Market Valuations - What do they really mean?

[DawgMan]

So when it comes to trying to understand today's market performance/valuations, what is it really taking into account...

- Recent/next quarter's/future projected performance?
- Talking heads?
- Financial data points (i.e. inflation, interest rates)?
- Current policy (i.e. current/projected tax policy, Fed policy)?
- Covid 19 vaccine timing?
- Election projections?

I like to play Monday morning QB and read the headlines and forecast the daily market performance and am frankly wrong many more times than I am right. Other than historical performance, I have given up making "this time it's different" decisions or "time to sell/market over valued" decisions in changing my financial strategy. I may test the different thinking out there, but so far have stayed the coarse. None the less, I get caught up in the chatter and scratch my head wondering... "should I do something THIS time?" The latest chatter getting my attention is the election. Many feel that if there is a change, new policy will cause the market to tank?? But, are the markets not efficient enough to have some of these probabilities already priced in? So, are the markets really valued right where they should be?

What say you?

 

[Retireby45ish]

I believe in efficient market theory.

Markets are valued exactly where the collective wisdom of the market sets the price at any point in time. I’m no smarter than everyone else so I have very little reason to believe that I can outsmart or time the market.

Yes , the election is priced in as are all other events.

Now whether the market is right in having it priced where it is now doesn’t matter because I don’t know if it’s too high or two low. It just is where it is this second.

Oops, there it goes...

My idea: Every talking head should have to plunk down serious personal money every time they make a prediction that they know where things are going. That way the 50% that are wrong wouldn’t just be quiet or dismiss their claim (or make excuses) but they’d feel their silly opinions in their pocketbook!

 

[HI Bill]

IMHO, market valuations for equities are like market valuations for real estate. Equities are worth what people are willing/able to pay for them. They are the sum of FEAR + GREED, and greed includes the effects of day traders, short sellers, futures, market timers, and high frequency traders. With the widespread adoption of MFs and ETFs, an individual company's PE ratio matters much less than it used to, unless you're trading just the one stock. This used to really annoy me, but I've given up on the markets being efficient with respect to earnings, profit, backlog, debt, etc.

 

[OldShooter]

I see pricing as a combination of two factors. At the bottom is the Efficient Market Hypothesis price. At the end of the day, stocks must have economic values based on the economic activity of the company. The second layer, though, which may be thick or thin, is the behavioral economics "spin." Tesla is an example where the spin dominates the stock price. It has always been thus with the most extreme of the growth stocks. Remember Worldcom? The "Nifty Fifty?" In most cases the greater fools finally stop showing up and the excited stocks tanks -- ideally back towards the EMH level.

Here is a very worthwhile 42 minute video of two Nobel prize winners; Gene Fama as an advocate of the EMH and Richard Thaler pointing out that there are often emotional, irrational, or erroneous factors also incorporated in a stock price. His illustration of a stock with ticker CUBA is a killer IMO. https://review.chicagobooth.edu/economics/2016/video/are-markets-efficient (note: the transcript is condensed and the author misses important stuff. Don't read it instead of looking at the video.)

 

[Lsbcal]

... But, are the markets not efficient enough to have some of these probabilities already priced in? So, are the markets really valued right where they should be?

What say you?

Price history is the only real hard evidence. We know most of the evidence for that but not the functions that translated that evidence into the output (price). The current price is ephemeral varying millisecond to millisecond. This is because new events occur and pass through the price function of each investor.

Regards,
Professor Lsbcal

 

[RetireAge50]

I think the factors you mentioned like elections, COVID, recent financials, etc is only noise/volatility. Over time stocks return about 10% (which really is quite a low number for a business. I would think 20% is more reasonable but perhaps these businesses are not publicly traded). Anyway based on an average of 10% stocks are currently undervalued by 7.1%.

 

[audreyh1]

I don’t believe in efficient market theory, at least not in the short term, and all of this is a giant Fed put, IMO. There is no where else for the money to go and investors expect to be bailed out at any sign of panic. Call it asset inflation.

 

[Lsbcal]

I don’t believe in efficient market theory, at least not in the short term, and all of this is a giant Fed put, IMO. There is no where else for the money to go and investors expect to be bailed out at any sign of panic. Call it asset inflation.

Prof. Robert Schiller says that all financial assets (bonds, stocks, real estate) are currently at very high valuations. So yes, where does money go?

 

[njhowie]

I don’t believe in efficient market theory, at least not in the short term, and all of this is a giant Fed put, IMO. There is no where else for the money to go and investors expect to be bailed out at any sign of panic. Call it asset inflation.

Completely agree.

I personally do not believe that the Fed is more powerful than world markets/investors. They print enough, buy enough, flood the markets enough, and the currency will collapse. Fiscal policy will not get them out of the ditch when they are devaluing the currency at warp speed. At some point, the Fed will lose control, and it will not be pretty when it happens.

Do what you know is right, not what you hope is right.

 

[bolt]

Completely agree.
Do what you know is right, not what you hope is right.

Heres a thought I heard somewhere.

"A country is only as solvent as it's currency"
I agree

Good luck & best wishes.....

 

[donheff]

I don’t believe in efficient market theory, at least not in the short term, and all of this is a giant Fed put, IMO. There is no where else for the money to go and investors expect to be bailed out at any sign of panic. Call it asset inflation.

+1 Of course, I read the MMT theorists and wonder whether we will ever hit the ceiling. I guess we could find out with a massive collapse. Or we could find out with gradually increasing inflation accompanied by a period of relative austerity. Or we could muddle on without any clarity for the rest of our lives. I don't have a clue or a guess which.

 

[sengsational]

Greater fool theory 1. Efficient market theory 0.

 

[pb4uski]

+1

Greater fool theory 1. Efficient market theory 0.

 

[target2019]

So when it comes to trying to understand today's market performance/valuations, what is it really taking into account...

- Recent/next quarter's/future projected performance?
- Talking heads?
- Financial data points (i.e. inflation, interest rates)?
- Current policy (i.e. current/projected tax policy, Fed policy)?
- Covid 19 vaccine timing?
- Election projections?

I like to play Monday morning QB and read the headlines and forecast the daily market performance and am frankly wrong many more times than I am right. Other than historical performance, I have given up making "this time it's different" decisions or "time to sell/market over valued" decisions in changing my financial strategy. I may test the different thinking out there, but so far have stayed the coarse. None the less, I get caught up in the chatter and scratch my head wondering... "should I do something THIS time?" The latest chatter getting my attention is the election. Many feel that if there is a change, new policy will cause the market to tank?? But, are the markets not efficient enough to have some of these probabilities already priced in? So, are the markets really valued right where they should be?

What say you?

This video from late 2018 explains how valuation is charted by a certain software (Fastgraphs).
How Overvalued Is The S&P 500? - Video from Sep 28, 2018 is less than 5 minutes.
https://youtu.be/lM546mfjFNQ

Here is today's chart for S&P 500 (^SPX). Note that it includes analyst estimate average for 2 years to come. I don't use this for action, just general knowledge about historical data for price and valuation.

 

[OldShooter]

Greater fool theory 1. Efficient market theory 0.

+2 at least for Bitcoin and Tesla. Other stocks, other times, maybe not always. Things are more peaceful with investments that do not attract the fools' interest.

 

[38Chevy454]

I see pricing as a combination of two factors. At the bottom is the Efficient Market Hypothesis price. At the end of the day, stocks must have economic values based on the economic activity of the company. The second layer, though, which may be thick or thin, is the behavioral economics "spin." Tesla is an example where the spin dominates the stock price. It has always been thus with the most extreme of the growth stocks. Remember Worldcom? The "Nifty Fifty?" In most cases the greater fools finally stop showing up and the excited stocks tanks -- ideally back towards the EMH level.

I tend to agree with OldShooter's words above. Theoretically a stock's price is a reflection of future expected earnings and assets of the company. The EMH covers this aspect. The unknown part is the Greater Fools aspect and how much news (fake news?), speculation, and gov't interference can affect this GF aspect.
One important thing to keep in mind, which is difficult in the current times now, is that the market does not equal the economy. This is hard to separate, especially with the seemingly large disconnect now between the two. Certainly Covid19 and upcoming elections with political rhetoric and influencing do not help make sense. Just be aware to not let short term emotional events and news to bias your longer term investing decisions

So in the end, I stick with buy and hold strategy. Don't try to time the market, but may make some asset allocation changes if I think it is good for the 1-4 year timeframe. I always keep more equities than most people on the board here, I do believe in the long term success of the market. Just be prepared for the volatility in short term.

 

[Lsbcal]

Then there is the old Marty Zwiege theory “the trend is your friend “.

 

[Toocold]

Higher valuations for tech, big core retail, pharma, core consumables, healthcare. Little change for utilities and telecom. Lower valuations for hotel, travel, entertainment, real estate, energy, financials. High valuations for bet the stars - tesla (similar to Amazon for the last 20 years).

Not reflected in any numbers: Decimated impact on small mom and pop shops for personal services, restaurants, and other retail.

This seems right to me. The sectors (subsectors) that have been directly impacted by covid account for ~20% of total market cap, and it seems like the money shifted to tech for likely good reasons.

Also, small businesses represent about 50% of GDP and 0% of public companies, so that's why covid is impacting main street alot more than wall street.

 

[OldShooter]

Then there is the old Marty Zwiege theory “the trend is your friend “.

Another way to describe a greater fool strategy.

 

[Lsbcal]

Another way to describe a greater fool strategy.

Or momentum?

 

[NW-Bound]

I don’t believe in efficient market theory, at least not in the short term, and all of this is a giant Fed put, IMO. There is no where else for the money to go and investors expect to be bailed out at any sign of panic. Call it asset inflation.

To be fair, an EMH proponent would say that the Fed put has to be taken into consideration, and that justifies the market going higher.

Greater fool theory 1. Efficient market theory 0.

I think it's more about FOMO.

 

[OldShooter]

Or momentum?

I think they are basically all the same. An expectation that a greater fool will take the asset off your hands with your indifference to the financial parameters of the asset. Some descriptive names are more gentle than others, I guess.

 

[NW-Bound]

I think they are basically all the same. An expectation that a greater fool will take the asset off your hands with your indifference to the financial parameters of the asset. Some descriptive names are more gentle than others, I guess.

But the above is my main gripe with EMH. People who bid up a stock without regard to its fundamental will say that a stock commands higher and higher prices because it "deserves" it. Wisdom of the crowd and all that jazz. If it were not good, how would people pay that much for it?

Once a stock gets propelled to the troposphere, people will come up with all reasons to justify its price, and it gets boosted further to the stratosphere. Mars is the next step.

 

[OldShooter]

But the above is my main gripe with EMH. People who bid up a stock without regard to its fundamental will say that a stock commands higher and higher prices because it "deserves" it. Wisdom of the crowd and all that jazz. If it were not good, how would people pay that much for it?

Once a stock gets propelled to the troposphere, people will come up with all reasons to justify its price, and it gets boosted further to the stratosphere. Mars is the next step.

Yes. Old news. Tulip bulbs, the South Sea bubble, ... Apparently this is in the basic nature of us humans.

If you haven't looked at the video I linked in post #4 above I encourage you to do so. It may calm you down.

The first three chapters of this book Volume 1: https://en.wikipedia.org/wiki/Extraordinary_Popular_Delusions_and_the_Madness_of_Crowds are great fun reading. I sort of ran out of steam after that but I'm sure there is more good stuff in there. The book was published in 180 years ago. (Gutenberg has it for free. Memoirs of Extraordinary Popular Delusions and the Madness of Crowds by Mackay - Free Ebook)

 

[NW-Bound]

I am quite calm, and amused at the moment.

I am not a vampire to live long enough to experience the Tulip and the South Sea bubble, but remember the dot-com mania just as yesterday. Analysts were tripping over each other to raise their targeted prices for stocks, when they shot up like roman candles. "What do you mean your 12-month target price is $400 when it closed at $500 just now? Aren't you ashamed to call yourself an analyst?"

Yep, I have been there. But I have not done that.

Well, maybe I did too. Never owned any dot coms, but lost out on a bunch of tech stocks. I thought that compared to the dotcoms, my "good companies" were real corporations, with real products, plus their P/Es were only 100 or so, compared to the dotcoms who did not have any sales let alone profit.

And that's why I lost only 50% counting from the top in March 2000 to March 2003, instead of losing 100% if I had the dotcoms.


PS. About Farma and his talk, I read "A Random Walk down Wall Street" by Malkiel a long time ago. I got the gist of the subject from this book, and have not found anything substantial by anybody to add to that. Malkiel may not be the 1st to write about this subject, but I liked his style a lot.