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Are We In a Bubble?


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For me, one big difference was that the Dotcom Bubble was really a two-tiered market.  
 

While there were obvious frothy and overvalued tech stocks, there were also many severely undervalued stocks trading alongside that market.  And it wasn’t just BRK trading at book value per share, it was numerous opportunities in obviously undervalued stocks.  

 

There’s a reason why many famous value investors had a superb record in the 2000-2004 period.

 

i don’t see a similar two-tiered market today.  FWIW.

 

I would also say the macro environment was different too.  The US was experiencing deflation due to consecutive Federal budget surpluses from 1998-2001 that was acting like a blanket slowly compressing asset prices everywhere.  Today, we have, uhhh, the opposite of that.

 

wabuffo

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The "feeling" is not the same as the dotcom bubble. The hype and fervor are not nearly like it was back then. 

 

Now, with that said, 2008 wasn't the same either (and the drawdown was actually worse that time overall). 

 

My point I'm trying to make is that very high valuations and national obsession with the stock market are not a requirements for large drawdowns. I will say that I think the "feeling" today is as close to 1999 as anytime sense though. 

 

The 10 year in 2000 was around 6.5% and the government was running a surplus then. Can you imagine what the economy would look like if the 10 year went back to that and the government ran a surplus? I'd imagine it would be worse than 2008 (and probably a lot worse). Heck, if either of those things happened, things would look very different than what they do today.

 

But, to answer your question as to whether we're in a bubble or not: I don't know. 😜

 

 

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You are asking about sentiment so who knows especially in terms of timing.

FWIW,

 

During the dot-com build-up, i was fresh out of university and forming some kind of self-directed investment framework. One of the holdings was BCE.TO (telecom giant) and it spun off Nortel shares (star dot-com darling in Canada) which i kept for a while. i sold Nortel before seeing it triple. The selling was not because i saw the bu**le (although i had read the Buffett 1999 general valuation article), it was because i was not able to understand Nortel’s business. Being not able to understand became a recurrent theme afterwards.

 

In social meetings (as a proxy for sentiment) with ‘friends’ in the extended circle (many graduates including in the technology and computer science fields), ‘investing’ was a prominent topic during the rise but became a taboo topic thereafter. Anyways, disclosing that i had sold Nortel disqualified me to the 'investing' discussions.

 

During that time and up to 2001-2, I was getting ready to invest in Fairfax Financial and to get an idea about the technology bubble sentiment then, reading the ‘investments’ section in Mr. Watsa’s introductory letters (1999, 2000 and 2001) may not be a poor investment of your time. The times, they are changin’ but human nature..

 

Who am i to say but, whatever you do, it’s probably a good idea to have a long term outlook. That period is also when i opened a self-directed higher education fund for my kids (both born and to come) and this also required hope for the future.

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We've had the benefit of investing through many bubbles, both in NA and the UK ....

 

Most will have no idea if they are in a bubble, until they have been in it for some time. You make money when you realize that, ahead of the crowd; the bubble itself really doesn't matter, ability to think 'independently' - does.

 

Bubbles are sector specific, (RE, BTC, o/g, etc), the sector rises relative to the broader market. O/G rises as demand/supply issues push it, the broader market declines as interest rates rise to deter inflation (lower P/E multiple). You do well because you know your sector very well - riding the cycle up and exiting before it turns. But it means exposing yourself to risk.

 

To STAY rich - you must keep taking $ off the table (risk management). If you know your industry, you already have a pretty good as to when - you do not need to be perfect. The real issue is what do you then do with the gains.

 

Good luck!

 

SD

 

 

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The wazoo commercial still makes me laugh!  I never forgot that one.  

 

I've been reading Chris Bloomstran's yearly letter, and he makes some data-backed arguments that we're pretty much in year 2000 territory again.  Looking at TSLA valuation, and looking at how many companies are being sold at more than 30x sales, and how well those have done for people in the past, it's sobering.  Combine that with Michael Burry's tweet that he believes we're in the largest speculative bubble of all time, in all asset classes, by two orders of magnitude.  

 

It seems like a bubble to me.  They let TSLA into the S&P 500 and it's one of the biggest components of the S&P now, hugely overvalued as it is.  😕

 

https://www.semperaugustus.com/clientletter

 

https://static.fmgsuite.com/media/documents/2bde00e4-7037-4c39-beb8-9946b2b2dce3.pdf

 

( If you only read a couple pages, go for 50 to 52 about Tesla's valuation, or 53 to 56 about some research he did comparing outcomes for stocks trading at >10x, >20x, >30x sales about 20 years ago and how they've done since.  Spoiler: buying high is always a bad strategy )

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I'm in my early 30's as well so I can't comment on the 90's. 

 

whenever i hear the B word, I pull this up. the index of high quality companies in the US. there are 125 of MSCI's definition. 

https://www.msci.com/documents/10199/4af921f5-0bbc-470b-ad69-19a177fad9cf

 

The US is the world's best performing market. these companies have tonned it and returned 16% / year for the past 10 years.

 

But are they "bubbly"? 

 

27x trailing and 24x forward. I would say NO. Prices don't seem bubbly at all; stretched? sure, they're stretched. I'd note that in early 2020, when RuleNumberOne was inundating us with bubble talk, this same index was 20x (not sure if trailing or forward). 

in my view we can't really be in a bubble unless earnings are VERY MATERIALLY unsustainable. I'm not talking a 10% ding from a little higher tax, I'm talking a 40% cut. my preferred definition of a bubble is that prices could halve and still be expensive. Any company on this list I would buy hand over fist at 14x trailing and 12x forward. So earnings must collapse or the cost of capital must skyrocket for us to be in a bubble.

 

there's a risk of either or both occurring, but is it the base case? is that what is most probable?

 

I also don't think we're in a real estate bubble. I'm not saying that everything out there is cheap, safe, and has a giant margin of safety or anything; it's not! 

 

But bubble is a strong word. 

 

and for all the attention that crypto and meme stocks get, I know plenty of people participating, but have yet to really meet anyone who's irresponsibly leveraged / allocated in that stuff. likewise w/ real estate. it doesn't at all feel like 2005/6 in south florida when i was in high school and EVERY one's parents regardless of circumstances were buying/buildingon spec/flipping on spec etc. 

 

No one is entitled to high real returns; we've been financially repressed for 10+ years and valuations may continue to go up as stocks re-price to deliver lower returns going forward. Stocks don't have to be as cheap as we'd all like. Most people and institutions are on autopilot. they have a lower cost of capital than a bunch of wannabe buffett's expecting to buy good companies for 10x. 

 

TINA TINA TINA fo feena fee fo fo meena TINA. 

 

Buy Stocks! They've reached a permanently higher plateau 😏

 

 

 

 

 

 

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Buffett has been saying for over half a decade that if the 10 year is 2%, then stocks are massively undervalued. The 10 year is currently 1.5%. The rest of the world is 0 or negative. I dont know where or when people became entitled to buy stocks at 10-15x earnings or established these outlandish parameters for an investment. I dont mean to pick on anyone(just making an example) but think its a good example of being to pessimistic....but if your baseline is that the 10 year goes to 10-15% in the next few years and the S&P drops 50% and won't touch anything that has less than 30+ year maturity debt....well you're just unnecessarily eliminating the majority of the things you can invest in. If you fight the urge to be sensational and stay grounded in whats rational and likely, chances are you will do a lot better. 

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You think the market is bubbly? Really? ....how do you actually KNOW that? how do you KNOW that you are just not over-reacting?

Then even if you are right (the market IS in a bubble) ... what are you really going to do? Not invest, simply because you are fearful?

 

Point? As in everything, all decisions carry risk - there are no guarantees.

If you aren't comfortable with that, there any number of investment professionals more than happy to help you. 

It will save you a lot of heart-ache, and a great deal of wealth!

 

SD

 

 

 

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he makes some data-backed arguments that we're pretty much in year 2000 territory again

 

I only take these arguments seriously when the presenter adjusts for tax rate and discount rate.    Back in 2000, the corporate federal tax rate was 35% and the 30-year Treasury was at 6%   Therefore $1 of pre-tax corporate earnings would be worth ($1 x (1-35%))/.067 = 9.7x pre-tax EPS.

 

Today, the corporate federal tax rate is 21% (for now) and the 30-year is at 2.2% - so $1 of pre-tax corporate earnings would be worth 35.9x pre-tax EPS.   Even if the corporate rate goes to 28% and the 30-year to 4% - its still 18x pre-tax earnings.  Without any growth in underlying earning power, $1 of pre-tax earnings is worth double what it was in 2000. 

 

I have trouble with folks like Bloomstran who use historical benchmarks without making any necessary adjustments. 

 

wabuffo

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13 hours ago, spartansaver said:

I'm only in my early 30s so I'm hoping to hear from some of the people that were investing amidst the Dotcom Bubble. How different do current times feel from Dotcom? How does it feel the same?  

The answer to the bubble question depends on

1) will interest rates remains low

2) will cooperate to rates remain low

3) will cooperate profit margins remain at current levels or even go higher.

 

If the answer to all those questions remains yes, then we are not in a bubble. If one or more of these factors (which so far have been tailwinds) become a headwind, then valuations are most likely adjust accordingly.

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58 minutes ago, Spekulatius said:

The answer to the bubble question depends on

1) will interest rates remains low

2) will cooperate to rates remain low

3) will cooperate profit margins remain at current levels or even go higher.

 

If the answer to all those questions remains yes, then we are not in a bubble. If one or more of these factors (which so far have been tailwinds) become a headwind, then valuations are most likely adjust accordingly.

 

Even if interest rates were to go up, if you have advantageous financing such as 30 year fixed rate mortgage on your house or some of the Liberty Complex' crazy 30-60 year debt at sub 5% interest rate, those are actually assets in that kind of environment.  This assumes that the operating business or RE assets' ability to generate EBITDA-Cap Ex remains the same or even go up.  If you have to keep rolling 5 year debt, it is a different conversation.  These are strategies that BAM, Blackstone, and everyday American homeowners can participate in.  The housing bubble was very different.   You literally have meatheads going "I bought a house and flip it for $30-50k profit in one week"  Meathead #2 "That doesn't make sense."  Meathead #1 "Dude, that's just the market!"  RE markets, bank lending, systemic risk, blah blah blah.  The RE side is much healthier.  Only the best credit gets approval.  SFH has an affordability issue.  But the existing homeowners are in much better shape.  

 

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One obvious side point is that those of us who remember it were a lot younger then...

 

There are some things e.g. Crypto that remind me of the time i.e. people having crazy paper profits in a very short time.

 

But Crypto is still relatively niche.  Back then there was a whole sector of the stockmarket where day traders could make crypto profits with tech companies, and the feeling that anybody could do it.  Even with the SaaS froth last year, it didn't feel like loads of ordinary people were doing it.

 

And as mentioned, there was the valuation disparity which isn't apparent now.  I was young and got a valuable lesson, buying 2 stocks tipped separately by a Financial newspaper in 1999.  One was a small-cap, racy tech stock.  The other was a very cheap, high-yielding large-cap utility...

 

But as people have said above, nobody really knows in advance - you just can't time these things.  That's what makes it interesting.

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2 hours ago, Gregmal said:

Buffett has been saying for over half a decade that if the 10 year is 2%, then stocks are massively undervalued. The 10 year is currently 1.5%. The rest of the world is 0 or negative.

 

This this this.

 

Stock market valuations hinge on interest rates. Currently the 10yr real yield in the United States is -0.84%. Throw this into a DCF model and it breaks down. If you believe rates can stay here (I tend to believe this) stocks could go much much higher. Baby boomers need to earn a reasonable return to meet their retirement goals; they can't do it in govt bonds or corporate bonds so the forward real earnings yield of +2.5% on stocks seems like a good deal.

 

Major risk to this outlook is on the political side if elected officials rein in the central banks. Low probability scenario in my mind since what politician doesn't like free money?

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40 minutes ago, BG2008 said:

 

Even if interest rates were to go up, if you have advantageous financing such as 30 year fixed rate mortgage on your house or some of the Liberty Complex' crazy 30-60 year debt at sub 5% interest rate, those are actually assets in that kind of environment.  This assumes that the operating business or RE assets' ability to generate EBITDA-Cap Ex remains the same or even go up.  If you have to keep rolling 5 year debt, it is a different conversation.  These are strategies that BAM, Blackstone, and everyday American homeowners can participate in.  The housing bubble was very different.   You literally have meatheads going "I bought a house and flip it for $30-50k profit in one week"  Meathead #2 "That doesn't make sense."  Meathead #1 "Dude, that's just the market!"  RE markets, bank lending, systemic risk, blah blah blah.  The RE side is much healthier.  Only the best credit gets approval.  SFH has an affordability issue.  But the existing homeowners are in much better shape.  

 

SFH affordability isnt an issue if you already own these assets. Canada has already shown us the crystal ball in terms of what lack of affordability/supply means. Its good to have DMV style lines of people waiting to buy your assets. 

 

Its still amazing to me how people gripe about returns or valuations when you can get 5-10% in RE, with your eyes closed. 

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I just finished reading "Devil Take The Hindmost".  It was originally published prior to the 2000 crash and of course the 2008 crash.

 

It is astonishing the parallels between stories from 300 years ago and today.  

 

Even though the past 2 (3?) crashes weren't included in the book, the author very accurately forecast the sentiment around the time of each peak.

 

I think bonds are in a bubble and certain stocks, sectors, and cryptos.  There is not a bubble in everything.

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6 hours ago, wabuffo said:

he makes some data-backed arguments that we're pretty much in year 2000 territory again

 

I only take these arguments seriously when the presenter adjusts for tax rate and discount rate.    Back in 2000, the corporate federal tax rate was 35% and the 30-year Treasury was at 6%   Therefore $1 of pre-tax corporate earnings would be worth ($1 x (1-35%))/.067 = 9.7x pre-tax EPS.

 

Today, the corporate federal tax rate is 21% (for now) and the 30-year is at 2.2% - so $1 of pre-tax corporate earnings would be worth 35.9x pre-tax EPS.   Even if the corporate rate goes to 28% and the 30-year to 4% - its still 18x pre-tax earnings.  Without any growth in underlying earning power, $1 of pre-tax earnings is worth double what it was in 2000. 

 

I have trouble with folks like Bloomstran who use historical benchmarks without making any necessary adjustments. 

 

wabuffo

Thank you for that perspective. 

 

I've only been investing for a few years but if the fed has said interest rates will eventually rise... Isn't that a headwind in itself? A ticking time bomb? 

 

Read a quote saying somewhere. It's not a bubble unless it bursts. 

 

Thanks. 

 

 

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7 hours ago, wabuffo said:

he makes some data-backed arguments that we're pretty much in year 2000 territory again

 

I only take these arguments seriously when the presenter adjusts for tax rate and discount rate.    Back in 2000, the corporate federal tax rate was 35% and the 30-year Treasury was at 6%   Therefore $1 of pre-tax corporate earnings would be worth ($1 x (1-35%))/.067 = 9.7x pre-tax EPS.

 

Today, the corporate federal tax rate is 21% (for now) and the 30-year is at 2.2% - so $1 of pre-tax corporate earnings would be worth 35.9x pre-tax EPS.   Even if the corporate rate goes to 28% and the 30-year to 4% - its still 18x pre-tax earnings.  Without any growth in underlying earning power, $1 of pre-tax earnings is worth double what it was in 2000. 

 

I have trouble with folks like Bloomstran who use historical benchmarks without making any necessary adjustments. 

 

wabuffo

OK, so i like John Deere, Disney and Costco (like in the sense of long duration assets) and wonder what discount rate to use for the ultimate cashflows that will be delivered over time during the ownership period.

 

The 'relation' between interest rates and valuation is kind of obvious, on a first level basis, but are there not potential problems (risks)?

The relation between interest rates and valuations have not been consistent over time and over different geographies (of course framing the question using certain specific time frames can do the trick). See:

Stock-Inflation-and-PE.pdf (crestmontresearch.com)

We know 10-year rates are tied to longer-term inflation rates at the hip and the 10-yr rate to CAPE correlation (for example) has been anything but consistent ie no obvious correlation over very long periods and, in fact, showed a completely non-intuitive strong and positive correlation between 1949-1968 (19 years!; a period during which certain partnerships did really well):

1844357656_capevs10-year.png.0e2258a24ec707a1651806e0c95b8144.png

In the spirit of necessary adjustments, the effective corporate tax rate was essentially the same at beginning and end of period and the US government did not produce fiscal surplus to kill the economy or something during the period (the US decreased public debt from 110% to 30% of GDP then due to productivity gains and real growth).

US_Effective_Corporate_Tax_Rate_1947-2011_v2.jpg.1ad1f821f669a74d5ea8013efbb3a100.jpg

This post is because i read these days (here and elsewhere) that low interest rates justify higher valuations and i wonder. If one follows the reasoning, if interest rates (like the 10-yr rate; scenario not as far-fetched as some may suggest) get divided by 2 or even 3, we could make the Japan stock and real estate market, 1989 edition, appear justified (that's what many people said then contemporaneously). The point is that today's valuations may make sense from a fundamental point of view but it is a stretch to suggest that low interest rates justify today's valuations.

 

Of course, the relevant question is not the rear-view mirror question. Opinion: it's likely that, in the future, the conclusion will be that, low interest rates, by themselves, do not justify valuations. Not everyone agrees and that's fine.

justified.gif.5b3244be5fb3ef73ea7aa0d176efc6be.gif

 

 

 

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2 hours ago, Cigarbutt said:

The 'relation' between interest rates and valuation is kind of obvious, on a first level basis, but are there not potential problems (risks)?

The relation between interest rates and valuations have not been consistent over time and over different geographies

 

Hussman concludes that low interest rates do not explain high valuations:

 

Market valuations versus interest rates: 1928-2021

Notice something. When interest rates have been extremely high (above 10% or so), valuations have been reliably low. But at rates below 10%, there is no reliable relationship between interest rates and valuations.

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1 minute ago, IceCreamMan said:

 

Hussman concludes that low interest rates do not explain high valuations:

 

Market valuations versus interest rates: 1928-2021

Notice something. When interest rates have been extremely high (above 10% or so), valuations have been reliably low. But at rates below 10%, there is no reliable relationship between interest rates and valuations.

 

Although his conclusion may be statistically correct, it looks from the chart like valuations tend to be highest when long-term rates are in the 3-6% sweet spot.

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15 hours ago, IceCreamMan said:

 

Although his conclusion may be statistically correct, it looks from the chart like valuations tend to be highest when long-term rates are in the 3-6% sweet spot.

 

Multiples are highest when inflation is between 2-4%. That may correspond well with rates being 3-6%, but it's inflation/real rates that matter and not the absolute level of nominal rates. 

 

I echo the same concerns with the interest arguments as Cigarbutt and IceCreamMan - Japan and Europe have had lower interest rates than the US (and lower inflation), but the adjusted enterprise values and multiples aren't significantly higher or relative to their own histories. Also, a low discount rate implies low growth and it is primarily earnings growth that justifies a premium multiple so low rates/low growth CAN'T justify a premium multiple. 

 

The U.S. has delivered on earnings growth in an environment of low growth/low inflation due to innovation in the internet/technology/social media space while the others haven't. This is why our multiples are elevated relative to history and to other countries. The tax cuts pushed that even further and persistently low inflation has allowed the persistently high multiples to continue to exist.

 

But as soon as earnings growth disappoints OR inflation falls out of the 2-4% range the drop will be quick. Just like it was in December 2018 and again in March 2020. A 30% correction is simply moving from above average to average with 0 consideration given to any incremental impact of higher discount rates or downward earnings pressure. The market will turn on a dime once these "inputs" have changed which is why I'm reluctant to jump on the "multiples are justified" train. They are until they aren't and the correction will be swift.

 

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TwoCities, given your view, what sort of net exposure do you run? what's your asset allocation? what hedges do you have in place? how might that differ if stocks went down 30% w/ some multiple contraction?

 

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