Below is a weekly update from our Chief Investment Officer, Dr. Scott Lummer. He co-hosts an audio segment entitled “Market Matters.” In this week's show, Scott explains his belief that the current stock market is not a bubble. He points out that many of the writers claiming that the market is a bubble have a history of always being bearish about stocks. He also shows how they inappropriately cite the research of Nobel laureate Robert Shiller. However, Scott also describes why he thinks Professor Shiller’s model has led to very poor investing decisions. Each week he covers a different piece of investment news focusing on recent events in the capital markets, and relates them to Savant Investment Group’s perspective on investing.
Daphne: Welcome to Market Matters, a weekly discussion about investing in today’s capital markets. I’m Daphne Feng and, as always, I’m joined by the Chief Investment Officer of Savant Investment Group, Dr. Scott Lummer. Scott, last week we talked about bubbles, and we ran out of time before I could ask you – do you believe the current stock market is a bubble?
Scott: No I don’t think it’s even close to a bubble. There are many factors that support the current price of stocks.
Daphne: Aren’t many experts, including Nobel laureate Robert Shiller, saying the current stock market is a bubble?
Scott: Let me parse your question into two parts. Yes there are analysts who are calling the current stock market a bubble, and many of them are citing Professor Shiller as being in agreement. But, many of those analysts are what our colleague Joe Sims describes as perma-bears. They always say the market is overvalued, and empirically, their wrong more than 90% of the time, but, just like sports prognosticators and political analysts, they have no accountability for their predictions.
Daphne: But many of them were right in 2008.
Scott: Yeah, and a stopped clock is correct twice a day. Most of them were also saying the market was still overvalued in February of 2009 – if you had bought the average stock then, you would have tripled your money over the next 5 ½ years. Even if you bought at the high of the market in September of 2008, you still would have earned a return of 10% per year since then.
Daphne: OK, so they were wrong in 2009, but now they have a Nobel Prize winner on their side.
Scott: That’s only true if you read what analysts are claiming that Professor Shiller said instead of reading what he actually wrote. If you read his article in the New York Times written two weeks ago, he never says that stocks are a bubble. He says, based on his model, stocks have been highly priced for almost all of the last 20 years. So if it’s a bubble, it’s a long-lasting bubble, which is an oxymoron. Bubbles by their nature are relatively short-lived.
Daphne: So stocks aren’t a bubble. But if they are overpriced, doesn’t that mean the same thing?
Scott: An academic has the luxury of saying, “my model says stocks have been overpriced for the past 20 years.” But we have to look at the market from an investor’s perspective. Let’s look at three investors twenty years ago, in September of 1994, each of whom had $1 million. Investor one listened to Professor Shiller and invested money in Treasury Bills. Investor two also believed stocks were overvalued and invested in a broad bond portfolio. Investor three was naïve to the good professor’s work and invested in stocks. Twenty years later, the first investor’s $1 million has grown to $1,793,000. Investor 2 is now worth $3, 303,000. But investor 3 is worth $6,471,000, or over $3 million more than investor 2. Given Professor Shiller’s cash award for the Nobel was approximately $350,000, from a pure financial perspective, investor 3 did much better not knowing that stocks were “consistently overpriced” than Professor Shiller did.
Daphne: So are you saying his model is wrong?
Scott: In economics, any model that consistently gives poor predictions over a 20 year period would have to be judged as flawed. His point is that stock prices, relative to earnings, have been higher over the past 20 years than in the past. Well on average, comparing the past 20 years to the 20 years before that, interest rates are lower, corporate efficiency (measured by profit margin) is higher, and investors are more knowledgeable. All of those factors might suggest a higher valuation for stocks in the 1990s, 2000s and 2010s than, for example, the 1970s. Paradigms change, so which is more likely: That investors have consistently overpriced stocks over the past 20 years, or a model using data primarily during a period when TVs were black and white or were non-existent might not be relevant today? I choose the latter.
Daphne: So that’s Market Matters for this week. Thanks to all of you for listening. Please join us next week when Scott and I will talk about market neutral investments.