How ultra-low interest rates support higher stock market valuations but also make the investment environment more challenging. Is there a stock market bubble?
Topics covered include:
- How expensive are stocks on an absolute basis and relative to bonds
- What are examples of individual investor enthusiasm for stocks
- Why stock valuations and prices increase when interest rates fall
- Why lower interest rates making it more difficult for central banks to support stocks during a downturn
- Why TIPs might be a better choice for a long-term bond allocation
- Why deglobalization is a reason to increase the geographic diversification of stock portfolios
- How investors can make invest decisions without having an informational edge
Show Notes
Day Traders Are Taking Over Korea’s Stock Market by Heejin Kim—Bloomberg
‘Fomo feeling’ propels Indian investors into stock market by Benjamin Parkin—Financial Times
Risky asset valuations and the fallout from coronavirus by Oliver Jones—Capital Economics
Adaptive Markets: Financial Evolution at the Speed of Thought by Andrew W. Lo
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Transcript
Welcome to Money For the Rest of Us. This is a personal finance show on money, how it works, how to invest it, and how to live without worrying about it. I’m your host, David Stein. Today’s episode, 315, is titled “Are we being forced to buy stocks?”
U.S. Stock Valuations
Last week in the Insider’s Guide email newsletter I pointed out the expensive valuation of U.S. stocks. Specifically, I showed that the forward price-to-earnings ratio (P/E) based on earnings estimates over the next year was 22.9. That’s three standard deviations above its average of 16 times, going back to 2003. That’s data from Ned Davis Research. In reply to that email, Andrew wrote:
“Regarding stocks being expensive on a forward P/E, true. But there’s no alternative. What do you do with bond yields near zero, and the Vanguard Total Stock Market Index Fund yielding 2%? Buy VTI, the Vanguard Total Stock Market ETF.”
He also forwarded to me a paper by Bridgewater Associates, which I’ll discuss in more detail later in this episode.
Is There a Bubble?
I had a similar question from a Plus member in the Money For the Rest of Us Plus forums. He wrote:
“So the Fed signals that it wants to keep rates lower for three more years. Canada’s pension fund is reevaluating bond holdings, and you’ve got an army of small and large investors bidding up companies like Tesla and Snowflake to absurdly high P/E’s. All this combines to make me think “Are we as individual investors now forced to buy equities? Is this the mother of all bubbles, in which there’s literally no other thing suitable for purchase?”
There is a lot of speculation in stocks right now. Jim Bianco of Bianco Research pointed out that small traders are dominating the options market. They are most of the trades right now, and 75% of that volume is in options contracts that expire in two weeks, so short-term bets.
We can look at South Korea—an article from Bloomberg pointed out that day traders in South Korea have accounted for 87.5% of the total value of stocks traded in the first part of September. You Seung-Min at Samsung Securities said retail investors appear to be seeking short-term profits after hearing their next-door neighbors earned lots of money from stocks after the March sell-off.
We’re seeing a similar situation in India. The Financial Times reports that the number of individual investor accounts rose 20% from the start of the year to 24 million. They point out that around the world an influx of investors is investing in stocks for the first time. Are we in a bubble? Is it a speculative frenzy? Are we forced to buy these stocks because there are no alternatives with bond yields so low?
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