Monday, September 02, 2013

Cheap Or Dear?

Cheap or dear? That is the question: Whether it is nobler for the pocketbook to buy stocks or sell them! Aye, there's the rub.  

The FT's John Authers squares Robert Shiller off against Jeremy Siegel in a debate over whether stocks are over priced or under priced.

I met Robert Shiller when he was first attacking the Efficient Market Hypothesis, a dogma that commanded stronger belief among finance professors than the Real Presence did from Catholics at the time.  He showed statistically that if stocks represent the present value of future earnings and/or dividends, stock prices are much too volatile to be correctly valued.  Later he took the profession on using the Cyclically Adjusted Price Earnings Ratio as his lance.  You can link to his data online.

Market strategists and the like have tried to use it to guage when the market as a whole is too dear or too cheap.  Shiller's measure is signalling stock prices are too rich in Great Britain and the U.S.  

Jeremy Siegel, like Shiller a student of long data trends, argues against this conclusion and, specifically, that "The ratio’s pessimistic predictions are based on biased data."  The problem with any P/E ratio is measuring the denominator.  Earnings reflect accounting and even adjusted for inflation, as Shiller does, may not be the proper measure.  Earnings are affected by companies' use of leverage and the growth in earnings is affected by firms dividend payout practices.  Faster earnings growth should be associated with higher valuations.

One factor neither seems to address is my observation that the business cycle is now a ten year cycle in the image of the nineteenth century British trade cycle.  This is a departure from the immediate postwar cycle which was a five year inventory cycle.

As an investor, you still have to choose whether to buy and hold or make timly entries into and out of the market:  "The fault, dear Brutus, is not in our stars, But in ourselves, that we are underlings."

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