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Why Historical Market Comparisons Are Meaningless

  • Written by Syndicated Publisher No Comments Comments
    April 20, 2014

    As Chief Strategist for STA Wealth Management I start each and every day by consuming copious amounts of a heavily caffeinated beverage and a data feed from a litany of web and blog sites. Over the last couple of days in particular, they have been numerous articles on whether the market is currently in a bubble.   Here are a few as an example that I just grabbed from realclearmarkets.com:

    Is This a Bubble Market? There’s One Way to Tell

    Is Financial Media Warding Off Stock ‘Bubble’?

    The Upside of Speculative Market ‘Bubbles’

    Yellen: Bubbles? What Bubbles?

    Well, you get the idea. First of all, bubbles only occur when no one is looking for them. Bubbles form when greed runs rampant and there is a mass hypnotic state that the current ride will never end. The shear fact that multitudes of articles are being written about “market bubbles” is a sign that we are likely not there, yet. (Read: Too Much Bubble Talk)

    However, as a shot of caffeine hits my brain, I read with interest a recent piece on Bloomberg entitled 5 Reasons We’re Not In a 2000 Bubble Redux.” which I have summarized for you:

    1) Volume of IPO’s is less than half of the first quarter of 2000

    2) First-day returns of IPO’s are just 1/5th of the first 1st quarter of 2000.

    3) Speculative companies carried a 43% higher valuation to dividend paying companies in 2000 versus just 26% today.

    4) Cash derived from equity issuance was 20% in 2000 versus just 11% today.

    5) Share turnover in 2000 was an annualized 89% rate versus 58% today.

    While these are certainly some interesting arguments, the comparison between now and the turn of the century peak is virtually meaningless. Why? Because no two major market peaks (speculative bubble or otherwise) have ever been the same. Let me explain.

    In late October of 2007, I gave a seminar to about 300 investors discussing why I believed that we were rapidly approaching the end of the bull market and that 2008 would likely be bad, really bad. Part of that discussion focused on market bubbles and what caused them.  The following two slides are from that presentation:

    Every major market peak, and subsequent devastating mean reverting correction, has ever been the result of the exact ingredients seen previously. Only the ignorance of its existence has been a common theme.

    As I discussed yesterday, the reason that investors ALWAYS fail to recognize the major turning points in the markets is because they allow emotional “greed” to keep them looking backward rather than forward.

    Of course, the media foster’s much of this “willful” blindness by dismissing, and chastising, opposing views generally until it is too late for their acknowledgement to be of any real use.

    The next chart shows every major bubble and bust in the U.S. financial markets since 1871 (Source: Robert Shiller)

    At the peak of each one of these markets, there was no one claiming that a crash was imminent. It was always the contrary with market pundits waging war against those nagging naysayers of the bullish mantra. Yet, in the end, it was something that was unexpected, unknown or simply dismissed that yanked the proverbial rug from beneath investors.

    What will spark the next mean reverting event? No one knows for sure but the catalysts are present from:

    • Excess leverage,
    • IPO’s of negligible companies,
    • Companies using cheap debt to complete stock buybacks and pay dividends, or
    • High levels of investor complacency.

    Either individually, or in combination, these issues are all inert. Much like pouring gasoline on a pile of wood, the fire will not start without a proper catalyst. What we do know is that an event WILL occur, it is only a function of “when.” 

    The discussion of why “this time is not like the last time” is largely irrelevant. Whatever gains that investors garner in the between now and the next correction by chasing the“bullish thesis” will be wiped away in a swift and brutal downdraft. Of course, this is the sad history of individual investors in the financial markets as they are always “told to buy” but never “when to sell.”

    For now, the “bullish case” remains alive and well. The media will go on berating those heretics who dare to point out the risks that prevail. However, the one simple truth is“this time is indeed different.”  When the crash ultimately comes the reasons will be different than they were in the past – only the outcome will remain same.

    Images: Flickr (licence attribution)

    About The Author

    Lance Roberts – Host of StreetTalk Live

    After having been in the investing world for more than 25 years from private banking and investment management to private and venture capital; Lance has pretty much “been there and done that” at one point or another. His common sense approach has appealed to audiences for over a decade and continues to grow each and every week.

    Lance is also the Chief Editor of the X-Report, a weekly subscriber based-newsletter that is distributed nationwide. The newsletter covers economic, political and market topics as they relate to the management portfolios. A daily financial blog, audio and video’s also keep members informed of the day’s events and how it impacts your money.

    Lance’s investment strategies and knowledge have been featured on Fox 26, CNBC, Fox Business News and Fox News. He has been quoted by a litany of publications from the Wall Street Journal, Reuters, The Washington Post all the way to TheStreet.com as well as on several of the nation’s biggest financial blogs such as the Pragmatic Capitalist, Zero Hedge and Seeking Alpha.

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