Excerpts:
Although nobody seems to care at the moment, rapidly rising prices make stocks more expensive—and thus riskier. Referring to the Graham/Shiller PE (below, in the written version), as highlighted in the 2008 MCM annual report and subsequent writings, its utility as a valuation tool for long-term investors is in its design: It was constructed to smooth out short-term fluctuations in earnings by using a 10-year moving average and, because it’s a longer-term measure, the effect of inflation/deflation on both earnings and the value of the S&P 500 index is largely nullified. While Graham/Shiller states the obvious, it isn’t commonly employed as a valuation tool. Given its several indisputable bubble warnings over the last 10 years, one must presume that neither Greenspan nor Bernanke is aware of its existence.
As noted on the chart, the PE fell to a month-end low of 13.3 times in February and is currently at 17.5. With one exception, no bubble market in the last 130 years—defined as one in which the Graham/Shiller PE rose above 20 times earnings—escaped the ignominy of sinking to single-digit PEs in the bust that followed. The exception, at least thus far, is the current bear market (or is this a new bull market?). The game is tight, the time short, and all about us are on their feet screaming for the home team. In the marketplace the rational player must keep his game face, and his seat, stoically aware that "the opera ain't over till the fat lady sings."
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The following appeared in our 2005 annual report and seems as apropos today as it was then:
John Kenneth Galbraith had the following to say about those who had the temerity to utter caveats when the “wonderful process of enrichment” was under a full head of steam. “There are, however, few matters on which such a warning is less welcomed,” he wrote. “In the short run, it will be said to be an attack, motivated by either deficient understanding or uncontrolled envy, on the wonderful process of enrichment. More durably, it will be thought to demonstrate a lack of faith in the inherent wisdom of the market itself.” Duty leaves us no choice. If the future proves us misguided, we will have cost you opportunity. If we are closer to the truth than even we would like to be, we may have protected your capital and, more importantly, your capacity to venture forth into an always uncertain investment world in the future, perhaps when low hanging fruit is begging to be picked…
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