When the time comes to ask the question – “What triggered the crash?” – remember that this is the least important question. A market crash requires nothing more than a shift in investor psychology from careless speculation to even modest risk-aversion (View Highlight)
At some point, enough investors stop basing their expectations for future returns on the mindless extrapolation of past returns, in a market where prices have become detached from fundamentals (View Highlight)
At some point, investors discover a basic fact of equilibrium: it is impossible, in aggregate, for investors to “exit” the market. Every single share of stock that has been issued has to be held by some investor, at every moment in time, until it is retired. (View Highlight)
Every bond certificate. All of them are already home. They can’t magically turn into something else. Not a single dollar comes “into” the stock market that does not simultaneously come “out.” Not a single share is purchased that is not simultaneously sold (View Highlight)
With valuations at the most extreme level in history, the one thing that the market simply cannot tolerate is the eager attempt of a substantial number of investors to exit. (View Highlight)
The chart below shows the ratio of nonfinancial market capitalization to corporate gross value-added, including estimated foreign revenues. I introduced MarketCap/GVA in 2015, and it remains more strongly correlated with actual subsequent market returns than any other measure we’ve tested or introduced (View Highlight)
Valuations are extremely informative about long-term investment returns (particularly over 10-12 year horizons) and the extent of potential market losses over the completion of the market cycle (View Highlight)
Yet even when we examine 10-12 year market returns, there are occasionally periods when valuations simply don’t seem to “work.” These periods have an unfortunate impact on investor psychology. If the market has advanced for quite some time, despite extreme valuations, investors can conclude – at the worst moment possible – that valuations don’t matter and prices can advance indefinitely (View Highlight)
When we compare actual 10-year S&P 500 total returns across history with the total returns implied by our most reliable valuation measures, we see several “errors” where actual returns over the next 10 years were either well-above or well-below expectations (View Highlight)
What’s so special about those particular 10-year periods? Simple. Just add 10 years. The 1922 “error” corresponds to the 10-year period ending at the 1932 depression low (View Highlight)
Quite simply, when you observe a period where valuations haven’t “worked” in a significant way, you should be either very concerned, or very enthusiastic, because it most likely means that market valuations are at either a bubble peak or a secular low (View Highlight)