'..My motive is to be of service to others, particularly over the complete market cycle. Most of what I’ve made in my lifetime has gone to philanthropic efforts, and the rest is invested in our value-conscious, historically-informed, full-cycle discipline. I’ll continue to follow our discipline on behalf of those who trust my work, whether others agree or not..
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One of the challenges with securities, banks, and other objects of finance is that while they actually rest on a very long-term stream of future expected cash flows, investors focus mainly on returns, rather than the quality of those underlying factors. That feature allows enormous departures between what investors think is true and the underlying reality that will unfold over time. Those departures can exist and deteriorate for years before they inevitably become common knowledge. It’s exactly the feature that Ponzi schemes rely on, whether those schemes are sold by crooks or central bankers (and it’s sometimes hard to know the difference).''It’s such a comforting, even satisfying assumption; the idea that “lower interest rates justify higher valuations.” The idea is one of the most basic principles of finance. Indeed, investors could consider it a law of investing. Except for the fact that it’s an incomplete sentence. Unfortunately, the convenience of investing-by-slogan, rather than carefully thinking about finance and examining evidence, is currently leading investors into what is likely to be one of the worst disasters in the history of the U.S. stock market.
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Meanwhile, I’ve got no personal conflict with people who choose to be bullish here. My motive is to be of service to others, particularly over the complete market cycle. Most of what I’ve made in my lifetime has gone to philanthropic efforts, and the rest is invested in our value-conscious, historically-informed, full-cycle discipline. I’ll continue to follow our discipline on behalf of those who trust my work, whether others agree or not; adapting it where the evidence requires, and maintaining patience where patience is what’s needed most. Despite speculation that has gone beyond every historical precedent in the recent half-cycle, I know that my open concerns about valuations in prior bubbles, as well as the constructive outlooks I’ve adopted after previous bear market declines, have ultimately proved to be of service to others by the time the market cycle has been completed.
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Based on the consensus of the most historically-reliable market valuation measures we identify, the U.S. equity market is now at the most offensive level of overvaluation in history, exceeding even the levels observed in 1929 and 2000..
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..What’s notable here is that unlike the 2000 peak, when overvaluation was concentrated in the top two deciles of stocks (primarily representing large-cap tech stocks at the time), the current valuation extreme is uniform across every decile. Based on the historical relationship between the valuations of various deciles and their subsequent losses over the completion of prior market cycles, I expect nearly every decile of stocks to experience losses in the 50-70% range as this cycle completes, much like the losses that I projected at the 2000 and 2007 peaks (recall that the tech-heavy Nasdaq 100 lost -83% in the 2000-2002 rout), but with the losses extending to a much broader set of stocks in this instance.
To offer a longer historical perspective, and further insight into the difference between the 2000 peak and the present extreme, the chart below overlays the median price/revenue ratio along with the margin-adjusted CAPE. Notice that the extreme valuation of the S&P 500 Index in 2000 was not associated with anything close to the broad overvaluation among S&P 500 components that we currently observe. Indeed, at the 2000 peak, nearly half of all U.S. stocks were at valuations that we viewed as reasonable. This is certainly not the case at present.
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One of the challenges with securities, banks, and other objects of finance is that while they actually rest on a very long-term stream of future expected cash flows, investors focus mainly on returns, rather than the quality of those underlying factors. That feature allows enormous departures between what investors think is true and the underlying reality that will unfold over time. Those departures can exist and deteriorate for years before they inevitably become common knowledge. It’s exactly the feature that Ponzi schemes rely on, whether those schemes are sold by crooks or central bankers (and it’s sometimes hard to know the difference).
For a while, Bernie Madoff’s investors felt great about their impressive “returns.” For a while, investors in dot-com stocks felt the same. For a while, investors in mortgage bonds felt the same. But when investors focus on returns rather than the very long-term structure, stability, and even existence of the underlying cash flows, terrible things can happen. All that’s required to get the snowball rolling is the creeping recognition that there’s no “there” there.'
- John P. Hussman, Ph.D.,
Why Market Valuations are Not Justified by Low Interest Rates, October 9, 2017
'Third, the types of experiments that are common in behavioral economics are very similar to experiments in psychology which are characterized by the “replicability crisis.” That is, we cannot be confident that the biases exhibited in experiments are robust even within the lab environment.''Economics is not an
experimental science, for the most part. This is inherent in the nature of the phenomena it studies. It is a social science, and running controlled experiments on societies is either impossible, is profoundly immoral, or usually has horrific results. The inability to run controlled experiments makes it difficult to assess causation in economic/social phenomena, hence the recent focus on “natural” experiments in which individuals are assigned different treatments due to some exogenous intervention.
Given the constraints of being a non-experimental science, economics still strives to follow the scientific method of theory-hypothesis-test, not always successfully or faithfully. But as we’ve known since Kuhn, even physical and biological sciences often fail to follow the classical scientific method. The paradigm/anomaly/change dynamic works in economics as it does in other physical sciences. From a sociology of science perspective, and from an ideal perspective, economics is scientific though it cannot rely on experiment to the same degree as some other sciences.
Alex K remarks about behavioral economics’ reliance on “repeatable experiments.” Yes, but. . . And the buts are very large, and fatal in my view.
First, as I noted (and as Rizzo emphasizes with reference to Vernon Smith, also an experimentalist), even if one believes the experimental results, the fallacy-of-composition problem makes it difficult to derive hypotheses about aggregate/market/social/emergent order patterns from these experiments. To do so requires modeling the interactions of the irrational individuals supposedly proven by the experiments. I do not believe that behavioral economics has done this, and indeed is far behind traditional economics in doing so. I understand the discipline is a relatively new one, but I really don’t perceive the same rate of progress in that endeavor as more traditional economics achieves, despite its more mature state.
Second, as Rizzo also notes, even on the level of individuals, it is not clear that the “odd” behavior observed in the lab actually occurs in the real world, at least with the frequency that it does in the contrived conditions of the lab.
Third, the types of experiments that are common in behavioral economics are very similar to experiments in psychology which are characterized by the “replicability crisis.” That is, we cannot be confident that the biases exhibited in experiments are robust even within the lab environment.
With regards to falsification, specific models embedding the rational actor assumption are clearly falsifiable. It happens all the time. This motivates the formulation of other models which vary certain other assumptions of the model, which can be many. I mentioned a few in my original post–information environment, strategic interaction, institutions, and yes, preferences.'
- Streetwise Professor, <a href="[
streetwiseprofessor.com];, October 10, 2017
Context'...the differences between social science and natural science...' - Lawrence H. White'..the Thaler Nobel is accurately reflective of the influence of behavioral economics on the profession..'(Praxeology) - '..the behaviorist and the experimentalists versus the praxeologists and the philosophers..''..Central banks have inflated the greatest Bubble in history..''..the true “Phillips Curve” .. is actually a scarcity relationship between unemployment and real wages, not general prices.''..Central banks have inflated the greatest Bubble in history..''..its the debt..'