While best known for its Consumer Sentiment Survey, the University of Michigan conducts a host of other subordinate surveys. The chart below shows the response of households to a specific question. “Suppose that tomorrow someone was to invest $1000 in a type of mutual fund known as a diversified fund. What do you think is the percent chance that this $1000 investment will increase in value in the year ahead?”
- S&P 500 (white, log scale)
- Percent of Households That Think the Market Will Be Higher a Year from Now (red)
The white line above is the S&P 500 index in logarithmic scale, excluding dividends. The survey in red tells us that 64.1% of people answered the question in the preceding paragraph affirmatively. It seems clear that confidence in the stock markets seems clearly tied with its recent performance.
Unfortunately, a majority of respondents to the survey look to the rear view mirror for determining where the market might head in the future.
The Other Side of the Coin
The standouts among institutional investors, however, take a different opinion. They do not focus on ephemeral signals from the market, but on the substantive factors from which the market derives its value. The phrase “price is what you pay, value is what you get” is no cliché for that crowd. The relationship between price and value weighs enormously on the decision to buy or sell. Compared to the amateur investor, the best professionals are generally “inversely emotional.” The higher prices go, the worse they feel. On the flip side, their appetite becomes borderline avaricious when panic grips the markets.
Howard Marks of Oaktree Capital, calls them as he sees them: “In the vast majority of asset classes, prospective returns are just about the lowest they’ve ever been. The Shiller’s Cyclically Adjusted P/E Ratio stands at almost 30 versus a historic median of 16. This multiple was exceeded only in 1929 and 2000—both clearly bubbles.”
Seth Klarman, whose risk-adjusted performance, in my judgment, ranks in the rarefied top 1% of the top 1%, writes that “those who know their companies the best, believe valuations have become full or excessive.” Klarman’s firm, Baupost Capital, currently has 40% of the portfolio’s assets in cash and is considering returning capital to shareholders at year-end because real bargains are scarce, reasoning similar to that which led to earlier returns in 2013 and 2010.
Jeff Ubbin, ValueAct Capital, has always been the picture of rationality. “These valuations can only be justified by assuming cyclically high corporate profit margins will persist, a certainty of lower corporate tax rates and a risk-free rate that stays near all-time lows. We are skeptical of all of the above.”
Paul Tudor Jones, a storied hedge fund manager with a macro bias, argues, “the value of the stock market rally to the size of the economy should be terrifying to a central banker.”
Legendary Bill Gross: “Financial markets are telling you there is not much reward. The return is going to be much lower and the risk much higher. You are buying high and crossing your fingers.”
Ray Dalio, whose worldview is perhaps as expansive but somewhat darker than Seth Klarman’s, writes “It seems to me that we are now economically and socially divided and burned in ways that are broadly analogous to 1937. During such times, conflicts (both internal and external) increase, populism emerges, and democracies are threatened, and wars can occur.”
Heads of Tail…Or does it matter?
Despite the sentiments of these luminaries, professional and occasional investors are actually two sides of the same coin. With notable exceptions—the likes of Seth Klarman—most investors, both the unsophisticated and the, allegedly, sophisticated, have one thing in common: They have most of their capital committed to equities in a market that the best experts describe as both expensive and risky. The amateurs do so out of irrational confidence; most professionals due to the mandates of the job.
I do not want to flip the coin, preferring portfolio optionality at the expense of equities. Eric Cinnamond has gone to the ultimate extreme, returning capital and exiting investment management entirely. His recent post on fiduciary responsibility raises essential questions for the profession. He finished a thought that I expressed in my own post the week before—the sentiments managers express are not always reflected in their portfolios.
No one knows how this bull market will end, but the particulars are irrelevant. At current valuations, one should expect low, if not negative, returns punctuated by unnerving volatility. Whether that takes a toll on your portfolio if wholly dependent on whether you choose to flip the coin and remain in equities, or wait out the cycle and look for value to reappear.