The Everything Bubble

[Blake Hampton]

I am curious as to your thoughts surrounding the subject of an everything bubble. It seems everywhere I look, equities, fixed-income, real estate, the prices seem absolutely disconnected from reality.

[Milu]

Ya things look a bit pricey at the moment, but I'd argue that the majority of time things are like this. For disciplined buyers there are always a few periods where prices get more realistic. (March/April 2020 during Covid crash, and at points during 2022 when the market came down by 20-25%). The key is to take advantage during these times, and then to just sit on your hands in times like today. Even today though there are some individual stocks that are coming back to reality, Lululemon and Starbucks to name a couple. Not saying they are cheap, but the prices (of these two stocks) are a lot fairer than they have been in the last 5 years or so.

Edited May 30 by Milu

[Sweet]

Things are not cheap, in some cases downright expensive, and I am having trouble finding anything I want to buy, but I don't see a bubble.  That's not to say things cannot come dramatically lower sharply, because they might, but nobody can know. 

 

 

[Intelligent_Investor]

Its because interest rates are low relative to historical rates, everything is priced vs risk free rate hence if bonds are overvalued everything gets expensive. As Warren said in 2018 if you think interest rates will remain low in the future, the S&P is dirt cheap.

[Milu]

7 minutes ago, Intelligent_Investor said:

Its because interest rates are low relative to historical rates, everything is priced vs risk free rate hence if bonds are overvalued everything gets expensive. As Warren said in 2018 if you think interest rates will remain low in the future, the S&P is dirt cheap.

Could you please define which interest rates are low relative to historical rates?

 

T-bills are 5.25%, the 10-year is 4.57% and the 30-year is 4.7%

 

Buffet's statement was accurate in 2018 when rates were quite a bit lower, not sure he's make the same argument today.

[Intelligent_Investor]

Its low relative to the long run average rate of the 10 year. IIRC the 10 year has historically averaged around 6% so it makes sense the market will be above the historical valuation of the S&P 500.

[vinod1]

9 hours ago, blakehampton said:

I am curious as to your thoughts surrounding the subject of an everything bubble. It seems everywhere I look, equities, fixed-income, real estate, the prices seem absolutely disconnected from reality.

 

Show me a person who calls the current environment "Everything Bubble", I can show you a person who has underperformed the stock market. 

 

Every.Single.One.Of.Them. Zero exceptions.

 

Vinod

[Gregmal]

Perhaps not everything is “expensive” but rather people need to adjust their view of what qualifies as “expensive”. I’ve been hearing “mother of all bubbles” talk since literally 2010. During which period I’ve made a fortune owning assets and those same people are still largely singing the same tunes about bubbles and expensive and how everyone needs to own gold. 
 

If you walk into a store and conclude that “everything is expensive” you need to base it on the fact that you can go down the street and get the same items significantly cheaper. If you can’t find a store anywhere around you that’s cheaper, then no, the store is not expensive, you just don’t know what the market is. Saying it’s expensive because in the past it was cheaper is just dumb. 

[coffeecaninvestor]

I think there are pockets of the market that always look expensive, but I wouldn't say everything is expensive. You can always find out of favor sectors like healthcare, Aerospace and Defense, Small Caps, financials, etc.. or wait for some kind of company specific event to happen. 

 

Personally I think if someone is trying to buy high quality companies based on easily quantifiable metrics like ROIC those stocks are undoubtedly trading at a rich multiple. They become cult-like because everyone wants to own a compounder, and that is very easy to screen for. Hopefully one day they fall out of favor, but I think it would take a multi-year draw down to cause that.. Covid was pretty short, and everyone flocked to quality. 

 

 

 

 

 

 

 

[mattee2264]

High valuations are rational in a low interest rate environment. They are also rational if the market is correctly anticipating rapid earnings growth. 

 

I suspect a combination of both factors are at play today. 

 

Everyone is expecting that the Fed will pivot in a meaningful way and interest rates will fall 200-300bps over the next few years. And if interest rates are 2-3% then a market PE of 25-30 doesn't seem unreasonable. 

 

And it is reasonable to pay a high price for current earnings if you think they will be a lot higher in the near future. And it isn't hard for tech optimists to contemplate a market with a very high tech concentration can do so, especially if the benefits of AI filter down to the rest of the index resulting in productivity improvements and much higher future earnings.

 

Of course with the benefit of hindsight the market could end up being overvalued if we are in a higher for longer interest rate environment or if the expected benefits of AI do not pan out and big tech companies hit maturity and their earnings growth slows meaningfully. 

 

And it is also worth remembering that the market takes some time to realize things have changed.

 

It took many years for the market to reward the likes of Microsoft, Meta, Google, Apple with premium valuations. And similarly it took markets a while to realize that ZIRP wouldn't be quickly reversed and to start pricing in the Fed put. So high valuations may persist for a while even if they may at some point no longer be justified. Of course it could be quicker if something does happen to shake the market's confidence. For example a meaningful 2nd wave of inflation which results in the Fed hiking rates and taking a much more aggressive stance which makes market's question whether the Fed pivot still exists. Or some kind of trigger event that undermines tech optimism or alternatively a wave of earnings disappointments. Or a recession which destroys historically high margins and tests faith in the idea that tech companies are immune to the cycle because their secular growth tailwinds are so strong. 

 

Then again it could be that the AI growth miracle is everything everyone hopes it will be and will deliver faster growth, lower inflation, lower interest rates, explosive growth for tech companies as far as the eye can see that trickles down to the rest of the market. And that will probably get things bubbling up. But markets will be way higher before anything bursts. 

 

 

[brobro777]

I know that I probably have a doom and gloom bias due to experiencing the Dot Com bust and Subprime Mortgage crash in my younger years so I've countered myself and stayed long 

 

Some stuff did work out though, like TSLA

[frommi]

22 minutes ago, brobro777 said:

I know that I probably have a doom and gloom bias due to experiencing the Dot Com bust and Subprime Mortgage crash in my younger years so I've countered myself and stayed long 

 

Some stuff did work out though, like TSLA

LOL. If you dont find cheap stuff at the moment you are not working hard enough.

Edited May 30 by frommi

[Gregmal]

Biggest problem younger investors have is they study the typical books everyone reads and then try to find ways to fit current investments into those boxes. A dynamic market will often rhyme but rarely repeat and trends they wrote the books based on are often no longer relevant. That’s why all those high FCF yield companies tend to be value traps with declining revenues and huge debts but the value boys still love em.

[brobro777]

15 minutes ago, frommi said:

LOL. If you dont find cheap stuff at the moment you are not working hard enough.

 

Oh I agree with you, I'm lazy as hell and I just wanna copy other people's good ideas

 

 

[Libs]

29 minutes ago, Gregmal said:

Biggest problem younger investors have is they study the typical books everyone reads and then try to find ways to fit current investments into those boxes. A dynamic market will often rhyme but rarely repeat and trends they wrote the books based on are often no longer relevant. That’s why all those high FCF yield companies tend to be value traps with declining revenues and huge debts but the value boys still love em.

COWZ has pretty good results though. 3- yr 11%, 5 - year 15%. 

[fareastwarriors]

3 hours ago, Libs said:

COWZ has pretty good results though. 3- yr 11%, 5 - year 15%. 

 

Thought this was a joke... but wow we got ETFs for everything nowadays. 

[james22]

4 hours ago, Gregmal said:

Biggest problem younger investors have is they study the typical books everyone reads and then try to find ways to fit current investments into those boxes. A dynamic market will often rhyme but rarely repeat and trends they wrote the books based on are often no longer relevant.

 

Think of all the kids at DFA/Buckingham piling into SV and EM the last 15 years.

 

Whoops.

[Blake Hampton]

I would like to do some math so that I can make my thought process seem a bit clearer. 

 

Equities and fixed income:

Short-term interest rates are currently sitting at about 5.25%, which is also the yield that you can get from owning a treasury bill right now. If you look back at past data, the average spread between short-term and long-term rates (20-year bond yields), you find an average spread of approximately 1.5-2%. So through this whole QE mess, I'm using a "real" long-term rate of about 7%. This alone implies to me that the market for fixed income seems quite off. But what about the discount rate for stocks? I do know that a 7% yield is a good long-running average for long-term governments. I also know that stocks have been known to yield about 10% over time. Discount rates seem to me a bit wishy-washy but I think discounting earnings at 10% during a time of 7% long-term rates makes sense. Now think about current stock valuations when discounting at 10%. Also what about the fact that corporate taxes are currently sitting at 21% during a time of huge fiscal deficits? To me, it seems like many companies are selling at huge multiples of earnings that have additionally benefited from a meager tax rate.

 

Real estate:

The median home sales price is currently at about 5.64x the median household income. This seems unsustainable. Assuming the median household income is $75,000, I believe the median sales price for a home shouldn’t be anything north of 300-325 thousand, it is currently 420.

 

 

Sources:

Median Sales Price of Houses Sold for the United States

Median Household Income in the United States

United States Federal Corporate Tax Rate

Edited May 31 by blakehampton

[Blake Hampton]

15 hours ago, vinod1 said:

 

Show me a person who calls the current environment "Everything Bubble", I can show you a person who has underperformed the stock market. 

 

Every.Single.One.Of.Them. Zero exceptions.

 

Vinod

 

This is from Seth Klarman in June of 2023. The market has appreciated approximately 20% since this interview was aired.

 

Legendary investor Seth Klarman on investing challenges: We've been in an 'everything bubble'

 

Edited May 31 by blakehampton

[mattee2264]

 Maths can be seductive because there are lots of assumptions you are making which can be questioned.

 

Equities and fixed income:

 

Bond yields have been manipulated for a long time. And with a lot of debt in the system financial repression is the least painful way out and with it some kind of yield curve control. 

Also you are implicitly assuming that short term interest rates are staying at 5.25%. The market doesn't believe they will and that is why they are using a lower discount rate. If the market is correct and we are at peak interest rates then it would be a mistake to base your valuation math off of this.

And if you are using a discount rate of 10% you are assuming a risk free rate of about 5% and an equity risk premium of a similar amount. I've already discussed the risk free rate. But there are reasons why investors might be prepared to accept a lower equity risk premium e.g. prevalence of passive investing which through diversification eliminates stock specific risks, continued confidence in the Fed put and the ability and willingness of central banks and government to actively manage the economy, and the belief that the future growth of stocks rather than an earnings yield greater than the bond yield is enough to compensate for the greater risk of equities. 

I agree with you that earnings and margins have had a boost from low interest rates (still largely locked in due to 2020-2021 refinancings) and lower taxes so that is certainly a headwind for stocks but there are plenty of tailwinds as well such as AI and other technological breakthroughs, the beneficial impact of moderate but low inflation on nominal earnings growth, benefits of US immigration etc. 

 

Real estate

 

Again depends on whether you think interest rates will stay at current levels. This is especially true because in the short term when houses are unaffordable people don't buy and people don't sell I am also a little suspicious of long term historical earnings multiples because most families these days are dual income and a lot of people have side gigs. And it could just be that in the past housing was cheap because it was more plentiful. Now in many areas it is in quite short supply which helps to explain high prices. 

 

38 minutes ago, blakehampton said:

I would like to do some math so that I can make my thought process seem a bit clearer. 

 

Equities and fixed income:

Short-term interest rates are currently sitting at about 5.25%, which is also the yield that you can get from owning a treasury bill right now. If you look back at past data, the average spread between short-term and long-term rates (20-year bond yields), you find an average spread of approximately 1.5-2%. So through this whole QE mess, I'm using a "real" long-term rate of about 7%. This alone implies to me that the market for fixed income seems quite off. But what about the discount rate for stocks? I do know that a 7% yield is a good long-running average for long-term governments. I also know that stocks have been known to yield about 10% over time. Discount rates seem to me a bit wishy-washy but I think discounting earnings at 10% during a time of 7% long-term rates makes sense. Now think about current stock valuations when discounting at 10%. Also what about the fact that corporate taxes are currently sitting at 21% during a time of huge fiscal deficits? To me, it seems like many companies are selling at huge multiples of earnings that have additionally benefited from a meager tax rate.

 

Real estate:

The median home sales price is currently at about 5.64x the median household income. This seems unsustainable. Assuming the median household income is $75,000, I believe the median sales price for a home shouldn’t be anything north of 300-325 thousand, it is currently 420.

 

 

Sources:

Median Sales Price of Houses Sold for the United States

Median Household Income in the United States

United States Federal Corporate Tax Rate

 

[Sweet]

5 hours ago, blakehampton said:

 

This is from Seth Klarman in June of 2023. The market has appreciated approximately 20% since this interview was aired.

 

Legendary investor Seth Klarman on investing challenges: We've been in an 'everything bubble'

 

 

I'm pretty sure that Seth Klarman's record has sucked ass since around 2010.  That's 15 years nearly and he is one of those people vinod is talking about.

[Sweet]

5 hours ago, blakehampton said:

I would like to do some math so that I can make my thought process seem a bit clearer. 

 

Equities and fixed income:

Short-term interest rates are currently sitting at about 5.25%, which is also the yield that you can get from owning a treasury bill right now. If you look back at past data, the average spread between short-term and long-term rates (20-year bond yields), you find an average spread of approximately 1.5-2%. So through this whole QE mess, I'm using a "real" long-term rate of about 7%. This alone implies to me that the market for fixed income seems quite off. But what about the discount rate for stocks? I do know that a 7% yield is a good long-running average for long-term governments. I also know that stocks have been known to yield about 10% over time. Discount rates seem to me a bit wishy-washy but I think discounting earnings at 10% during a time of 7% long-term rates makes sense. Now think about current stock valuations when discounting at 10%. Also what about the fact that corporate taxes are currently sitting at 21% during a time of huge fiscal deficits? To me, it seems like many companies are selling at huge multiples of earnings that have additionally benefited from a meager tax rate.

 

Real estate:

The median home sales price is currently at about 5.64x the median household income. This seems unsustainable. Assuming the median household income is $75,000, I believe the median sales price for a home shouldn’t be anything north of 300-325 thousand, it is currently 420.

 

 

Sources:

Median Sales Price of Houses Sold for the United States

Median Household Income in the United States

United States Federal Corporate Tax Rate

 

 

Good luck trying to make sense of stocks using a 10% discount rate.  Valuation is largely subjective, and I think it is fairly clear that very very few people are using a 10% discount rate, and haven't been for many years.

 

My own mantra, posted in another thread, is that if you feel the urge to crank numbers into a DCF to check if it is a good investment, its almost certainly not a good investment.  Buffett talks discounted cash flows, Munger said he has never seen him using DCF model even once. 

 

I do believe though there is no sense investing in a company at PE 25 with little to no growth, when you could just buy a treasury yielding 5%.  I do expect valuations to rerate over time especially if GDP growth slows, but I would be surprised at a large crash.

 

 

Edited May 31 by Sweet

[frommi]

While i believe there are still cheap stocks available, i would not be surprised by a large crash this year. In fact all facts that i see point to at least a 70-80% chance of a 15-20% drawdown. Not because stock market valuations are very high by historical standards, but because the economy is slowly bending over. I looked at the past 50 years, and 1 year after the yield curve inverts and the unemployment rate creeps up (vs. the 3 month average) in 80% of all cases the stock market tanked at least 15% over the summer. Maybe history is not a good guide here, but i see no reason why it should be different this time. You see it already in the numbers of retailers like TGT, SBUX or MCD that the consumer is stretched to the hill.

So be prepared

Edited May 31 by frommi

[Luke]

Lots of inflows into the US and MAG 7+ because they are perceived as ultra safe and "only go up" (based on last 20 years)...the SP 500 is priced at 27x earnings, the last 10 years these 500 companies grew their sales at 4.1% all together and they pay out 1.3% annually at current valuations. Shares outstanding for all SP 500 companies went 0.7% lower per year over the last 10 years. If you have margins stable you will make-> 4.1% sales growth+1.3% divid. yield+0.7% buybacks= 6,1% annualized the next 10 years. 

 

10 year treasury is at 4.5% with 0 risk. 

 

Lots of value in smallcaps, europe/emerging markets/asia. 

[pricingpower]

1 hour ago, Luca said:

If you have margins stable you will make-> 4.1% sales growth+1.3% divid. yield+0.7% buybacks= 6,1% annualized the next 10 years. 

 

10 year treasury is at 4.5% with 0 risk. 

You have to consider tax impact to make a fair comparison, for a high income person that "0 risk" treasury is actually locking yourself into a loss when you consider your marginal post-tax real return in a 3% inflation world

 

treasuries at 4.5% * (100% - 37% ordinary income federal tax - 3.8% investment surtax) = +2.66% gross return - 3% inflation = a -0.34% annual loss in purchasing power

 

your 6.1% steady state return from stocks benefits from a lower cap gains / qualified dividends tax rate (and a real life huge advantage of mostly being tax deferred) and gets hit less hard if inflation goes higher in the future (either taxes/inflation/government spending presumably have to rebalance eventually)

 

stocks at 6.1% * (100% - 20% - 3.8%) = +4.65% gross return - 3% inflation = +1.65% real return expected