Nobody knows more than Elroy Dimson about the history of asset prices.
I'm not kidding...
He wrote the book on it – called Triumph of the Optimists – covering more than 100 years of stock market history in dozens of countries.
He has created historical databases of dozens of stock markets going all the way back to 1900. And he has done the same for bonds, currencies, and even collectibles (like wine, violins, and more).
He understands what asset prices do over the long run as well as anyone on earth.
So what does Dimson think about stock prices today?
My friend Meb Faber interviewed Dimson on his podcast recently and asked him this question. I believe his answer is exactly right...
Dimson is obviously well aware that stock prices have gone up for nine years in a row – and that, based on historic measures of value, stocks are somewhat expensive. But here's what he said about it:
High valuations don't necessarily mean that we're going to see asset prices collapse. It's a reflection of the low-interest rates that we have today compared to [history].
Any investment you make is relative to something else... And so is any measure of valuation.
In plain language... if the bank was paying you a 10% yield on the cash it holds for you, then you would want stocks or bonds that could top that yield – or you'd never part with your cash.
We can do this math pretty easily... All you need is to find an asset's "earnings yield."
For example, if a stock's price is $100, and the earnings per share
The earnings yield makes it easier to compare investments.
In 2000, you could earn a 6%-plus yield on a boring U.S. Treasury bond. Meanwhile, the earnings yield in the stock market was about 4%.
So in 2000, it was far smarter to earn 6% safely in bonds than to earn 4% in stocks... In other words, it was smarter to sell stocks and buy bonds.
We saw the opposite situation in late 2008...
Treasury bonds paid 2%. And the forward earnings yield on stocks was around 8%. (The "forward" earnings yield is based on analyst earnings for the coming year.)
Knowing the yield in stocks was a much better deal back then, it was far smarter to sell bonds and buy stocks at the end of 2008.
If you'd followed these two pieces of advice over the last 20 years (sell stocks / buy bonds in 2000 and buy
But what about today – here in 2018 – after stocks have gone up for nine years? Where do we stand? Which is it? Are stocks or bonds the better deal?
This year, Treasury bonds are paying about 3% interest. But the earnings yield on stocks is closer to 6%. (Said another way, the forward P/E ratio for stocks is about 16.)
Stocks are the better deal.
Dimson knows that, too. As he said on the show...
So the world is very different [with low interest rates today], and that has had a bearing on the valuations... The high valuations that we see are because real interest rates have become very low compared to one or two decades ago.
The man who knows more than anyone about the history of asset prices GETS IT.
Of course, this doesn't mean that stock prices can't fall. Dimson makes the case in his work that low real interest rates lead to low stock market returns going forward.
But he gets that "value" is not static. It's not an absolute measure. Something is a "value" relative to something else. And today's ultra-low interest rates tilt "fair value" higher.
Most value investors are unwilling to give in to this idea. But they will miss out on the gains in the next few
Don't you miss out on them, too...
P.S. You can check out the interview with Elroy Dimson on Meb's website right here. It's episode No. 100 of his podcast, The Meb Faber Show.
"Can stocks soar from today's valuation? Absolutely!" Steve says. Everyone believes stocks are expensive – but as he explains, an important measure of value is telling a different story right now. Learn more here: Watch the Lie: Stocks Are No Longer Expensive.
"A value trap is like quicksand for your money," Kim Iskyan writes. That's why you need to know which cheap stocks are a good buy. Read more here: How to Tell If a Stock is Cheap... Or If It's Just a Value Trap.
Today, we’re revisiting one of our favorite Market Notes themes…
We’re talking about “bad to less bad” rallies. Steve coined the term years ago. Simply put, it means you can buy an asset after it was crushed and make big profits as the market returns to normal… or simply gets “less bad.”
One example of this is offshore oil driller Transocean (RIG). The company’s shares endured a huge long-term downtrend after the tragic accident in 2010 that sent oil spilling into the Gulf of Mexico. Then, the oil bust of 2014 struck. Shares fell from around $90 in 2010 all the way to less than $9 in 2016. But as the years passed, Transocean’s situation has quietly improved… And with crude oil prices on the rise, that trend should continue.
As you can see in the following chart, shares are up about 65% since bottoming last August. It’s more proof that things don’t have to be perfect to make money in the market. Sometimes, they just have to be “less bad”…