C.A.P.E Fear?

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Our Recommended New Year Resolution

Preparations are underway for the birth of a New Year, as 2017 will soon be upon us.  In a few days, our nation will be swept away by a collective desire to make our annual Resolutions, and promises to ourselves that we will be skinnier, smarter, more successful, and more disciplined in the coming year.

As a financial advisor, I am recommending an idea for a New Year’s resolution which should help make you more successful, and perhaps even happier:  Stop being distracted by the financial media.

There is an old saying in the media and journalism business that “if it bleeds it reads” – for some reason we all have a fascination with bad news, and the 24 hour news cycle is more than willing to take advantage of this fascination.  In my experience, the financial media has two primary functions:  First, to foster the illusion that stocks are casino chips – total random speculations, completely rootless and inherently unstable – and not shares of businesses with real earnings, cash flows, and assets.  Second, to perpetuate another illusion that the stock market is tied directly, and minute by minute, to the economy, which is forever on the brink of implosion.  The financial news is deliberately a culture of fear, and has no interest in reporting the truth. Instead it flits from crisis to crisis, and it presents each crisis as the very thing that will take down the stock market every day. This may sound familiar because we have written about this before [see Turn Off The Financial News Spigot].

My recommendation is that you decide to avoid the financial media in 2017.

C.A.P.E Fear

One of my favorite fear mongering topics in the financial media is the publicity afforded to the “Stock Valuation Chicken Littles”.  This is my nickname for the many analysts and investment managers who appear during any significant bull market, and advance the theory that the market is significantly “overvalued”, and thus set for a crash.  Thanks to the recent bullish behavior since the election, these characters are now beginning to come out of the woodwork.

I have always been very skeptical of the idea that anyone can determine what the true valuation of the stock market “should be”, and then use that information to make a judgment about whether stocks are overvalued or undervalued.  My skepticism stems from the fact that these “valuation” techniques almost always claim that stocks are overvalued, and are also almost always wrong.

As an example, one of the most sophisticated valuation methods out there is called the C.A.P.E ratio.  Even the name sounds academic and intimidating: the “Cyclically Adjusted Price to Earnings Ratio” is a complicated formula developed by some very smart academics to determine the proper valuation of the stock market.  The problem is that it is almost useless as a tool for making investing decisions.  As noted investor Barry Ritholz recently wrote in his blog:

Let’s start with CAPE – the Cyclically Adjusted Price to Earnings ratio. Think of it as the 10-year P/E. It is high for US equities by historical averages, elevated for Japan, moderate for Europe, and low for emerging markets. If we wanted to scare people, we would selectively pull data out showing at present we have the highest reading outside of 2000 (43.2), 1929 (32.5) and 2007 (27.6).

Since 1990, the S&P 500 has been trading above the average CAPE ratio during 307 out of 324 months – that’s a total of 95% of the time. If you exited US equities when the CAPE ratio was overvalued, you would have missed gains of more than a 1000% over that time. In fact, had you only invested when the CAPE was 25% overvalued – i.e. when stocks were “very expensive” – your total returns since 1990 would have been 650%. This is one of the many reasons why it is ill advised to use valuation as a timing mechanism.

My second recommendation is that, if you are going to watch the financial media in 2017, please tune out whenever they start talking about sophisticated measurements of how overvalued the stock market is.

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About the Author:

Erik is one of the co-founders of Concentus Wealth Advisors and currently serves as the Chief Executive Officer of the firm. With over 25 years of industry experience, Erik guides the firm’s overall strategy. After graduating from Amherst College in 1991, Erik spent a year working with Rittenhouse Capital Management, before joining Gerald in 1992. Erik currently holds his general securities registrations and insurance licenses, as well as CERTIFIED FINANCIAL PLANNER™ and Chartered Financial Consultant designations. In addition to his formal designations, Erik has appeared on CNBC’s Worldwide Exchange, Fox News’ America’s News HQ, Live Well’s Mary on Money, CN8’s Money Matters Today and The Real Estate Connection. In 2012, Erik was one of thirteen advisors named to Main Line Today’s Top Financial Advisors list. Erik lives in Bryn Mawr, PA with his wife and three children. He serves on the boards of the Philadelphia Chapter of the Salvation Army, Acting Without Boundaries (serving young people with disabilities) and The Holy Child School at Rosemont. In addition, he is on the financial advisory board of the Sisters of St. Francis in Media, PA.

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