In 2013, a closely-watched market valuation metric declared that U.S. stocks were dangerously overpriced.
The S&P 500 was around 1,500… and the smart move, according to the indicator, was to get out or at least stop buying.
But the SPY jumped almost 4x in the next decade…
The metric was the CAPE ratio (Cyclically Adjusted Price-to-Earnings), which compares stock prices to average corporate profits over the previous ten years, adjusted for inflation.
It has been flashing overvalued… sometimes severely overvalued, for over a decade.
Yet anyone who sold on that signal in 2013 and waited for the all clear is still waiting 13 years later.
Now a different metric is doing the rounds…
The equity risk premium (the gap between what stocks are expected to earn and what you'd get from a government bond) has nearly disappeared, sitting at its lowest point since the dot-com bust.
So you have fund managers coming out with hard hitting analysis like “valuations might be stretched”
They’re not wrong about the number… but the confusing part is what you're supposed to do with it.
Because there is always a number that quote-unquote proves the market is overvalued or on the brink of disaster… there has been for as long as markets have existed.
The Buffett Indicator, which measures the total value of the stock market against the size of the entire U.S. economy, crossed into "significantly overvalued" territory years ago and has stayed there ever since.
Margin debt levels… insider selling ratios… the Conference Board Leading Economic Index… take your pick.
On any given Tuesday, something is flashing red.
And when the market eventually does fall…because at some point it always does… the same commentators who spent years being wrong suddenly get credited with being right.
The number they'd been waving around for 36 months finally pays off, and the narrative writes itself…
The warning signs were there all along…
Which, interestingly enough, is EXACTLY how a discipline like astrology maintains its credibility.
The inconvenient reality is that most of these metrics have a poor track record as actual timing tools.
Robert Shiller, the Nobel Prize-winning economist behind the CAPE ratio, has himself acknowledged that the measure tells you relatively little about what markets will do in the next year or two…
And that it was designed to highlight potential returns over the next decade
That's a long time to sit in cash while everyone else collects gains.
None of this means the current setup is consequence-free. The bond market and the stock market genuinely are sending different signals right now, and when that divergence gets resolved, it tends to be bumpy.
Oil above $100 by late summer would alter the picture for everyone. If the Iran deal falls apart and the Strait of Hormuz stays closed, the earnings growth needed to justify current prices becomes very difficult to deliver.
Those are real risks and worth factoring in…
What's less useful is pretending that the equity risk premium turning negative is a flashing sell signal… when the CAPE ratio has been saying the same thing since 2013 and the market has nearly quadrupled since.
The investors who've done well through all of this aren't the ones who found the right indicator. They're the ones who had a strategy that generated returns regardless of whether the CAPE said the market was cheap or expensive.
Selling cash-secured puts on quality companies, collecting premiums, buying stock at a discount when assigned… that process doesn't require you to have a view on whether the equity risk premium is at -0.3% or +0.8%.
The market's job is to make you feel like you're missing something…
But usually the something you're missing is patience.
Oliver