They couldn’t have known

The thing very few people tell you about “overvalued” markets is that, occasionally, the fundamentals arrive to justify them. Later, of course, which is how risk takers are compensated for owning stocks selling at a higher than normal multiple. If there were no chance of this happening, then stocks would never reach these higher valuations to begin with, because no one would pay up for them.

But it can happen. It does happen. At the micro level (individual stocks and sectors), there are hundreds of recent examples one could rattle off.  Amazon, Netflix, Nvidia – you could go back a decade and pretty much never find a moment where these stocks sold at what investors would traditionally call a “reasonable” valuation. Their stock prices soared and then soared again, thousands of percentage points, as the fundamental stories grew up to justify the valuations investors had already been paying.

Not every bet like this works out, but sometimes it does.

This also applies to entire markets. The critics of stock market valuations can’t know what the future holds in terms of fundamentals, They can guess, and guess negatively if they’d like, but they can’t know. It is unknowable. But sometimes the economic backdrop and corporate opportunity set becomes positive enough to justify expensive markets ex-post.

Michael Batnick and I were talking about this recently with regards to the S&P 500, which had made a new record high in the spring of 2013. It was easy to look at the rising valuation multiple and conclude that stocks were expensive relative to history on key metrics like trailing earnings. Mike pointed out that you were buying stocks at that moment, five years ago, at a cyclically adjusted price-earnings (CAPE) ratio that was higher than 87% of all readings for this measure throughout history. The stock market had only been that expensive during 13% of all months.

And then the S&P 500 went up 90%.

No one could have known that the fundamentals would arrive to back up the elevated valuations for stocks eventually. There was a possibility that they would, and a possibility they wouldn’t. There’s no formula for calculating the odds for something like this, given all the inputs and variables.

But earnings grew, floats shrunk, the economy steadily improved, the international economy joined in, gasoline prices eased, the labor market tightened, the Fed began to extricate itself from QE, stimulus from overseas poured into asset prices, a contentious election was weathered, Congress and the White House slashed the corporate tax rate by an unimaginable degree, earnings growth reaccelerated, buybacks reaccelerated.

In 2013, they couldn’t have known.

Just as in the 1980’s they couldn’t have foreseen the birth of the internet and the explosion in wireless and cellular technology in the 1990’s that would transform the world.

Just as in the 1950’s they couldn’t have foreseen the go-go conglomerates and the space-age empire building of the 1960’s that would remake American capitalism forever.

Today we consider the possibilities for things like automation, virtual reality, machine learning, artificial intelligence, decentralized apps and the blockchain. They might be societally transformative and, as a result, under-appreciated based on the multiples investors are paying for technology stocks today. Or, they could be a series of busts, one after another, where profits don’t materialize, innovation hits a dead end, financial backers grow disillusioned or some other exogenous event forces us to rethink everything we currently expect.

We couldn’t know.

So when you hear someone carrying on about backward-looking valuation measures, remember that there is another possibility beyond just stock markets being expensive. That possibility? The fundamentals coming along to make things look as though they were meant to be.


This post originally appeared here on May 14th, 2018.


This content, which contains security-related opinions and/or information, is provided for informational purposes only and should not be relied upon in any manner as professional advice, or an endorsement of any practices, products or services. There can be no guarantees or assurances that the views expressed here will be applicable for any particular facts or circumstances, and should not be relied upon in any manner. You should consult your own advisers as to legal, business, tax, and other related matters concerning any investment.

The commentary in this “post” (including any related blog, podcasts, videos, and social media) reflects the personal opinions, viewpoints, and analyses of the Ritholtz Wealth Management employees providing such comments, and should not be regarded the views of Ritholtz Wealth Management LLC. or its respective affiliates or as a description of advisory services provided by Ritholtz Wealth Management or performance returns of any Ritholtz Wealth Management Investments client.

References to any securities or digital assets, or performance data, are for illustrative purposes only and do not constitute an investment recommendation or offer to provide investment advisory services. Charts and graphs provided within are for informational purposes solely and should not be relied upon when making any investment decision. Past performance is not indicative of future results. The content speaks only as of the date indicated. Any projections, estimates, forecasts, targets, prospects, and/or opinions expressed in these materials are subject to change without notice and may differ or be contrary to opinions expressed by others.

Wealthcast Media, an affiliate of Ritholtz Wealth Management, receives payment from various entities for advertisements in affiliated podcasts, blogs and emails. Inclusion of such advertisements does not constitute or imply endorsement, sponsorship or recommendation thereof, or any affiliation therewith, by the Content Creator or by Ritholtz Wealth Management or any of its employees. Investments in securities involve the risk of loss. For additional advertisement disclaimers see here:

Please see disclosures here.

What's been said:

Discussions found on the web
  1. bitcoin era commented on Sep 30

    … [Trackback]

    […] Read More on on that Topic: […]

  2. Bitcoin Era Review 2020 commented on Oct 01

    … [Trackback]

    […] Find More Info here to that Topic: […]

  3. Quality formula commented on Nov 24

    … [Trackback]

    […] Read More on to that Topic: […]

  4. log in tangerine commented on Nov 26

    … [Trackback]

    […] Read More on on that Topic: […]

  5. Intelligent automation services commented on Nov 28

    … [Trackback]

    […] Find More Information here on that Topic: […]

  6. 홀덤사이트 commented on Nov 29

    … [Trackback]

    […] Read More on that Topic: […]

  7. how to sleep 8 hours in 4 hours commented on Dec 10

    … [Trackback]

    […] Find More Information here on that Topic: […]

  8. rolex replica commented on Dec 17

    … [Trackback]

    […] Read More Info here to that Topic: […]

  9. Software Testing Services company commented on Jan 15

    … [Trackback]

    […] Read More on on that Topic: […]

  10. what is digital transformation commented on Jan 17

    … [Trackback]

    […] Find More on that Topic: […]

  11. EarthQuake MB1 manuals commented on Jan 22

    … [Trackback]

    […] Info to that Topic: […]

  12. VTech Smart Friends Bowling manuals commented on Jan 23

    … [Trackback]

    […] Find More Information here to that Topic: […]

  13. click this over here now commented on Feb 02

    … [Trackback]

    […] Find More on to that Topic: […]