were in the early 1980s, when interest rates were very high. Conversely, we're basically seeing the second highest CAPE values in history, but expected real interest rates are also near record lows.
Isn't Vanguard's "fair value CAPE" an attempt to incorporate interest rates into the over / under value assessment of CAPE 10?
I've not looked into how they calculate it, so I don't know.
I haven't found a detailed disclosure on how it works, either. It is proprietary, after all.

What they've said, that I've found, is too broad to DIY it at home.
This is the article that described how they calculate the fair value CAPE via a VAR model.

https://mebfaber.com/wp-content/uploads ... ecasts.pdf
Thanks, that looks like good bed time reading tonight. :)
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Re: Stock Bubble? History Argues the Contrary

Post by Prudence »

It's a bubble. Barry Ritholtz's Masters in Business podcast interview of Bill Gurley was very interesting and made a very salient point about the strong effect of zero interest rates on corporate behavior, Wall Street and stock valuations.

https://podcasts.google.com/feed/aHR0cD ... IAxAF&ep=6
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Re: Stock Bubble? History Argues the Contrary

Post by jarjarM »

Well, Prof. Shiller did provided an argument for current market valuation via low bond yield. He created the new excess-CAPE yield metric to justify it. The data/calculation is already available via his usual data site.

https://papers.ssrn.com/sol3/papers.cfm ... id=3714737
Image

Here's the counter point to the argument.

https://www.bloomberg.com/opinion/artic ... ler-s-cape

TLDR: Japan/Europe/US all went through high valuation period, Japan in the 1980s, Europe and US in the late 90s. When the bubble bursted, Japan valuation and bond yield both went down, same for Europe/US after 2000/2008. However, QE driven spending post GFC in US drove up the equity price (along with expansion of FAANG market cap). We will soon face the Ice Age when CAPE is down around 10... Interesting read
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Re: Stock Bubble? History Argues the Contrary

Post by watchnerd »

jarjarM wrote: Mon Mar 22, 2021 12:39 pm
Here's the counter point to the argument.

https://www.bloomberg.com/opinion/artic ... ler-s-cape

TLDR: Japan/Europe/US all went through high valuation period, Japan in the 1980s, Europe and US in the late 90s. When the bubble bursted, Japan valuation and bond yield both went down, same for Europe/US after 2000/2008. However, QE driven spending post GFC in US drove up the equity price (along with expansion of FAANG market cap). We will soon face the Ice Age when CAPE is down around 10... Interesting read
If the implication is that, if you take out FAANG, the US for the next 10 years ends up looking like international / VXUS has for the last 10 years, with near 0 inflation, I could live with that.

VXUS last 10 years = 4.95%

If inflation is 0, that gives me 4.95% real.
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Re: Stock Bubble? History Argues the Contrary

Post by TheLaughingCow »

sapphire96 wrote: Sun Mar 21, 2021 11:57 am
HootingSloth wrote: Sun Mar 21, 2021 10:49 am It would be great to see these same charts with the trend fixed by, say, a 1937 start date and 2009 end date as a robustness check that addresses JoMoney's point. How much does your qualitative assessment depend on the period chosen?
So for giggles, I just created an all-time exponential average. It would imply a few things...
1873-1897 had elevated prices with no growth.
The 1925-1929 "bubble" was never a bubble.
The US never got back to average until the 1960s, but barely.
Prices have been elevated since 1990 - the tech bubble never fully popped.
The bottom of the Great Financial Crisis crash had evaluations back to average.

The question I think arises was there a fundamental economic shift in the US starting in the 1930s that created a new exponential average growth line and does this create the possibility of a lower (or higher?) exponential growth line for the future.
Image
Yes. Dividends decreased substantially during that time, replaced by buybacks and buyouts. Dividends reduce the index price while other methods of returning value to shareholders do not.

The growth depicted on the chart is of index price and not total return.
Last edited by TheLaughingCow on Mon Mar 22, 2021 1:35 pm, edited 2 times in total.
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Re: Stock Bubble? History Argues the Contrary

Post by protagonist »

nisiprius wrote: Sun Mar 21, 2021 1:14 pm I think we're in a stock bubble, and I am personally trying to take no action at all based on that belief.

One confusing thing is that I really do think we are seeing clear signs of some kind of mania as evidenced by GME, SPACs, NFTs, etc. etc. However, the total dollar amount is trivial compared to the total size of the market. Robinhood is the bucket shop for the 21st century, but VTI is not one of the things being gambled on.

I don't like starting at 1933. Basically, if you believe that the history of the stock market is discontinuous, then history shouldn't be used to argue anything. Jim Otar published an interesting chart:

Image

I don't know how seriously to take it. I do think it suggests that when we look at a century or so of data, we are looking at eight independent data points, not a hundred. It does fit with one traditional view of the stock market, which is that it is an episodic sequence of separate "markets," last around a decade or so, each with its own independent "personality" and characteristics.
That sort of pattern would certainly fit with modern chaos theory and the idea of punctuated equilibrium applied to complex nonlinear systems such as the stock market. I recall seeing a similar pattern of interest rates, going back considerably further, shifting from increasing to decreasing every few decades or so.
Last edited by protagonist on Mon Mar 22, 2021 1:33 pm, edited 1 time in total.
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Re: Stock Bubble? History Argues the Contrary

Post by Chief_Engineer »

My main issue with this type of argument or when people talk about "reversion to the mean" is the assumption that there is a mean to begin with. It implies that the stock market is a stochastic process with a fixed mean, as opposed to the changes in valuations of companies based upon economics and human expectation. It is not some rule of the universe that the US stock market will average 7% real until the heat death of the universe. And what does the historical data tell us in a world where US GDP growth hasn't cracked 4% since 2000?

For my own planning purposes I assume stocks will average 4% real going forward. My hope is that ends up being needlessly pessimistic and conservative. Past returns do not predict future performance, and yet historical data is our best guess for what the future will look like. Quite the pickle.
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Re: Stock Bubble? History Argues the Contrary

Post by protagonist »

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Re: Stock Bubble? History Argues the Contrary

Post by jarjarM »

watchnerd wrote: Mon Mar 22, 2021 1:20 pm
jarjarM wrote: Mon Mar 22, 2021 12:39 pm
Here's the counter point to the argument.

https://www.bloomberg.com/opinion/artic ... ler-s-cape

TLDR: Japan/Europe/US all went through high valuation period, Japan in the 1980s, Europe and US in the late 90s. When the bubble bursted, Japan valuation and bond yield both went down, same for Europe/US after 2000/2008. However, QE driven spending post GFC in US drove up the equity price (along with expansion of FAANG market cap). We will soon face the Ice Age when CAPE is down around 10... Interesting read
If the implication is that, if you take out FAANG, the US for the next 10 years ends up looking like international / VXUS has for the last 10 years, with near 0 inflation, I could live with that.

VXUS last 10 years = 4.95%

If inflation is 0, that gives me 4.95% real.
In the article, Albert Edwards of Societe Generale SA (perma bear) basically argue that US should've follow EU in CAPE. Given where EU is right now, US CAPE should be also around 10, so 72% drop in price if earning doesn't change.

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Re: Stock Bubble? History Argues the Contrary

Post by willthrill81 »

Chief_Engineer wrote: Mon Mar 22, 2021 1:32 pm My main issue with this type of argument or when people talk about "reversion to the mean" is the assumption that there is a mean to begin with.
That's a fair point, but I think that many of the 'reversion to the mean' arguments are often simply implying that good returns over a substantial length of time will likely be followed by poor returns for a substantial length of time and vice versa in a cyclical fashion. Of course, that alone is not actionable at all because the length of time of either good or bad returns can vary significantly.
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Re: Stock Bubble? History Argues the Contrary

Post by nisiprius »

Steve Reading wrote: Mon Mar 22, 2021 10:20 am
nisiprius wrote: Sun Mar 21, 2021 1:14 pm I think we're in a stock bubble
Cliff Asness' pet peeve #2 is how loosely people use the word "bubble":
the term bubble should indicate a price that no reasonable future outcome can justify. I believe that tech stocks in early 2000 fit this description. I don’t think there were assumptions— short of them owning the GDP of the Earth—that justified their valuations. However, in the wake of 1999–2000 and 2007–2008 and with the prevalence of the use of the word “bubble” to describe these two instances, we have dumbed the word down and now use it too much. An asset or a security is often declared to be in a bubble when it is more accurate to describe it as “expensive” or possessing a “lower than normal expected return.” The descriptions “lower than normal expected return” and “bubble” are not the same thing.
https://www.aqr.com/Insights/Research/J ... -10-Peeves
Fair criticism. I was echoing the thread title and I guess I shouldn't have.

And I see that Asness states pretty clearly that he thinks tech stocks, but only tech stocks, were in a bubble circa 2000. I'm not sure whether or not you'd say that the stock market as a whole has ever met the criterion of "a price that no reasonable future outcome can justify." On the other hand, when you read about crowds of people assembling in Wall Street in 1929 just to be there in this magical place where miracles were happening, there was certainly a level of mania that I've never seen in my lifetime.
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Re: Stock Bubble? History Argues the Contrary

Post by protagonist »

protagonist wrote: Mon Mar 22, 2021 1:44 pm
protagonist wrote: Mon Mar 22, 2021 1:30 pm
nisiprius wrote: Sun Mar 21, 2021 1:14 pm I think we're in a stock bubble, and I am personally trying to take no action at all based on that belief.

One confusing thing is that I really do think we are seeing clear signs of some kind of mania as evidenced by GME, SPACs, NFTs, etc. etc. However, the total dollar amount is trivial compared to the total size of the market. Robinhood is the bucket shop for the 21st century, but VTI is not one of the things being gambled on.

I don't like starting at 1933. Basically, if you believe that the history of the stock market is discontinuous, then history shouldn't be used to argue anything. Jim Otar published an interesting chart:

Image

I don't know how seriously to take it. I do think it suggests that when we look at a century or so of data, we are looking at eight independent data points, not a hundred. It does fit with one traditional view of the stock market, which is that it is an episodic sequence of separate "markets," last around a decade or so, each with its own independent "personality" and characteristics.
That sort of pattern would certainly fit with modern chaos theory and the idea of punctuated equilibrium applied to complex nonlinear systems such as the stock market. I recall seeing a similar pattern of interest rates, going back considerably further, shifting from increasing to decreasing every few decades or so.
Here is an example of interest rates following a punctuated equilibrium pattern for centuries (dates are crude estimates based on graph):
~1300-~1740 down
~1740-~1800 up
~1800-~1830 down
~1830-~1900 flat
~1900-~mid-late 1920s up
~1925-~1950 down
~1950-~1980 sharply up
~1980- now sharply down

https://i.insider.com/576443ef52bcd0240 ... &auto=webp

Or look at the 10-yr treasury bill (years also estimated from graph). https://i.insider.com/4fee38e7eab8ea6f0 ... &auto=webp :
1790-1815 up
1815-1840 down
1840-1860 up
1860-1900 down
1900-1920 up
1920-1945 down
1945- 1980 sharply up
1980- now sharply down

All arguably like "punctuated equilibrium".
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Re: Stock Bubble? History Argues the Contrary

Post by Chief_Engineer »

nisiprius wrote: Mon Mar 22, 2021 1:50 pm On the other hand, when you read about crowds of people assembling in Wall Street in 1929 just to be there in this magical place where miracles were happening, there was certainly a level of mania that I've never seen in my lifetime.
I wonder how much of that is apocryphal. Like the shoeshine boy giving stock tips story.
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Re: Stock Bubble? History Argues the Contrary

Post by MathWizard »

Is the price real (inflation adjusted) or nominal?

This does not take into account dividends, I assume, correct?

It looks like the slope would suggest that the straight line represents
a return of about 4.3% , am I reading that correctly?

Thanks for making the chart.

Note that the "over the mean" is about the same as in 2008, though clearly not
as large as the tech bubble.
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Re: Stock Bubble? History Argues the Contrary

Post by whereskyle »

The only present day analogue to the tech bubble is Bitcoin. Think about how high stock valuations would be if people weren't pouring money into a currency with nothing backing it!

Big tech has had incredible earnings growth sustained for a decade and the market expects it to continue for the foreseeable future. Hence the very high valuations.

This isn't rocket science. Stop trying to time the market.
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Re: Stock Bubble? History Argues the Contrary

Post by Steve Reading »

nisiprius wrote: Mon Mar 22, 2021 1:50 pm
Steve Reading wrote: Mon Mar 22, 2021 10:20 am
nisiprius wrote: Sun Mar 21, 2021 1:14 pm I think we're in a stock bubble
Cliff Asness' pet peeve #2 is how loosely people use the word "bubble":
the term bubble should indicate a price that no reasonable future outcome can justify. I believe that tech stocks in early 2000 fit this description. I don’t think there were assumptions— short of them owning the GDP of the Earth—that justified their valuations. However, in the wake of 1999–2000 and 2007–2008 and with the prevalence of the use of the word “bubble” to describe these two instances, we have dumbed the word down and now use it too much. An asset or a security is often declared to be in a bubble when it is more accurate to describe it as “expensive” or possessing a “lower than normal expected return.” The descriptions “lower than normal expected return” and “bubble” are not the same thing.
https://www.aqr.com/Insights/Research/J ... -10-Peeves
Fair criticism. I was echoing the thread title and I guess I shouldn't have.

And I see that Asness states pretty clearly that he thinks tech stocks, but only tech stocks, were in a bubble circa 2000. I'm not sure whether or not you'd say that the stock market as a whole has ever met the criterion of "a price that no reasonable future outcome can justify." On the other hand, when you read about crowds of people assembling in Wall Street in 1929 just to be there in this magical place where miracles were happening, there was certainly a level of mania that I've never seen in my lifetime.
Not sure about 1929, I know many people point to the euphoria/sentiment of the times, high degree of leverage and huge returns in 1929, but valuations weren't unjustifiable IMO. If you were reinvesting dividends, you recovered losses decently quickly, I think like 10 years (certainly faster in real terms). The crash was arguably too much; it's not that prices were too high, it's that they got obscenely low.

OTOH, the PE of the Japanese market was like 100 at the peak of the 80s. I think that counts as a bubble as you'd require earnings to grow multiple times faster than ever before to ever justify that price.
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Re: Stock Bubble? History Argues the Contrary

Post by watchnerd »

whereskyle wrote: Mon Mar 22, 2021 2:10 pm
This isn't rocket science.
You're right.

Rocket science is much easier.
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Re: Stock Bubble? History Argues the Contrary

Post by dogagility »

sapphire96 wrote: Sun Mar 21, 2021 11:57 am
HootingSloth wrote: Sun Mar 21, 2021 10:49 am It would be great to see these same charts with the trend fixed by, say, a 1937 start date and 2009 end date as a robustness check that addresses JoMoney's point. How much does your qualitative assessment depend on the period chosen?
So for giggles, I just created an all-time exponential average. It would imply a few things...
Shiller's website has the SP500 total return data beginning at 1871. Graphing these data shows a similar continuous (non-hockey stick) increase over time. My avatar shows this too.
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Re: Stock Bubble? History Argues the Contrary

Post by whereskyle »

watchnerd wrote: Mon Mar 22, 2021 2:19 pm
whereskyle wrote: Mon Mar 22, 2021 2:10 pm
This isn't rocket science.
You're right.

Rocket science is much easier.
Exactly. Rocket science is actually doable, whereas market timing is not.
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Re: Stock Bubble? History Argues the Contrary

Post by JBTX »

sapphire96 wrote: Sun Mar 21, 2021 10:28 am There has been discussion of the dramatic rise in the US stock market and how a bubble is forming. I would like to make the proposal that evaluations are not that far from normal historical deviations and should not influence a person's asset allocation.

Chart A is the S&P 500 since 1933 (excludes dividends). I have calculated an exponential average of the price returns throughout this period (up to 2017, when I first created the tracking file) and have extrapolated that average forward to today; this is the red line. Traditionally, if the S&P 500 (blue) is above the red line, it implies the price is higher than where it should be on average; this can, in turn, imply the likelihood of decreased expected future returns. Better future expected returns would be implied if the S&P 500 was below its expected average price. We can see a few prolonged periods of when the S&P 500 was below and above its expected average price.

Note, however, just because the S&P 500 is above or below "where it should be," does not stop the market from rising. If anything, the transition from above to below average (and vice versa) is often sudden (1-3 years) and you can have many years of steady growth between these sudden changes. To better illustrate this, I took the S&P 500 price as a percent of the exponential average to generate a premium percentage (Chart B). We can see more clearly these above and below implied average periods. The tech bubble sticks out like a sore thumb, but note how today's evaluations are no where near the late-90s. In fact, note the period of 1955-1970: that period of "above average" prices lasted steadily for 15 years and our current evaluations are nearly identical to the beginning of that period.

Granted, past performance is not a guarantee of future results. However, the past is our best indicator of the future, and as far as I can see, current evaluations are above average but not to the degree of a bubble. I would not be surprised if in 10 to 15 years we have a transition to below average pricing, but that seems far off. Considering this, investors should not change their asset allocations when markets rise or fall since they ultimately do not know when the transition "back" will occur.

Edit: grammar and spelling.

Chart A - S&P 500 Price with Exponential Average since 1933.
Image

Chart B - S&P 500 Percent Over Exponential Average.
Image
Your second graph puts them about where 2008 was, yet stocks crashed anyway. I would agree that stocks by themselves are not an egregious bubble that will collapse just on its own weight, like 2000. However, stocks could crash like in 2008, due to other factors, such as a real estate bubble burst. If you had a series of mini bubbles crash, like Bitcoin, tesla, and a few other things, a rapid unexpected rise in long term interest rates, causing housing prices to stall, or possibly a new variant of more potent covid resistant to vaccines, a combination of the above could cause a setback.
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Re: Stock Bubble? History Argues the Contrary

Post by Makefile »

JoMoney wrote: Sun Mar 21, 2021 12:42 pm
sapphire96 wrote: Sun Mar 21, 2021 11:57 am ....
The question I think arises was there a fundamental economic shift in the US starting in the 1930s that created a new exponential average growth line and does this create the possibility of a lower (or higher?) exponential growth line for the future....
There have been several shifts, notably in dividend payout ratios/retained earnings. Since your chart is price only, any growth an investor saw from current income/dividends is left out. A chart on bond prices ignoring coupon interest payments would look dreadful.
Jeremy Siegel looks at the different dividend payout regimes in Stocks For The Long Run. You might also look at his trend line that incorporates Total Return and Inflation.
Not to mention the start of the SEC in this time period too.
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Re: Stock Bubble? History Argues the Contrary

Post by jarjarM »

Since the OP was using price index only, I plotted the same info with real total return index (data source: Shiller's dataset). While the current price is higher than longer exponential average, it's not quite as bad as the end of the last major bull market (50-60s and 80-00). Just for reference.

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Re: Stock Bubble? History Argues the Contrary

Post by nisiprius »

Chief_Engineer wrote: Mon Mar 22, 2021 1:55 pm
nisiprius wrote: Mon Mar 22, 2021 1:50 pm On the other hand, when you read about crowds of people assembling in Wall Street in 1929 just to be there in this magical place where miracles were happening, there was certainly a level of mania that I've never seen in my lifetime.
I wonder how much of that is apocryphal. Like the shoeshine boy giving stock tips story.
The shoeshine boy isn't apocryphal.

It was a particular shoeshine boy, and he was named Pat Bologna, and the authors Gordon Thomas and Max Morgan-Witts interviewed him for their 1979 book The Day the Bubble Burst: A Social History of the Wall Street Crash of 1929 and cite him as a source a couple of dozen times.
The short, well-built Bologna was the self-appointed shoe black to the titans of Wall Street. Joseph Kennedy, Charles Mitchell, Billy Durant, and Ben Smith were among a long list of impressive names who had their shoes burnished by Bologna. From them he picked up useful financial tidbits which helped him invest sensibly in the market; like most small speculators, Bologna bought on margin, dabbling in variety of stocks. Sometimes, when he was "on to a real winner,' the gregarious young Italian liked to share his luck with his regular customers.
It may be apocryphal that Joseph Kennedy said "If shoe shine boys are giving stock tips, then it's time to get out of the market" and then acted on that insight and avoided the crash.
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Re: Stock Bubble? History Argues the Contrary

Post by nisiprius »

The crowds in the streets weren't apocryphal, either, although this New York Times story is about a bad day (October 25th, 1929), not a good one:

Image

The next day: "Operators of sightseeing buses. diverted some of their cars from regular routes to take crowds down to see the "excitement" in the financial district." However, by that day there was nothing unusual to see.
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Re: Stock Bubble? History Argues the Contrary

Post by watchnerd »

nisiprius wrote: Mon Mar 22, 2021 6:56 pm The crowds in the streets weren't apocryphal, either, although this New York Times story is about a bad day (October 25th, 1929), not a good one:

Image

The next day: "Operators of sightseeing buses. diverted some of their cars from regular routes to take crowds down to see the "excitement" in the financial district." However, by that day there was nothing unusual to see.
This kind of physical manifestation of mania has migrated to Twitter.
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Re: Stock Bubble? History Argues the Contrary

Post by Chief_Engineer »

nisiprius wrote: Mon Mar 22, 2021 6:56 pm The crowds in the streets weren't apocryphal, either, although this New York Times story is about a bad day (October 25th, 1929), not a good one:
Maybe apocryphal was the wrong word for what I was thinking. But now in the light of a new day I don't quite remember what I was thinking. Either way, thanks for the background info.
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Re: Stock Bubble? History Argues the Contrary

Post by nedsaid »

nisiprius wrote: Mon Mar 22, 2021 6:36 pm
Chief_Engineer wrote: Mon Mar 22, 2021 1:55 pm
nisiprius wrote: Mon Mar 22, 2021 1:50 pm On the other hand, when you read about crowds of people assembling in Wall Street in 1929 just to be there in this magical place where miracles were happening, there was certainly a level of mania that I've never seen in my lifetime.
I wonder how much of that is apocryphal. Like the shoeshine boy giving stock tips story.
The shoeshine boy isn't apocryphal.

It was a particular shoeshine boy, and he was named Pat Bologna, and the authors Gordon Thomas and Max Morgan-Witts interviewed him for their 1979 book The Day the Bubble Burst: A Social History of the Wall Street Crash of 1929 and cite him as a source a couple of dozen times.
The short, well-built Bologna was the self-appointed shoe black to the titans of Wall Street. Joseph Kennedy, Charles Mitchell, Billy Durant, and Ben Smith were among a long list of impressive names who had their shoes burnished by Bologna. From them he picked up useful financial tidbits which helped him invest sensibly in the market; like most small speculators, Bologna bought on margin, dabbling in variety of stocks. Sometimes, when he was "on to a real winner,' the gregarious young Italian liked to share his luck with his regular customers.
It may be apocryphal that Joseph Kennedy said "If shoe shine boys are giving stock tips, then it's time to get out of the market" and then acted on that insight and avoided the crash.
Full of bologna or is that full of baloney? :wink:
A fool and his money are good for business.
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