So, how do I characterize 2017? I call it The Little Market that Could. Why? Few draw downs, low implied volatility, and skepticism that gave way to uncritical belief. Just as we have lost touch with the idea that government deficits and debts matter, so we have lost touch with the idea that valuation matters.
When I talk to professionals (and some amateurs) about the valuation model that I use for the market, increasingly I get pushback, suggesting that we are in a new era, and that my model might have been good for an era prior to our present technological innovations.
I simply respond by saying, “The buying power has to come from somewhere. Our stock market does not do well when risk assets are valued at 40%+ of the share of assets, and there have been significant technological shifts over my analysis period beginning in 1945, many rivaling the internet.” (Every era idolizes its changes. It is always a “new era.” It is never a “new era.”)
If you are asking me about the short-term, I think the direction is up, but I am edgy about that. Forecast ten year returns are below 3.75%/year not adjusted for inflation. Just a guess on my part, but I think all of the people who are making money off of low volatility are feeding the calm in the short-run, while building up a whiplash in the intermediate term.
Time will tell. It usually does, given enough time. In the intermediate-term, it is tough to tell signal from noise. I am at my maximum cash for my equity strategy accounts — I think that is a prudent place to be amid the high valuations that we face today. Remember, once the surprise comes, and companies scramble to find financing, it is too late to make adjustments for market risk.
This article was republished with permission from the Aleph Blog.