Investing in stocks is a different proposition than it used to be
- Several important trends have altered the market for stocks
- The proliferation of index funds, the transition of the management of stocks from owners to third party agents, and more recently the Fed's program of quantitative easing have all contributed to a breakdown in market diversity
- Due to very high levels of debt, most financial and economic metrics have become politicized which substantially increases the difficulty of determining underlying economic fundamentals
- The most effective long-term valuation metrics suggest stocks are significantly overvalued (as of August 2014)
“The growth in trading of passively managed equity indices corresponds to a rise in systematic market risk. From this finding, we can infer that the ability of investors to diversify risk by holding an otherwise well-diversified U.S. equity portfolio has markedly decreased in recent decades.” "Because the goals of the agents and investors are not always aligned, many professional investors get paid to simply take part in the game." |
"Why do markets fail? Most simply, investor heterogeneity breaks down and everyone acts in unison, leading to excessive optimism (greed) or pessimism (fear)." "What I’m saying is that in the Golden Age of the Central Banker it is impossible to distinguish fundamental economic reasons for asset class price movements from politically-driven strategic reasons." |
"The median price/revenue multiple for S&P 500 constituents is now significantly higher than at the 2000 market peak ... As a result, the Fed has produced what is now the most generalized equity valuation bubble that investors are likely to observe in their lifetimes."
"The Future is Now", John P. Hussman, Ph.D., Hussman Funds Weekly Market Comment, April 28, 2104
Areté's Take:
- While stocks inherently have several attractive characteristics for long-term investors, their attractiveness varies depending on circumstances
- Several trends, notably the proliferation of index funds, have caused systemic risk to increase.
- Several effective long-term valuation metrics indicate stocks are significantly overvalued (as of August 2014).
- These conditions suggest that maintaining the same exposure to stocks in your portfolio involves accepting both greater risk and lower expected returns. In other words, doing nothing allows ever-greater risk to accumulate.
- Purchase price is always an important determinant of future returns. If attractive prices can't be found it is best to wait.
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