Sign up with your email address to be the first to know about new products, VIP offers, blog features & more.

Deja Vu

THE social media stock, which everyone has been atwitter about, became a public company last month. A lucky few were able to get it at its initial public offering price. Opening price for the rest of us was about 70% higher. Since then it has risen another 64%. There is no Price/Earnings ratio because there are no earnings. Even the Price/SALES ratio is obscene. The market capitalization of this company now makes it bigger than most of the companies in the S&P 500. We have seen this sort of price action before, 15 years ago during the Internet bubble. *

“History doesn’t repeat itself, but it does rhyme.” – Mark Twain

*Since I wrote this 2 days ago, the stock is off almost 20%.

Are We In an Investment Bubble?

Over the past few months, many experts have been trying to make sense of the performance of the US stock market. It has been on a roll for about two years now! Is it too good to be true? Are we in the midst of an investment bubble? Economists are debating the issue now, as it’s hard to identify one during the moment.

It’s hard to find information that can help you make up your mind. Either, it’s an overs implication of the facts, an exaggerated piece written by someone looking to scare the reader, or so academic that you can’t fully understand the article. Below are a two pieces that I’ve found to be helpful.

The chart below suggests that we are (and have been for quite some time) outperforming the long term average of the market. There is always a reversion to the mean. It may happen in 20 years or tomorrow. I like this chart because it puts the past few years in context.


Robert Shiller, Nobel Memorial Prize recipient in Economic Science and author of Irrational Exuberance, outlines six points that can contribute to a bubble:

  • The sharp increase in the price of an asset or share class
  • Great public excitement about these price increases
  • An accompanying media frenzy
  • Growing interest in the class among the general public
  • ‘New Era’ theories justifying the high price
  • A decline in lending standards

Some of these conditions appear to have been met, but many have not. Lending is still has high standards and much of the general public has not participated in the market. They are still cautious.

I think many people are confusing an economic bubble with a normal market correction. Will we experience a 5%-10% market correction in the near future? Most likely. Will the bubble burst bringing us back to the lows of 2009? Probably not, but you can never tell.

This serves as a reminder to keep to your investment strategy. It’s all too easy to make an emotional decision and jump on the band wagon as the headlines tout new highs. But that’s where people can get in trouble. They load up in one asset class at the wrong time.

A Brief History of Bubbles

Excerpt from Faber’s “Learning to Love Investment Bubbles: What if Sir Isasc Newton Had Been a Trendfollower”

“From a behavioral and psychological standpoint [a trend following investment strategy] is often the most difficult to deploy when it is most useful. Strong discipline would have been required to sell technology stocks in 2000, REITs in 2007, or South Sea stock in 1720, especially when one’s colleagues, friends and neighbors were making money hand over fist. In the end, for those who imposed such discipline, it was the prudent choice.”

Seems relevant for what we’re seeing in today’s recovery.

If you want to read more about how trend following works during investment bubbles, read this paper (especially the summary at the end):

Have you shopped at Target lately?

Target announced today (article) that it was the victim of what may prove to be the largest data theft ever recorded. If you shopped at a Target in the last few weeks, your personal credit card or debit card (not just the Target-branded cards) may have been one of more than 40 million credit cards that were compromised. 40 million is also the population of California!

If you suspect you’re in that unfortunate group, you can check to see if there is any unusual activity on your account by going on line or calling customer service for your credit card. You can protest any fraudulent charges, and the credit card company will probably waive the charges after a brief investigation. Keep monitoring your account for the next month or so. If you’re suspicious and want to be extra cautious, ask your credit card company to freeze your account, and ask for a new card.

Identity theft has now affected one in 14 Americans, and losses from identity theft exceeded $47 billion in the last year, far more than all other property crimes combined.

Have you ever been affected? Send us an email with your story and we can post your experience, confidentially of course.

The Mississippi Bubble: One of the First Bubbles

There’s a lot of talk about if the US market is in a bubble these days. It’s next to impossible to determine if we are, in fact, in a bubble. But the media will do just about anything to produce a story that will get more people to read their publications.

Instead of reading their predictions, consider watching this video about one of the first economic bubbles ever recorded.

John Law and the Mississippi Bubble by Richard Condie, National Film Board of Canada

John Law and the Mississippi Bubble

Why Wasn’t There a Taper Tantrum?

If you recall, the markets declined by about 5% in May and then again in August due in part to the possibility of the fed reducing its bond buying program.

And then yesterday happened – the Fed went ahead and started to taper the bond buying program.

Based on the past, you would think the markets would have declined, right? Wrong. They surged upon hearing the news.

USA Today has a brief article that outlines five reasons why the markets reacted positively to the news.

Seven Mistakes to Avoid In the First Year of Retirement

USA Today outlines seven common mistakes that we constantly flag for our clients. If you are close to retirement, chances you have overlooked at least one of these. We see a lot of new retirees who don’t consider inflation in their planning process. Maybe they are more concerned about long tail events, like the great recession. And they forget about the slow, ever present erosion of purchasing power that occurs each and every year.

Properly Pricing a Stock

In the past writings below, I referred to the concept of a fair value for stocks. However, I skipped a step. I did not define what I meant by fair value. So here goes…

To start, let us assume that we are not in extraordinary times (link). Assume that we are in normal times, that the economy is fine.

The first concept is the Price/Earnings ratio. It compares a stock’s 12-month trailing earnings over the current price. For example, currently a major U.S. car company’s P/E is 12x and a cell phone equipment company is 18x. The P/E difference is due to the expected future earnings growth of the cell phone company being higher than the car company’s. Therefore, the higher the future prospects for a company, the higher the P/E ratio of its stock.

Next is the PEG ratio. The PEG ratio is the P/E ratio over the expected growth rate in earnings. A company that is 15x earnings which is expected to grow earnings at 15% has a PEG ratio of 1 (This is considered fair value, some would argue for a higher number). Below 1 (or 2), the stock is cheap, above …expensive. Yahoo finance is an excellent webpage to find this out and more on almost all stocks.

Lastly, because earning can be volatile, a leading economist, Robert Shiller developed the Cyclically Adjusted Price Earnings ratio (CAPE10). This ratio is based on average inflation-adjusted earnings from the previous 10 years instead of just the last trailing 12 months. It is believed to be a more accurate measure.

Of course, due to a cornucopia of various factors, the CAPE10 ratio is a poor predictor of short-term movements in stock prices (and there is certainly no shortage of various factors lately). Lazlo Birinyi well documents this (he continues to call for higher prices). However, over the longer term, I believe the inevitable gravity of fair value pulls on prices (link).

What is the current CAPE10 ratio on the S&P 500 you ask?

What Investors Have In Common With Dinos in Jurassic Park

There’s a great scene in Jurassic Park where Alan, Tim and Lex watch a stampede of dinosaurs suddenly change direction and head right toward them.  What made them change direction?  What made them decide that this new direction was any better?

Turns out investors do the same thing, just with their investments.  As they sense other investors moving into the market, they follow. As investors move from bonds to stocks, others follow. There is a perception that there is safety in numbers. Both dinosaurs and investors tend to act as “herds”.

Problem is that it’s a misperception. Following the herd can cost investors in the end.

Remember to stick to your investment strategy and don’t follow the heard… they could be headed for a cliff and not even know it.