Another Stock Bubble Is Well Under Way

December 1, 2009

Just a heads up for anybody with significant stock investments. I’m a tax expert, not a financial advisor, so don’t take this as financial advice. On the other hand, mountains of research has shown that financial advisors aren’t any more accurate than the proverbial dart board, so the truth of the matter is nobody is an expert on this stuff. So with that caveat, here’s an observation.

For some time now I’ve been analyzing long-term data on stock valuations from Robert
Schiller (one of the few economists who never stopped trusting long-term valuations and was therefore able to correctly predict both the stock market bubble of the last decade and the housing bubble). From his exhaustive data I’ve found that every time in the last 130 years that the PE10 of the S&P 500 has gone over 20, an investor would have done better to just pull out of stocks, invest in government bonds, and wait for the bubble to collapse. This last bubble took almost 15 years to collapse, but it did. And an investor who had bought bonds the last time PE10 passed the 20 mark (Jan, 1995) and just waited for valuations to return to the historical average of about 15 (February of this year) before buying into stocks again would have done about 20% better than an investor practicing buy and hold. Today the PE10 passed 20 again for the first time since last year’s collapse.

** (PE10: P/E ratio w/ earnings averaged over the last ten years)

Maybe we’re headed into another decade+ bubble, but staying in at this point means trusting your (or your broker’s) ability to call the top of the bubble, something nobody has ever done with any consistency. Individual stocks may be able to buck this phenomenon, but again it’s trusting your (or your broker’s) ability to be significantly better than average at picking individual stocks, something few “professionals” are able to do with consistency. In fact, the “professional” mutual fund managers do better than average only about 20% of the time, even though by pure luck they should do better than average about 50% of the time.

Draw your own conclusions.

UPDATE: The S&P 500 closed at 1109 on the day this blog was published. In the six months’ since, the index has bounced around between almost 10% up and 5% down, with a closing price today of 1070. We’ll see what happens in another six months…