The Stock Market's Missing Ingredient
Amid a wealth of potential problems, markets are now close to record highs. Military conflicts in Syria, Iraq, Gaza and Ukraine are an unending source of concern. Domestically, economic growth remains below potential. The civil strife in Ferguson, Missouri, reveals the U.S. to be a nation even more divided than previously thought by many. At the very least, the buffoonish local cops there are a national embarrassment.
None of this seems to matter to Mr. Market. He continues to power on, oblivious to issues that don't affect corporate earnings. They have, by the way, been stellar, growing at a 9 percent annual rate. Meanwhile, interest rates are still low and inflation is subdued.
Rarely have conditions for market gains been so promising at a time when investor psychology has been so negative.
Gallup reports that only 7 percent of those surveyed were aware of last year's scorching gains in the Standard & Poor's 500 Index. "Fewer than one in 10 aware that stocks averaged 30% increase in 2013," read one of the headlines on a report from earlier this month. More than half of those polled would put any new cash into bank accounts or CDs, eschewing equities, according to the survey.
The less interested the public seems to be in stocks, the higher they seem to go. Stephen Suttmeier, technical analyst at Bank of America Merrill Lynch, points out that the present rally is the fifth-longest since 1928:
The S&P 500 Index moved above its 200-day moving average on November 19, 2012 and has not closed below it on a daily basis for 21 months. The record is 30 months between 11/25/1953 and 5/23/1956.
The last time we had a streak of 21 months was between 7/27/1950 and 4/30/1952, which coincided with the S&P 500 secular bull market breakout in 1950. The current streak is part of the secular bull market breakout in April 2013. This 21-month streak for the S&P 500 above its 200-day moving average is another similarity between the current secular breakout and the secular breakout from 1950.
I blame the Internet for this state of investor apathy and anxiety. The deluge of Web warnings, along with post-crash traumatic stress syndrome, has investors obsessing over the next market meltdown. They still haven't recovered from the psychic wounds of the last one.
The endless parade of crash calls, negative omens and recession warnings plays into these fears. Never before has there been so much misleading content so freely offered by so many unqualified fear mongers. As we discussed earlier this week, much of the public is wholly unable to place this information in the appropriate context.
The most recent source of angst is Yale professor Robert Shiller's CAPE, his long-term valuation measure. It is the outlier among standard valuation yardsticks, along with deceased Yale professor James Tobin's Q ratio. Both show markets to be significantly overvalued, with the CAPE at 26.3 compared with the average of 16.6 and the Q at 1.17 versus an average of about 0.68. Most other metrics show markets to be fully valued, or slightly rich.
Salil Mehta, an adjunct professor at Georgetown University, takes issue with CAPE, partly because of the collapse in earnings caused by financial crisis. In an e-mail he writes:
Of course eventually prices will underperform earnings, and the financial crisis earnings forever pass from the 10-year window. Both would, on their own, cause the CAPE to regroup. This still isn't a tool for conjecturing on crash timings, though it would take a high, single-digit number of years where prices underperform earnings, in order to drive the CAPE back to its normal long run, 15-16 average.
In other words, we can slowly grow our way out of high CAPE valuations. Just don't try telling that to the public -- they wouldn't believe you anyway.
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Barry L Ritholtz at firstname.lastname@example.org