Back in the day – and by that I mean the dot-com bubble of the late 1990s – I was working at The Wall Street Journal, writing about investing for the paper’s “Money & Investing” and “Personal Journal” sections. In that moment, a paradigm shift was underway on Wall Street…
As Internet companies with no profits and nothing more significant than an idea racked up stock market valuations in the billions, the Street’s army of analysts contorted themselves to justify prices that made no sense to anyone with more than a couple brain cells. Traditional metrics no longer applied, they assured investors. Price-to-earnings ratios, cash-flow multiples, net-profit margins… those were all passé, old-school in a new-school world. What mattered was “customers per click,” time spent on a website, measuring “eyeballs” and not earnings.
The sad part is that Wall Street convinced Main Street that the new paradigm was legit. Technology was different than the manufacturing and industrial past, and it had created a “new normal” way of valuing stocks.
And then truth alighted to mock the merrymakers on Wall Street… and, sadly, to erase trillions of dollars of wealth from Main Street investors who had put their faith in the Street’s supposedly learned analysis.
Beware: Another paradigm shift is underway on Wall Street. And this time, like last time, Main Street will get screwed.
Just recently, Wall Street investment banking firm Barclays dispatched a note to investors that argued the laughable: That the stock market, at historically extreme valuations, is not overvalued one bit… that because of “animal spirits” – as economist John Maynard Keynes called the emotions that drive human behavior – that have welled up in the wake of the Trump victory, the current P/E ratio approaching 20 “is far from pricing [in] excessive optimism.”
Folks, that is the kind of analysis that comes back to haunt a Wall Street analyst. And it will come back to haunt the wallet of any investor gullible enough to buy into that nonsense.
What’s going on here is a concept similar to what was going on back in the dot-com bubble. Wall Street, knowing something is amiss but constitutionally incapable of conceding that reality, is creating a new paradigm to explain to us Main Street sheep why it is that “no, indeed – stocks aren’t expensive… if you look at this new way of valuing stocks.”
Some might call it an “alternative fact.”
When traditional valuation measures tell you one thing, and Wall Street analysts are telling you tradition no longer matters… well, my best advice is to tell you to pay attention to history. Because Wall Street has an exceedingly long and colorful history of putting its interests above yours.
Stocks Are Expensive
As I’ve pointed out in previous dispatches, stocks today are at extreme valuations.
I use the Shiller price-to-earnings (P/E) ratio, which uses inflation-adjusted earnings over a 10-year period in order to smooth out the business cycles and the vicissitudes of corporate earnings that can swing wildly from one year to the next.
The Shiller P/E today is approaching 30, putting the U.S. stock market as one of the single most expensive in the world. Usually, the Shiller P/E is in the midteens.
In the last century, it has been this high on only two other occasions: The paradigm-shifting dot-com bubble (which actually shifted no paradigms), and just before the global financial crisis, when the entire world of investors was mainlining pixie dust.
But even on the basis of the current P/E ratio (based on the current year’s earnings only), stocks are now at 20 times earnings. Again, that’s well above historical norms that are in the midteens.
See, the thing is, smart Wall Street analysts can rationalize anything. They can manipulate numbers any way they want by adjusting for this, that and the other thing all day long in explaining why this time it’s different… why this time it makes sense that 20 is the new 15… and why you should not be worried that stocks are expensive because, duh, they’re clearly not.
Only, the problem is that nothing is ever different.
Traditional valuation metrics are traditional for a reason: Because they make sense.
They’ve served investors well for many a generation because they work. New metrics rarely work, mainly because they’re usually engineered to fit a particular moment in time – and usually a moment in which markets are out of whack and Wall Street wants you to believe otherwise.
Don’t Trust Wall Street
I will point out one other fact before I sign off…
One of the rationales Barclays (and other analysts) use to justify higher P/E ratios as the new normal is the fact that interest rates are low. Yet interest rates are headed higher, if one believes the Fed… and if one believes Trump, they’re headed even higher than expected because the new administration will unleash inflation with the spending, tax and tariff plans built into Trumponomics.
Rising interest-rate regimes coincide tightly with shrinking market valuations… not a good omen for Barclays.
So, take it for what you will: We are either in a new paradigm, where the traditional measures of cheap and dear have been suspended… or we’re simply in another moment in which Wall Street must contort itself to rationalize irrational exuberance.
My bet is that Barclays will wish it hadn’t distributed this particular note.