Plus good reads from around the Web.
A recent investor event I attended gave the usual insights into the average private investor’s mindset.
In 2011 I went to a monthly investing meet-up in a pub, where the talk was all of gold and oil miners. Literally nobody wanted to talk about anything else. It was one of the biggest contrarian signals I’ve ever encountered.
This time virtually everyone was debating how to prepare for the imminent stock market crash.
I’m not exaggerating – about the only people who weren’t preparing for a crash were those who believed such preparation was futile. On balance they still expected a crash, but they had a sort of passively-active mindset that steered them towards investing through the seemingly inevitable meltdown.
Is this just as big a contrarian signal as the one I saw in 2011? Does this universal pessimism mean we can be optimistic about future returns?
I’m not sure.
American splendour
While a five-year old and largely hated and ignored bull market doesn’t in itself point to an imminent plunge, higher share prices do mean inferior value and so lower returns in the future.
That’s just the way the maths works.
The US market still looks to me by far the most expensive. I’m very underweight there, and what I do own tends to be in the ‘beaten up’ category.
The always thought-provoking Meb Faber highlighted the relative expensiveness of US stocks this week in an article on home bias:
The U.S. is actually above the upper end of the range for expensive countries. […]
The U.S. was cheap relative to the rest of the world in the early 1980s, which also happened to be the start of the long bull market. [Whereas] the late 1990s saw the U.S. near the top of the range, which preceded the bear market that began in 2000.
Will the current overvaluation signal another bear or perhaps a time to shift more assets to foreign markets?
There was a similar point made by another US blog, A Wealth of Common Sense, which pointed out the average investor is greedy and fearful at exactly the wrong times:
A recent study from Harvard showed that in February of 2009 (during the crash), investors expected annual returns of only 3.9% a year going forward.
But in January of 2000 (during the tech bubble), expectations were for 14.3% annual returns.
Of course 2009 was a terrific buying opportunity while 2000 was not the time to be upping your expectations for future gains.
Perhaps those skittish investors I met are right to be cautious then – at least if they’re thinking of the US market?
Or are they set to be confounded again by this huge long melt-up that nobody has ever really celebrated?
To bail or not to bail
While I agree the US seems to be the most over-valued stock market index, that doesn’t mean it’s a reason to bail out of equities altogether.
Indeed The Wealth of Common Sense blogger seems to fall into this trap himself.
Wisely admitting how difficult market timing is – and addressing a US audience – he suggests that only the following three classes of investor should sell US stocks here:
1) Investors that have spending needs within the next few years (this has always been the case).
2) Investors that have seen their asset allocation to stocks drift much higher than their target portfolio weight (this has always been the case).
3) Investors that don’t have the willingness or ability to withstand periodic losses in exchange for longer-term gains (this has always been the case).
This is very solid advice, but I would suggest there’s also some home bias creeping in here, of the kind Meb Faber writes about.
That’s because there’s a fourth class of investor who might sell – an investor who is prepared to reduce his or her US exposure in favour of apparently cheaper overseas markets.
Cheap and expensive countries
Where might they be? The Meb Faber article has some pointers, and so did the Telegraph this week.
Its analysis looked at cyclically adjusted P/E (CAPE) ratios, price-to-book values, and dividend yields:
To be named “cheap”, markets had to be trading below their own historic valuation across all three measures.
Only a handful of stock markets managed to achieve this feat – Greece, China, Hong Kong, India, Japan, Russia and Turkey.
And the expensive? By its reckoning the US, followed rather oddly by Pakistan and Sri Lanka. (The UK is up there, too, judged by two of the measures – by CAPE we’ve still more room to run).
To conjecture wildly, I’d guess the US is so expensive because of the general fear that still persists in the financial world. Despite shares offering better value elsewhere, those with money feel more confident having it invested in America. The weight of this money may have bid up prices to excess.
In contrast, Pakistan and Sri Lanka may be the sort of expensive-looking markets that defy obvious analysis. Perhaps investors are correct to bid up these former backwaters because company profits there are going to explode?
Time will tell.
What to do if you must do something?
Valuing markets is something that looks easy to novices but is notoriously difficult, especially over the short to medium term.
Seemingly expensive markets can continue to deliver strong returns for many years, and even an eventual crash may not be enough to make up for the gains missed by those who bailed out too soon.
For passive investors, the best advice is to make sure you’re globally diversified, and then let your automatic rebalancing take the strain.
Passive investors don’t believe they’re smarter than the market, so they shouldn’t start now.
As for us active adventurers, my feeling is too many people are cautious in the UK for this to mark the top of the bull market, although of course anything can happen at any time to change that. Stock markets are inherently unpredictable!
But I do think with plenty of still-cheap countries around the world, it makes more sense for active investors to favour putting more money abroad instead of hugely dialing down their equity exposure altogether.
While I did take some money out of the market at the start of the year – someday I’ll need to buy that still-postponed property, and I was at well over 90% equity exposure by the end of 2013 – that’s mainly what I’ve been doing.
I haven’t had so much invested in emerging markets in my investing lifetime, for example, and it’s started to come good in the past few weeks. If anything I’m tempted to add more.
