Is Stock Market Too High

7/28/2019 Is Stock Market Too High

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The stock market is flirting with highs and euphoria is omnipresent: pundits

on TV tell us that its insane to miss the boat. While battle between bulls and

bears is raging, I thought of seeking wisdom of the legend one and only

Warren Buffett.

Most analysts hate him because he wont give them guidance. And media

ignores him because he wont predict stock prices. Nonetheless, Oracle of

Omaha has uncanny ability to learn from history and to consistently beat

major indices while most Ivy League educated fund managers fail to beat the

market.

In pursuit of seeking true wisdom from the greatest investor, I found a pearl

of wisdom from his speech at Allen & Company back in 1999 when market

was irrationally exuberant.

Interest Rates

In economics, interest rates act as gravity behaves in physical world

Warren Buffett

Any minute changes in interest rates impact all financial assets. His

hypothesis is simple: we tend to forget what an investment is. Its a process

of laying current dollar with expectation of receiving higher future value of

the same dollar. Having said that, a dollar invested when interest rates are at

10% will yield lower return than the same dollar invested when interest rates

are at 5%.

While interest rates are low since Fed Chairman has pledged to keep rates

lower till our economy runs on all engines, I can only think of rates going

higher in the future. Even if rates remain low, it wont go much lower than the

current rate.

Corporate Profits


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Another vital factor is the corporate profitability. For most of last century,

corporate profits range was in 4-6% range. Corporate profits accounted for

more than 11% of GDP in the last four quarters. Thats a staggering number

even for Warren Buffett who predicted that its difficult for corporateprofitability to remain much higher than 6% consistently.

While higher corporate profitability dictates higher returns, any financial

turmoil can ruin the party.

Relationship between the total value of U.S. stocks to GNP

This is the single most touchstone to gauge future market direction.


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Historically, total stock market value has ranged from 35% to almost 200% of

GNP. Oracle of Omaha considers 75% and below as an indicator that market

is largely undervalued to over 100% as largely overvalued. While market has

not soared to 190% of GNP as it did back in March of 2000 before the

collapse, it has briskly moved up to 110% of GNP.

Both interest rates and corporate profitability indicate that all is well, Oracle

of Omaha has the ultimate advice for us mere mortals: People are habitually

guided by rear view mirror, and for most part, vistas immediately behind

them.

This wisdom speaks volume about the marvelous mix of simplicity and

financial genius of the master investor.

Often most of us sell when market is too low and buy when market is too

high as we are indeed guided by the rear view mirror.

History largely backs this hypothesis. In early 1900s, in the midst of the

greatest industrial revolution, while GDP was growing rapidly, market barely

moved higher. On the other hand, in the last few decades of the century, GNP

grew at the half of what it did in the previous 20 years, yet markets zoomedto a new high.

Markets can march higher as long as interest rates remain low and corporate

profits remain high, but both of those have hit the plateau. If you like

simplicity of Warren Buffett, start thinking twice before adding more dollars to

your investments as stock prices go way ahead of US GDP.

This is one reason I dont have cable. It allows me to seek true wisdom while

most people mortgage their mind to CNBC. Do you agree?

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Is Stock Market Too High