Is the Market Overvalued?
Board: Berkshire Hathaway
So OK. We've seen a couple years with 20%+ returns, and Jim has put up discussions about CAPE and people talk about the markets running ahead and such. People on this board, being mostly value investors, say they aren't seeing the values out there and are preparing for a drop or at least low returns for several years.
I've tended to agree with those sentiments. I mean, 30% is like 4 years average returns, right? And the bull is more than 5 years old. Marketplace just called the end.
With this in mind I've been playing around with numbers, looking at average returns and average inflation and trying to get an idea of what I need to make in order to retire comfortably.
First, life expectancy. Outliving your savings really sucks. I think we can all agree on that. And you occasionally see lifestyle articles talking about how we are on the verge of so much and that the first person to reach 150 is probably alive right now. Good lord, what if it's me? I don't just need an annuity, I need a perpetuity.
Realizing this, I decided to look up the worst 50 year return on the S&P over the last roughly 100 years. It turns out to be 7%.
Then I looked up the worst 50 year inflation rate. It turns out to be 4%.
Which means when I retire I should be able to sell 3% / year and be mostly OK. There are a couple caveats due to volatility, but hey that's not supposed to be the point of this post.
No, the point is whether the market is overvalued. And in trying to determine that I want to point out that over time the S&P has returned at least 7%. And we all know that it just hasn't done that for the last decade or so.
Here are some values:
date S&P 500
The return from July '01 to Nov '11 was flat 0. A decade of flat 0. OK, the 90's were frothy, but come on. There really were a lot of innovations. The world really did change. Surely we've worked thru it all by now and can see some normal increases, right?
Maybe this all sounds kinda like touchie-feelie qualitative chartism. Guilty. But I gotta think that by the end of 2011 the market was not overvalued. If so, and if we are in a low interest environment with no obvious end, then maybe 10% growth isn't unreasonable. That would give an S&P value of around 1600, which IIRC is at the top of Jim's estimate.
That in turn implies the S&P overvalued by 25%. As a value investor that is certainly more than I like. But I also don't see it as nose-bleed territory.