Winter is Coming?

It’s hard to imagine that there is much value left in US and other developed nations’ equities.  The Global Financial Crisis (GFC) ended in March 2009 and with it, the last bear market.  The current bull market is about to enter it’s ninth year.  According to the National Bureau of Economic Research, since 1945 there have been eleven business cycles as measured from peak to trough.  The average cycle has lasted 5 ½ years.  Furthermore, the average bull market has been 97 months (8 years).  While the average duration for a bear market since the 1930s has been 18 months.  With that backdrop, it’s an interesting time to be investing in equities.

According to Burton Malkiel, the author of “A Random Walk Down Wall Street,” “for equities, the cycle-adjusted price/earnings ratio, or CAPE – the valuation metric that does the best job in predicting future 10-year rates of return – is about 34.  That’s one of the highest valuations ever, exceeded only by the readings in 1929 and early 2000, prior to crashes.”  We’ve seen similar work and sentiments from other groups, such as the findings from Yale University’s Nobel Laureate Robert Shiller.


Shiller PE Ratio

Given the title of this paper (and its not-so-subtle reference to Game of Thrones), the message can be translated into one of caution and constant vigilance.  However, all is not lost.  There are a couple of takeaways that should be considered in the face of this overwhelming negative information.  Just because the CAPE is 34+, doesn’t mean the sky is falling.  No valuation metric can be simply taken at face value.


While the data suggests we’re on the verge of a serious correction in the equity markets, it’s almost impossible to predict when that correction is going to occur.  At the start of 2017, for example, the CAPE for US equities stood at approximately 30.  If one were to rely solely on the CAPE to try to time the market, one would have gotten out of the equity market at that time.  However, it turns out that the S&P 500 returned an excessive 21.8% for 2017.  Therefore, we advise clients not to attempt to time the markets because it’s impossible to know when the up- or downturn is going to happen.  Jack Bogle, the founder of Vanguard funds, has written, “After nearly 50 years in this business, I don not know of anybody who has [timed the market] successfully and consistently.  I don’t even know of anybody who knows anybody who has done it successfully and consistently.”


What do you do with this information?  Be aware and more importantly, DIVERSIFY!  Coval and Moskowitz in December 1999 published an academic paper on the “Home Bias at Home:  Local Equity Preference in Domestic Portfolios.”  What their research determined, is that money managers of all stripes have an extreme bias towards investing client assets locally, meaning the country in which the manager resides.  Based on this information, it is critical that one must diversify geographically, as well as through asset classes and sectors.

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