by Lance Roberts, Clarity Financial
“Price Is What You Pay. Value Is What You Get.” – Warren Buffett
One of the hallmarks of very late stage bull market cycles is the inevitable bashing of long-term valuation metrics. In the late 90’s if you were buying shares of Berkshire Hathaway stock it was mocked as “driving Dad’s old Pontiac.” In 2007, valuation metrics were being dismissed because the markets were flush with liquidity, interest rates were low and “Subprime was contained.”
Today, we once again see repeated arguments as to why “this time is different” because of the “Central Bank put.”
First, let me just say that I have tremendous respect for the guys at HedgEye. They are insightful and thoughtful in their analysis and well worth your time to read. However, a recent article by HedgEye made a very interesting point that bears discussion.
“Meanwhile, a number of stubborn bears out there continue to make the specious argument that the U.S. stock market is expensive. ‘At 22 times trailing twelve-month earnings,’ they ask, ‘how on earth could an investor possibly buy the S&P 500?’
The answer is simple, really. Valuation is not a catalyst.”
They are absolutely right.
Valuations are not a catalyst.
They are the fuel.
But the debate over the value, and current validity, of the Shiller’s CAPE ratio, is not new. Critics argue that the earnings component of CAPE is just too low, changes to accounting rules have suppressed earnings, and the financial crisis changed everything. This was a point made by Wade Slome previously:
“If something sounds like BS, looks like BS, and smells like BS, there’s a good chance you’re probably eyeball-deep in BS. In the investment world, I encounter a lot of very intelligent analysis, but at the same time I also continually step into piles of investment BS. One of those piles of BS I repeatedly step into is the CAPE ratio (Cyclically Adjusted Price-to-Earnings) created by Robert Shiller.”
Let’s break down Wade’s arguments against Dr. Shiller’s CAPE P/E individually.
Shiller’s Ratio Is Useless?
“The short answer…not very. For example, if investors followed the implicit recommendation of the CAPE for the periods when Shiller’s model showed stocks as expensive they would have missed a more than quintupling (+469% ex-dividends) in the S&P 500 index. Over a shorter timeframe (2009 – 2014) the S&P 500 is up +114% ex-dividends (+190% since March 2009).”