Alert! Alert! My BS Detector is Pinging

Wednesday, 1 May 2024

[3 min read]

Dear Reader,

Oh dear. Oh dear. My BS detector is flashing red. Alert! Alert!

The Economist this week is doing something no investment writing should ever do.

Too late…they’ve done it!

The ‘Buttonwood’ column is trotting out the Shiller ‘CAPE’ ratio to flag a potential big draw down in US stocks.

To quote:

‘America’s stock market is in an unusually precarious position…Take valuations first. The cyclically adjusted price-earnings (CAPE) ratio…is now higher than it was in the late 1920s.

‘The ratios current level has been exceeded only around the turn of the millennium and in 2021. Both occasions preceded market crashes.’

Yawn. Blah blah. Next. Have a nice day. Goodbye.

You see…no indicator, in my experience, has a worse track record at helping investors.

I ought to know. I’m not kidding when I say I’ve been reading the same warning, seemingly every year, for about 10 years.

The potential lost opportunity from those who avoided US stocks because of the CAPE could run into the billions.

US stocks have delivered outstanding returns over the last 10 years.

What a decade it’s been.

We’ve had the rise of social media, an energy revolution in US oil and gas, a US housing boom…and now the explosive potential in artificial intelligence.

The CAPE ratio can tell you diddly squat about any of this.

Indeed…

The vaunted CAPE ratio was higher than history said it ‘should’ be for most of this time.

Naturally, any time US stocks went down sharply it appears that the CAPE ‘predicted’ the falls.

The CAPE ratio did no such thing. A broken clock is right twice day.

Fund manager Ken Fisher happened to address this issue just the other day. Here’s what you need to know:

‘The CAPE Shiller PE looks at ten-year normalized price earnings ratios calculated in a particular way, and shows that ten years after that, stocks tend to have below average returns.

‘And that’s been true. Not negative returns, but below average returns. That’s true.

‘The fact is, if you take that same CAPE Shiller PE data and instead look at subsequent one, three, and five year returns, it’s got a correlation to stocks of zero. Once you get that, you realize that it’s not a very good forecasting tool.’

In other words, you can take a wild guess at what the world looks like in ten years, or you could look at what’s happening right in front of us right now.

I know what’s easier!

None of us know for sure what’s going to happen tomorrow…

Perhaps China invades Taiwan…and investors panic, sending stocks diving.

Or perhaps AI sends productivity soaring…and investors load up with margin debt to bid stocks to extreme levels.

Or perhaps…

You get the idea. The future is unknowable.

But one ratio cannot synthesise into your entire investment strategy.

The CAPE ratio looks at aggregate prices and earnings. OK.

What about cash levels? Margins? Buybacks? Growth rates? Interest rates? Government deficits? Fed policy? Oil prices?

You can see from this alone that the market is very complicated. The CAPE ratio has nothing to say about any of this.

However, history is clear on one point: the market rewards the optimistic. Shares deliver long term.

Former fund manager Peter Lynch once said that investors have lost far more money trying to avoid stocks falling than if they just rode through the dud periods when they do.

That’s because it so difficult to get your timing right.

Check out this recent quote…

A recent fund manager report said:

‘Since late 2023 investors have been wrong-footed. High interest rates, high inflation readings, global turmoil and economic unease prompted retreat among the many “expert” commentators. How wrong they have been, as local and global share markets move higher.’

Yep. How wrong they were.

Not us here at the Fat Tail Daily, of course…
at least on Wednesdays

All last year I said to buy stocks while they were depressed, in a funk, looking like duds. I didn’t know that the CAPE ratio said at the time, and didn’t care.

Today stocks have a spring in their step again.

You see…it pays to hang around the optimists among us.

Peter Lynch was right. And he made his comment about 30 years ago. Ha!

The Economist can cite the CAPE ratio to avoid US stocks – and by implication, Aussie ones as well – all it likes.

If you like, I could give you another dozen reasons right now to go along with that.

For example, there are big government deficits, war in Ukraine, high oil, high mortgage rates, a Presidential election looming, gold spiking, Biden’s incoherent rambling, Trump’s brain farts, and on and on we could go…

But you know what?

The market knows all this already!

These issues are ‘in the price’.

Our job is to try and find mispriced opportunities.

What is the market missing that could send stocks soaring? What is something other investors don’t know?

That’s the helpful thing to consider, and NOT the CAPE ratio. Go here for more.

Best,

Callum Newman,
Editor, Small-Cap Systems and Australian Small-Cap Investigator

Callum Newman is a real student of the markets. He’s been studying, writing about, and investing for more than 15 years. Between 2014 and 2016, he was mentored by the preeminent economist and author Phillip J Anderson. In 2015, he created The Newman Show Podcast, tapping into his network of contacts, including investing legend Jim Rogers, plus best-selling authors Jim Rickards, George Friedman, and Richard Maybury. He also launched Money Morning Trader, the popular service profiling the hottest stocks on the ASX each trading day.

Today, he helms the ultra-fast-paced stock trading service Small-Cap Systems and small-cap advisory Australian Small-Cap Investigator.

[2 min read]

Dear Reader,

‘Like a sheep he was led to the slaughter

‘And like a lamb dumb before its shearer...

‘Acts 8: 26-40’

One of the key dates for understanding how we got where we are is 1992.

That was the year when Francis Fukuyama wrote his famous essay and wondered if it was the ‘end of history’. The West was triumphant. No need for further ‘history’. No further experiments. No need to learn...to evolve...or to question.

Wars? Revolutions? New systems of government or economics? All of that was in the past. We had found the winning formula.

Looking in the mirror, back then, it seemed obvious what would happen next. Everybody wanted to be like us. They’d all become ‘Westerners’. China was already learning fast. Following the model set for it by Japan, it was building an export-led economy...selling cheap products, gaining expertise and capital...and building out its manufacturing sectors.

All those exports helped to keep US consumer prices low...and gave China the money to buy US bonds. And why wouldn’t they? Everybody knew they were the world’s largest, most liquid, and safest asset.

Putin as Capitalist

Russia, back then, had just become Russia again. The Soviet Union, with its central planning and stifling economic controls, just couldn’t compete. Its insiders looked across the border at West Germany and wanted what they saw. They realised that owning the means of production — as capitalists — would be better than continuing to control them as bureaucrats. They gave up being apparatchiks in the Soviet system and became oligarchs in the new ‘Western’ system. Vladimir Putin even thought Russia might join NATO.

The trouble for the oligarchs was that the Soviet Union produced very few goods or services that Westerners would buy. All they really had was raw materials and energy. But with the profit carrot in front of them, rather than the communist whip on their backs...the oligarchs cranked up the mines and wells...and were soon driving down prices for basic resources.

Talk about sweet spots! With the Soviet menace out of the way, the US could enjoy a ‘peace dividend’; it could cut military spending by hundreds of billions. And with the oligarchs now flooding the world with cheap commodities...and the Chinese pumping out cheap finished products — ‘The West’ never had it so good. Its consumer costs were going down as its asset prices were going up. Let the others sweat, it could think…and print dollars.

A colossus of plenty...a titan of justice and goodness...a Goliath of military might — the US, and its whole client kingdom — basked in glory for a charmed decade. The Primary Trend was up for financial assets...and policymakers in China, Russia and the US helped keep the boom going.

But they also laid the groundwork for the next Primary Trend.

The US might have used this Goldilocks period to increase its savings, update its institutions and improve its infrastructure. Instead, after 1999 its deciders — perhaps guided by an ‘invisible hand’ to take the empire down a notch — made some of the most pigheaded, disastrous policy mistakes in US history.

No Peace Dividend

Military spending actually increased. There was no ‘peace dividend’. Instead, there were capital calls to pay for an outrageous invasion of Iraq and a farcical War on Terror. Then, in 2009, the feds (including the Fed itself) bailed out Wall Street...and took interest rates down below zero (adjusted for inflation) and left them there for more than 10 years.

If this weren’t enough, trade barriers were set up to slow Chinese imports. Sanctions were imposed wantonly, weakening the dollar-based international payments system. And trillions of dollars were squandered funding wars abroad and stimmy cheques at home.

In 1992, the US had a remarkable opportunity. It already stood on top of the world. And thanks to new policies in China and Russia, it could have shored up its position — debt free, entanglement free...at peace, and more prosperous than ever.

Instead, it went on a spree of war and deficit spending...adding $30 trillion to its debt. And now...its domestic politics are a laughingstock; its foreign policies are a disgrace...and as it is shackled to a $34 trillion ball and chain, America struggles with a new and pitiless Primary Trend. Its asset prices are going down as its consumer prices are going up; its economy is slowing as its financial obligations speed up.

And much of the rest of the world, watching the catastrophe in ‘real time’, vows not to follow. Instead, it is eager to ‘de-Westernise’.

Stay tuned.

Regards,

Bill Bonner,
For Fat Tail Daily