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The Iron Law of Valuation

The discipline which holds that stocks and the market in aggregate have a fair value based on past, current, and estimates of future earnings. This method is calculated through exhaustive mathematical analysis and statistical back-testing.  Through this methodology, a current fair value can be derived.  The Iron Law of Valuation is that, while actual prices will fluxuate, the inevitable pull of fair value will win over the long run. This analysis compares the current price to what is historically normal and can further demonstrate the degree of the difference; whether this market is under or overvalued.

Furthermore, by assuming, what has been true will continue to be true and comparing the current price to an expected future fair value, the probability of an expected future average annual return can be derived. Therefore, history gives a fair value: an average, a mean, a best fit. In addition, because stocks are no more than the present value of future earnings, these earnings can be anticipated, then assigned a current value discounted at some function of the Federal Reserve’s ‘neutral policy’ interest rate. It becomes a simple matter to determine whether the current price of the stock market is above or below fair value; whether it is under or overpriced.

Right now, the current price of the stock market is higher than this discipline would expect. But reality often turns theories about the appropriate value of the stock market into junk. Recent history is full of instances where the stock market continued to make substantial gains long after these theories stated otherwise. No one better documents this divergence than Laszlo Birinyi, and he is still bullish.

However, I believe knowing fair value is very important. The Iron Law of Valuation is like gravity.  Over the long term, it wins.

A Wake Up Call: How Not to Deal With an Inheritance.

The following story offers a great example of what can go wrong when a young, financially inexperienced individual becomes wealthy overnight. This author’s advice at the end is exactly what we recommend to clients in this situation:

  1. Get advice from someone on how to use this new found wealth.
  2. Create a plan. Put it in writing. Understand what these funds will be used for it.
  3. Stick to the plan. Without controlling your budget, you can slowly lose track of the wealth.
  4. Don’t be tempted to rely too much on this wealth. It’s very, very easy and tempting to dip into the inheritance when things get tough. But it’s nearly impossible to rebuild a nest egg has been decimated.

How I Blew a $250,000 Inheritance

You Can’t Predict the Next Black Swan Event

What’s wrong with this chart?

Give up? The folks that created the chart are trying to predict the next Black Swan – the next significant event that could derail the economy. The problem is, that by definition, black swan events are unpredictable and exceptionally rare. Much of what’s listed here has been dissected and extensively analyzed. They are serious concerns but may already be baked into the current price of the markets. Just look at how the S&P 500 has responded due to the tensions in Russia and Ukraine

Sometimes the biggest risks are the ones that do not appear on anyone’s Black Swan chart!

What’s the best investment?

In a recent Gallup poll, Americans were asked what they thoughts was the best investment to make over the long term. Their choices:

Real estate
Savings Accounts

The average American incorrectly believes that Real Estate is the best investment over the long term.

The following article presents a good argument for why Stocks may be the best investment over the long term. And I’m glad that they made note that investors should be shifting to lower risk assets the closer they get to retiring.

Less Than a Quarter of Americans Get the Most Important Investment Right