Longest-Ever Bull Market Raises Concerns

transcript

The market, by any historical standard, looks very pricey. Things like the cyclically adjusted price-to-earnings ratio look very high when compared to the 100 years of history of that measure that we have. It’s difficult to argue that that’s not the case.

Now, there are a couple of things that perhaps the investor should keep in mind. First, there’s been a profound transition of the US economy toward the service sector. Manufacturing, as we all know, has been dying. The American economy is less dependent on manufacturing than it was, say, 30 to 40 years ago, and it’s more of a service-oriented economy.

The sources of customer captivity, of bias to entry, are stronger in the service sector. On account of that, the profitability of US corporations is higher than it was in the past and also justifies higher multiples. So, it may be that there is a structural change in the US economy that justifies high valuation ratios, effectively. There’s a lot of evidence that the profitability of the US corporate sector has increased over the last, I would say, 20 years, which lends additional support to this thesis.

Second, of course, we live in a very peculiar world, in terms of monetary policy, where there’s been enormous amount of liquidity provided by central banks — not just in the United States, but also in Europe and Japan and many other countries. And that’s certainly having an effect on yields across, not just equities, but across all asset classes.

And in addition, policymakers have signaled strongly that they are happy to intervene to prevent market meltdowns, which removes the catastrophic scenarios that preoccupy investors all over the world, which also adds to the valuations that we see in the market. So, these several factors are combining to produce high valuations.

It may be the case, as well, that some of these valuations, in some of the tech sector, in particular, are the usual trick of Mr. Market paying too much for stocks that should be trading at half their prices.