Alright, now let’s take a quick look at where the market is today. We’ll look at and discuss a few different methods of finding the value and likely returns of the market, and what they mean to us. Focus on how I’m doing this, rather than the specific point in time, that way, you’ll be able to do the same whenever you’re curious about the current market.
What we’ll cover today
1. Where the Market is today
2. The current market trend (with charts!)
3. Valuing the current potential return in the market
4. Buffett's favorite Market valuation tool
A snapshot of the market
The first metric I always look at when I’m trying to value the overall market is something called the Shiller PE. This comes from Professor Robert Shiller's timely book Irrational Exuberance. It’s the same as the CAPE ratio, which is the Cyclically Adjusted Price to Earning ratio. I know, it’s a mouthful. In other words, it’s the PE ratio based on average inflation-adjusted earnings from the previous 10 years. The Shiller PE gives a much better snapshot of our current market conditions than simply using the PE ratio.
Today we have a historically high Shiller PE of 28.93. I drew a trendline through the chart to show where the historical ceiling was for the Shiller PE levels. Look at the market in 1929, 1999, and 2008. This is where we had the highest ever Shiller PE levels. You can see that we’re already above the market value of the stock market in march of 2008. We’re also approaching the 1929 peak (known as Black Tuesday) which had a Shiller PE of 30. But, if we look at the Dot Com bubble of 1999, we can see that the Shiller PE hit it’s all time high of 44.19, so we’re not quite that irrationally exuberant (yet).
What this means
This doesn’t mean the market can’t go higher, it absolutely can. What it means to me is that the stock market is getting more risky as we get higher into these more unreasonable valuations. The market is very asymmetrically priced to the high side, meaning that it has much more downward pressure than it does upward pressure. Said another way, the market currently has much more risk associated with it, then potential award.
Note: What I get from this chart is that it’s going to be difficult to find those no-brainer wonderful companies on sale right now. And that’s what we want to look for. Buffett says we want to jump over 6 inch hurdles not 6 foot ones. Right now, i’d say the market is mostly offering 6 foot poles for us to try to jump over. I don’t know about you, but I can’t jump that high.
Market direction
The next step I take is to load up the S&P 500 on my favorite charting platform, and look at the current chart in different time periods. The human mind is very good at recognizing patterns, and all I do is draw in some trend-lines to map out where the market has been, and potentially where it’s going.
You can add in floors and ceilings to mark out potential tipping points for the market, and potential stopping points to the downside. These are called support and resistance lines. Support lines refer to an imaginary floor that’s built into the stock price, while resistance is the imaginary ceiling that’s stopping the stock from going higher. Usually, the stock will bounce off of these support and resistance lines and either go the opposite direction, or breakthrough and continue the current trend. One Author, that I read a few years back referred to these lines as Magnets (Michael Benklifa). I’ve always liked the analogy. In other words, the stock will be drawn to the support and resistance lines. Once you’ve drawn a lot of charts, that analogy does seem to ring true...
Charting can give you a better feeling for market direction and momentum. And it only works because so many professional investors use it. They set floors and ceilings at certain price points, and buy and sell around those points. It's a self-fulfilling prophecy. Kinda funny right?
Charting is a bit of an art, and it's never perfect. So, keep that in mind as we first look at the one year chart for the S&P. (I use the SPY index. Which trades at 1/10 the S&P 500).
(Think or Swim, 2017)
As you can see in the chart above, we’ve been in a bullish trend since November 7 2016. People have been calling this recent run-up the Trump-Bump, because the market seems to like all his tax cutting ideas. The problem is, they are likely to take more time than the market thinks to actually have an effect on the underlying businesses.
This short is looking at the short term trend of the market. You can see it’s been channelling tightly to the upside, and we just had it break through the channels floor. This could mean that the bullish trend has finally ceased. Or, it could be taking a break, trade sideways for a while and continue its bullish trend upwards. The other options is that we have something people are calling the Trump-Dump, and see the market fall back to pre-election levels (which is the horizontal channel drawn in the chart).
Note: If you look at the channels, you can see that they do seem to act like magnets… as soon as one is touched, it seems to be drawn to the other side.
Now let’s look at the long-term trend of this bullish market. I went all the way back to the beginning of this Bull run, eight years ago, to March 9th 2009. (for you charting nerds out there, I used a 10 year chart, with a weekly time period).
(Think or Swim, 2017)
As you can clearly see, we’ve been in an amazing bull run since March of 2009. With barely any sort of disturbance in the trajectory. In fact, it never left the area of the channel through all the 8 years shown here. I think that’s pretty rare. You can use a chart like this to potentially see where the market could be going, or where it could drop to next. You can continue to trace these trend lines out into the future, and as long as it doesn’t break through the floor, you can be reasonably certain it will continue with its trend.
Economic Cycles
It’s important to note that short term economic cycles usually last 7-10 years. (Eg 2000-2008). Long term cycles typically last 100 years. According to Ray Dalio, who’s a genius in my view, we aren't only at the end of a short term credit cycle, but also coming to the end of a long term credit cycle. If you haven’t watched his amazingly informative video:
How the Economic Machine Works. I’ll post it below for you. This is required viewing for any serious investors, and is done in an informative and easy to grasp way.
Tomorrow I’ll post the next value metric which is one of my favorites. Until then, watch the video, and don’t forget to sign up to my email newsletter!
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