Saturday, May 4, 2013

Where Is the Market Headed?

I focus this blog on discussing the market as it pertains to my portfolio. I try to follow the Benjeman Graham school of value investing. So I don't try to predict the market. I look at current value, and discount predictions of the future.

But now, the S&P 500 is at an all time highs of 1615, and we are in uncharted territory. I am trying hard to get some visibility of the future. We have just come from two huge bubbles in ten years. Now four years after the second bubble, we appear to be well into recovery. But the recovery in doesn't feel like a normal recovery. This recovery seems to be artificial creation of the major central banks. The central bankers of the world seem to be in a race to debase their currencies.

In such uncertain times I look for wisdom from financial thought leaders. People I really respect are the likes of Buffett, Berkowitz, Munger and Robert Shiller.

Robert Shiller is the co-creator of the Case/Shiller index, author of Irrational Exuberance, and the person who predicted both bubbles in the last fifteen years. Robert Shiller created the inflation adjusted cyclically adjusted price earnings ratio (CAPE). He says CAPE is much better than the traditional PE because it captures the effect of a whole business cycle on earnings. I have plotted the CAPE earnings yield (simply the reciprocal of the CAPE) along with long term interest rate and the inflation rate from data in Shiller's website.

The median earnings yield is 6.5%. Today, the yield is 4.5%. Compare that with the inflation and interest rate, we can see that the yield is reasonable. But still, it is lower than the median. And is the inflation rate reasonable? Can we expect this to continue in light of central banks printing so much money? That is the billion dollar question. I certainly don't know. But I am very wary because we are in such unprecedented times.

I also said in a post last year that, who knows we may hit a all time high on the S&P 500. That has happened. But I am really uncertain what's next. I just don't see how it can go much higher without coming into pricey or even bubble territory.

Do you have any comments?

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