Bogle, Buffett, Shiller & Tobin – Valuations Are Expensive

Bogle, Buffett, Shiller & Tobin – Valuations Are Expensive




  • Central banks act to provide more liquidity to offset recessionary drag and restart economic growth by dragging forward future consumption. 
  • Wash, Rinse, Repeat.
  • If you don’t believe me, here is the evidence.

    The stock market has returned more than 60% since 2007 peak, which is more than three times the growth in corporate sales growth and 30% more than GDP. The all-time highs in the stock market have been driven by the $4.5 trillion increase in the Fed’s balance sheet, hundreds of billions in stock buybacks, PE expansion, and ZIRP.

    It is critical to remember the stock market is NOT the economy. The stock market should be reflective of underlying economic growth which drives actual revenue growth. Furthermore, GDP growth and stock returns are not highly correlated. In fact, some analysis suggests that they are negatively correlated and perhaps fairly strongly so (-0.40).

    However, in the meantime, the promise of a continued bull market is very enticing as the “fear of missing out” overrides the “fear of loss.”

    Valuations Are Expensive

    This brings us back to Jack Bogle and the importance of valuations which are often dismissed in the short-term because there is not an immediate impact on price returns. Valuations, by their very nature, are HORRIBLE predictors of 12-month returns should not be used in any strategy that has such a focus. However, in the longer term, valuations are strong predictors of expected returns.

    I have adjusted Bogle’s measure of valuations to a 24-month, versus 12-month, measure to smooth out the enormous spike in valuations due to the earnings collapse in 2008. The end valuation result is the same but peaks, and troughs, in valuations are more clearly shown.

    At 26.81, Bogle is clearly correct that valuations have reached expensive levels. More importantly, outside of the peak in 1999, stocks are more highly valued today than at any other point in history. (The two points during bear market troughs are excluded as those valuations were due to earnings collapsing faster than prices due to recessionary conditions.)

    Bogle’s view is also confirmed by other measures as well. The chart below shows Dr. Robert Shiller’s cyclically adjusted P/E ratio combined with Tobin’s Q-ratio. Again, valuations only appear cheap when compared to the peak in 2000. Outside of that exception, the financial markets are now more expensive than at any other single point in history.

    I have also previously modified Shiller’s CAPE to make it more sensitive to current market dynamics.

    “The need to smooth earnings volatility is necessary to get a better understanding of what the underlying trend of valuations actually is. For investor’s, periods of ‘valuation expansion’ are where the bulk of the gains in the financial markets have been made over the last 116 years. History shows, that during periods of ‘valuation compression’ returns are more muted and volatile.

    Therefore, in order to compensate for the potential ‘duration mismatch’ of a faster moving market environment, I recalculated the CAPE ratio using a 5-year average as shown in the chart below.”

    To get a better understanding of where valuations are currently relative to past history, we can look at the deviation between current valuation levels and the long-term average going back to 1900.

    With a 63.62% deviation from the long-term mean, a reversion will be quite damaging to investors when it occurs. As you will notice, reversions have NEVER resulted in a “sideways” consolidation but rather much more serious, and sharp, declines. These rapid “maulings” of investors is why declines are aptly named “bear markets.” 

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