You know how I reported that this is now the third biggest stock market bubble in U.S. history?
I was wrong.
By one way of looking at it, it isn’t the third biggest bubble at all.
It may be the biggest.
Yes, really. Bigger even than 1999-2000 - the daddy bear of all stock-market bubbles.
Yikes.
That’s because the average overvaluation today may actually be higher
than it was back then. There are fewer wacko bubble stocks - but there
are also far fewer good-value stocks.
We tend to think of 1999 as the off-the-charts nuttiness classic of all
time, the “Caddyshack” of stock-market wackiness. And when you look only
at the big picture, that’s right.
For example, when you look at the total value of the stock market
compared to gross domestic product, or the total value of stocks
compared to cyclically adjusted earnings, or the total value of stocks
compared to the cost of rebuilding every company from scratch (a measure
known as the Tobin’s q), then 1999 remains the grand champ. We remain
well below those levels today.
Alas, there’s a caveat.
That big picture in 1999-2000 was thrown out of proportion by a relatively small number of psycho stocks - like Cisco Systems
CSCO
+0.02%
, a jumbo cap which traded at a ridiculous 150 times forecast earnings
(the historic average for stocks is about 14 times). Large-cap growth
stocks, such as Cisco, and Microsoft
MSFT
-0.19%
, and Intel
INTC
+0.02%
, and Yahoo
YHOO
+0.02%
and eBay
EBAY
+0.02%
and Amazon
AMZN
+0.02%
were in crazy bubble territory.
But everything else on the stock market was relatively normal. Indeed
“value” and “old economy” stocks, especially smaller value stocks, were
cheap. I remember buying stock in clothing retailer Joseph A. Banks,
then a small company, in the summer of 2000 when it was about five times
earnings.
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Back then my Daily Mail colleague in London, an acerbic Irishman named
Brian O’Connor, memorably characterized the tech bubble as “5% of the
economy pretending it was 50%,” and he was right. But the other 95% of
the economy was actually pretty cheap. So long as you avoided tech, you
were actually OK.
Not any more.
To get the details I asked my data guru in Switzerland — Joachim Klement
at Wellershoff & Partners — for an analysis not of stock market
“means” but “medians.”
People who know the difference can skip the next two paragraphs.
For the rest, let me briefly explain. The “mean” is what we usually
think of when we think of the “average.” You add up the totals and
divide by the number. So 10 people on Skid Row plus Bill Gates have a
“mean” or “average” net worth of $7 billion. They have zero billions, he
has $80 billion, and when you add them all up and divide by eleven you
get $7 billion apiece. You can see the problem.
But the “median” is often a better measure. To get the median you line
everybody up in a row - from the tallest to the shortest, the richest to
the poorest, or whatever - and then pick the guy slap bang in the
middle. Bill Gates and ten people on Skid Row have a “median” net worth
of $0 billion. Yes, there are issues both ways. But the median treats
Gates, correctly, as an outlier.
Klement looked at the top 1500 stocks by market value. What did he find?
When you look at medians, or in other words the typical stock,
valuations are higher today than they were at the peak in 1999-2000.
For example, the median stock today is 20 times earnings. In January 2000, it was 16 times.
The median stock today trades at 2.5 times “book” or net asset value. At the start of 2000 it was just 2.2 times.
The median stock today trades for 1.8 times annual per-share revenues. In 2000: just 1.4 times.
Only on dividend yields (1.3% today versus 0.8% back then) are we better off.
There are some caveats. Each individual measure is subject to a lot of
variability and noise. Price-to-earnings ratios, for example, can seem
artificially high in a slump because profits are depressed (and can seem
artificially low in a boom because profits are temporarily elevated).
According to Klement’s data, median p/e ratios were actually higher than
today at certain points in the past, such as in 2002. For that matter,
price-to-book ratios were briefly higher than today back in the later
1990s. So no individual measure can tell the whole story.
Furthermore, there are some constraints with the dataset. Klement looked
at the top 1,500 companies on the market and then traced the valuation
backwards for each one. However, that analysis suffers from what’s
called “survivorship” bias. Stocks which dropped out of the index don’t
show up. That will skew the results.
Overall, we should beware trying to force too much precision from general data.
Nonetheless based on the medians, rather than mere means, today’s stock
market valuation seems at the very least to be in a similar ballpark to
1999-2000.
Does this mean the stock market is inevitably going to “crash”? Of
course not. I have absolutely no idea if the market is going to crash,
or, if so, when. I remember Peter Lynch’s famous dictum, that investors
have lost far more money over the years fearing a crash than they have
ever lost in an actual crash.
But it does mean that, if history and mathematics are any guides, the
long-term returns on stocks from today are probably going to be
mediocre.
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