Article published by José Alberto León in El Día on 06/21/15.
In the 1980s, Shiller, awarded the Nobel Prize in Economics in 2013, showed that a simple investment rule can be established with which it is very likely to make money. Shiller showed that people's investment decisions respond more to emotional or intuitive factors than to rational behavior, as investors behave irrationally during bubbles and depressions in the economic cycle, following herd or herd behavior. He said that sometimes investors experience periods of “irrational exuberance,” which explains bubbles. Psychological biases such as the fact that people remember recent prices more than old ones are the fuel for bubbles. That is why such absurd thoughts are spread as that “housing prices are not going down” and properties are bought at any price, no matter how high. Shiller claimed to be able to detect bubbles or undervalued values.
He based his arguments largely around his own indicator, the CAPE (Cyclically Adjusted Price Earnings or cyclically adjusted price-earnings ratio). Instead of comparing stock prices to their most recent earnings, as the P/E does (P/E or price-earnings ratio), he compared them to their average earnings over the previous decade, because earnings over the past year could be very volatile. By comparing the CAPE at any time with the historical average, undervalued or overvalued values could be detected. This indicator revealed that the American stock market before the year 2000 reached its maximum overvaluation in history, and predicted its fall. It is a very good indicator pointing out bubbles, moments of extreme overvaluation, but the problem is that it does not indicate how long the overvaluation will last, so it does not help to choose the moment to enter or exit the market. So CAPE is not the philosopher's stone of investment. After all, from the moment Shiller predicted the bubble would burst, dotcom and the timing of it was over four years (1996 to 2000) during which the market rose an additional 70%, and those who heeded this prediction in 1996 missed out on a tidy profit.
What does the CAPE tell us about current prices on the stock markets? Well, the current CAPE of the American stock market is 27.5, a level similar to that prior to the subprime crisis of 2007 (27.3), below the figures prior to the crash of 1929 (32.6) and well below the dotcom crash in 2000 (where it exceeded the figure of 44). The American market exceeds its average CAPE by 66%, which is 16.61. Does this mean that the American stock market will fall 66% in a short time? Nothing of the sort. It can continue to rise for several more years and does not have to fall to the average but less (or more), as has happened in the past, but whenever the CAPE of the United States has been greater than 22, the real return in the following 20 years has been negative. So I warn sailors for those who have invested in the American stock market. The bubble in the American stock market seems clear, but it is not known when it will burst. And another bubble prediction indicator is not reassuring either, since investments in the stock market with borrowed money are at all-time highs, which usually happens before sharp stock market falls.
The zero rate policies that have been maintained by the Central Banks of the most developed world to avoid the collapse of debt have completely distorted the financial system, “forcing” investors to shift their money to higher risk assets to obtain attractive returns. For this reason we have attended the Rallying of the stock markets and the fall in the cost of the most insolvent debt, causing situations as absurd as Spain, which was on the verge of bankruptcy just two years ago, charging for financing itself in the markets. This unsustainable situation can explode at any time and with any excuse. Will Greece be the excuse that will cause investors to flock out of risk assets? At the time of writing these lines, the last and unpromising meetings between that country and its creditors are taking place, and the signing of an agreement cannot be extended beyond the end of the month... at most. But the chances of an unintended “accident” increase day by day. Between the inexperience of the Greek government, as well as its bluffs, miscalculations and internal electoral pressures, it seems that they have gone too far in the game of getting the most chicken out of the way before the imminent collision. The Greek government seems more concerned about blaming Europe for all its ills (and that its bakers and hairdressers are still retiring at age 52) than about saving its country from economic suicide. Faced with this situation, Greek citizens have been choosing wisely for months to take their euros out of the country (if they can) or keep them in their mattress. On the other hand, Europeans seem convinced that they are prepared to manage the Greek bankruptcy if it were to occur, but in overvalued markets there is nothing more dangerous and uncontrolled than a stampede of nervous investors.
Let's hope they know what they are doing and have a firm and quick response planned if the worst happens. Scenarios of a Cyprus-style banking corralito in Greece, a massive intervention by the European Central Bank in the debt markets and even the creation of Eurobills and/or Eurobonds are already being considered in response, but I trust that these measures are already planned and decided, because if the nineteen euro countries have to agree, I fear that the wildebeests will have devastated the European countryside by the time we see the white smoke.
In the end. Now that we were beginning to get used to living without problems.
