Martin Tarlie of GMO just recently wrote a great piece on the issue of the current U.S. Stock Market Bubble asking the question of whether or not it has finally burst. To wit:
“A new model explains this dichotomy between price action and fundamentals by suggesting that a bubble in the U.S. stock market started inflating in early 2017, and continued to inflate through the third quarter of 2018. In the fourth quarter, however, indications were that the bubble had started to deflate. And when bubbles deflate, they generally do so with a volatility bang.”
The primary premise is one of “mean reversions” particularly from elevated levels of valuations. These reversions are simply the liquidation of the excesses built up during the previous bull market cycle. The chart below shows the secular cycles of the market going back to 1871 adjusted for inflation. As Martin notes, current valuations, while lower than the 2000 peak, are still at levels seen only rarely in history. As I discussed just recently, new “secular” bull markets are not launched from such lofty levels.
As Martin concludes:
“The Bubble Model teaches us that bubbles form when times are good – high valuation – and expected to get even better – changes in sentiment are positive. Bubbles burst when changes in sentiment – not level out – turn negative.
Given that valuation is still high, our advice, consistent with our portfolio positions, is to continue to own as little U.S. equity as career risk allows.”
Since Martin is most likely correct in his assumptions, here are 10-basic investment rules which have historically kept investors out of trouble over the long term. These are not unique by any means but rather a list of investment rules that in some shape, or form, has been uttered by every great investor in history.
1) You Are A “Saver” – Not An Investor