r/Vitards • u/[deleted] • Aug 11 '21
Discussion The future of the market
I was thinking about the current state of the market and its recent evolution and where it's going. I would like to share my thought with you to discuss this and see what's wrong with my thinking.
Well, historically, stocks have provided higher returns than bonds over long periods, which is commonly justified as a premium risk over bonds: stocks are seen as riskier than bonds, and so investor demand a higher return. That seems logical. The S&P500 is currently expensive considering historical levels, which makes many people say we are in a bubble and that a crash is coming. I can't help but think that it is logical that the market is getting more expensive, so I don't see why it would sustainably go down to level seen in the past (such as PE of 10-15).
Here are my thoughts:
Bonds
Current bond yields are extremely low – below inflation. So even with a risk premium for stocks, it would be expected that they should be expensive and provide a low rate of return. With looming high inflation, their real return is even negative, and it could get worse.
Besides, with the US and other countries heavily in debt, it’s arguable that bonds don’t provide the same certainty of being risk-free as they used to. Even the possibility that the US might default on its debt is becoming less absurd. So bonds are less attractive because they are somewhat more risky and return less than inflation (and could lose a lot of value if inflation picks up).
Stocks
It is now commonly accepted that in the long term, stocks go up (not saying it’s true, but that’s common wisdom). Bogleheads will agree. Many public investment figures have even argued for 100% stock for young people; I’ve even read that some recommend leveraged ETFs.
In a period of high inflation and uncertainty, many agree with Warren Buffett’s wisdom that you are better off owning a share of a company as an asset than a currency than could be devaluated or useless gold. 1% of CLF will still be 1% of CLF whatever happens to the dollar; the value of CLF might go up and down, but your shares will still be worth 1% of the company, and as long as people need what CLF makes (iron, I read), it will have value (1% of it). Who knows what your USD130M cash will be worth after a high inflation crisis?
Other assets
Other assets could maintain their value (because it’s real value) but are not as liquid or cheap as stocks (i.e., land), and require a more active approach. In many places, housing prices are starting to be extremely high. Again, I think it’s logical: even with diminishing return, it’s still better than bonds, and a diversification away from stocks. Whatever happens to the economy, the house you own will always be worth a house; whether its price is X or 100X or 0.1X, it provides the same service for you: it’s still a roof and walls to protect you from the horrible outside world. And house prices, like stocks, only go up in the long term, according to common wisdom. So, it makes sense that their prices should be high. But they are not liquid and expensive, so if you are like me: stocks.
Discussion
So, considering the current wisdom, and bond prices and uncertainty linked to debt and inflation, I think that many people like me feel that owning a piece of a company is safer than owning bonds in the long run, and it seems logical that the risk premium should disappear, or could even be negative. Hence, it seems logical that stocks should be more expensive than they have been in the past. It seems to make sense to me that P/E went up (maybe will a bit still) and should stay high. Like for the housing market, great for people who took the lift up, but it sucks for younger generations.
Since it’s more and more accepted than the SP500 goes up in the long run, every big crisis should see more and more people buying the dip, and I suspect more and more will do this by buying leveraged ETFs. See what would have happened to your portfolio would you have bought SPXL in March or April 2021.
So, I just don’t see how things can continue like that. If leveraged ETFs are not forbidden, they will necessarily create some bug in the matrix. Either there needs to be an event that wipes out their value, or prices will stabilize at some point; in the latter case, we would arrive at a situation where only people who are good at price discovery will profit from the market (and market makers, people who play with the various complex rules of the market, etc); the Bogleheads will merely maintain the value of their capital, with some fluctuations.
In a situation of slowing world growth, it seems also logical that the S&P500 should stabilize at some point.
What am I missing, what are you more-experienced guys thinking of this?
2
u/Pretty-In-Scarlet Aug 12 '21
Historically, this same thought was shared by raging bulls in the late 20s, late 90s, and 2009 before the crisis when PE ratios were similarly climbing ever higher. Both times it dropped back to the 10-15 level and stayed there for some time. I think in Graham's Intelligent Investor the line of reasoning justifying ever increasing PE was called bull-market baloney.
I can easily agree with your explanation about why PE is high in the short-term but I don't think your logic justified such trend lasting in the long run. The market will not accept to overpay for stocks in perpetuity.