Leithner Letter – Are You Listening?VW Staff
Chris Leithner Letter No. 200-204: 26 July-26 October 2016; Markets Are Greatly Overvalued: Are You Listening?
Credible Nobel Laureates and the World’s Greatest Investor Reckon Markets Are Greatly Overvalued: Are You Listening?
A year ago, in the wakes of ructions in China, Greece and elsewhere, Australian investors and speculators asked themselves: “are stocks attractively cheap, reasonably priced or unduly dear? Are prospective returns good, fair or poor?” As they virtually always do, “experts” advised that all was well and that the crowd should buy. “Four Reasons Why It’s Time to Buy Shares Now” (The Australian Financial Review, 15 May 2015) typified their mantra:
AMP Capital’s Shane Oliver, whom the article cited, was equally upbeat:
The mainstream’s ebullience about the present and complacency regarding the future continued into the 2015-2016 financial year. According to “Bulls, Bears Predict Market Extremes, Most Reckon 6,000” (The Australian Financial Review, 1 July 2015), for example,
Got that? In July of last year, NO “expert” polled by the AFR prophesied that the ASX might decrease during the 2015-2016 financial year – and certainly nobody foresaw that the S&P/ASX 200 index would, albeit briefly, plunge below 4,900. Instead, without exception everybody expected that it would rise (Table 1). The most optimistic seer – Credit Suisse – predicted that during the six months to 31 December 2015 it’d zoom 19%; the least optimistic, RBS Morgans, reckoned it’d lift 4%; and the average (“safe”) prediction was an increase of 10%. During the year to 30 June 2016, the average prediction was a lift of 12%.
Figure 1 plots these alleged experts’ average (“consensus”) forecasts against the actual course of the S&P/ASX 200 index during the year to 1 June 2016. It’s hardly a surprise that they haven’t been unable to predict with any reasonable degree of accuracy (see Letter 196-197); equally predictably, their forecasts have been overly optimistic (see Letter 198-199). The professionals reckoned, on average, that during the six months to 31 December 2015 the index would rise to 6,019; in fact, it fell to 5,415. And in the six months to 30 June, they predicted that it would rise further (albeit marginally) to 6,100; instead, early it 2016 it plunged below 4,900 before partly recovering to 5,400.
In sharp contrast, during the past year Leithner & Co.’s communications to its shareholders have been cautious. Its scepticism wouldn’t have impressed the ex-Treasurer (see Doubters Are Clowns, Says Hockey, The Australian, 4 June 2015 and “Talk of Recession Irrational: Hockey,” The Weekend Australian, 5-6 September 2015).1 No matter; its directors have long been reprobates. As it’s been since the Company’s inception in 1999, our concern remains today: the overall level of major market indices such as the S&P 500, which is at or near all-time records, is very – and perhaps dangerously – elevated. So, by implication, is the ASX/S&P 200. If, a year ago, they had chosen to open their eyes and use their brains, “experts” might have discerned these risks (see, for example, “Stock Index Loaded with Risks,” The Australian Financial Review, 27 May 2015). Alas, it’s in their interest – but not in yours – virtually always to remain thoughtlessly optimistic. There were and are, of course, some exceptions to this rule. Alan Kohler, the avuncular face of ABC1’s nightly finance report, for example, wasn’t blind. “It’s clear,” he belatedly confessed to Business Spectator on 30 August 2015, “that the Australian economy of the first decade and a bit of this century was built on a [consumption, interest rate and real estate] bubble.”
Today’s prices and tomorrow’s returns are inversely related; moreover, returns have always – eventually – regressed to their historical means. “Eventually,” however, can take a long time to arrive: indeed, and as we’ll see below, since the mid-1990s stocks have generally been unduly dear; moreover, in an effort to curry the crowd’s favour, experts have spread spurious and even risible ideas that “justify” stocks’ high prices. What, then, to do? Be alert for extremes in markets – very undervalued or overvalued. When you possess a roughly valid and reliable means to detect such extremes, you avoid the problem that arises when, figuratively speaking, you stumble around in the dark over chairs and night stands. Given these means, you can begin to visualise in the dark – which is where investors must necessarily tread. Almost 20 years ago James Grant said: “The future is always unlit. But with a body of theory, you can anticipate where the structures might lie. It allows you to step out of the way every once in a while.” The three measures that I detail below are all (to use another analogy) flashing amber – and perhaps red – warning lights; all indicate that stocks are significantly and perhaps greatly overvalued. Further, they possess the ability – at least roughly – to foretell poor long-term returns. Price is what you pay today; value is what you get tomorrow. Today’s high valuations thus portend – for those who don’t prepare themselves – poor returns and perhaps hefty losses in the future.
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