I saw a great chart today from Callum Thomas of Topdown Charts. The chart does a great job of illustrating the so-called “everything bubble”.
Here it is:
Notice how back in 2000 - during the dot com boom - equities looked wildly expensive, but Treasuries and property were undervalued.
Then in 2007 - during the hosing boom and just before the global financial crisis - the property market looked crazy expensive, but equities and Treasuries were both around fair value.
Fast forward to today and equities, property and Treasuries ALL look very expensive.
Money printing and fiscal stimulus do not happen in a vacuum. The consequences of such - intended or otherwise - are presenting investors with some challenging decisions.
Equity Valuations
One of the main arguments used to justify current stock prices is that stocks still look reasonable value relative to bonds. But this is only because bonds look damned expensive! Remember, 10 year Treasuries are barely yielding 1.6% while inflation is running at 6.2%. Bonds are hardly a bargain in this environment.
Playing a relative valuation game in an everything bubble can result in some misleading conclusions.
Other often-used measures of equity valuation point to a very expensive stock market.
Warren Buffett’s preferred measure of stock market valuation - GDP to market cap - is at an all-time high, eclipsing prior peaks in 2000 and 2007:
The cyclically-adjusted PE ratio (which compares current price of the S&P 500 with the average inflation-adjusted earnings over the previous 10 years) is trading at a higher level than any time except the 2000 dot com peak.
Implications Of The “Everything Bubble”
Let me be very clear that none of these valuation metrics mean - or even imply - that markets are about to crash. What they do mean however is that:
1. Future long-term expected returns from the stock market are likely to be very muted from this starting point
2. Long-term investors are presented with a real challenge in terms of where to invest their money. Stocks at or near all-time high valuations? Property, at valuations last seen immediately prior to the Global Financial Crisis? Or bonds yielding 1.6% when inflation is the highest it’s been for three decades? In other words, they’re faced with the everything bubble. Not an attractive menu, I’m sure you’ll agree.
3. There is nothing to diversify into. Traditionally investors will allocate part of their portfolio to stocks (for growth) and another part to bonds (for income and stability). When both stocks AND bonds are expensive, there is a genuine concern that when the cycle turns, both stocks AND bonds could fall. There will be nowhere to hide.
I would hate to be a long-term investor right now, faced with these choices.
But I am extremely happy participating in the market as a trader. Exploiting short term trends, having a well-defined risk management plan and having the ability to swing my portfolio from long to short with a few mouse clicks make this an exciting market environment for me.
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