MICHAEL BURRY IS a hedge fund manager who gained fame betting against the housing market in 2008. When that market collapsed, Burry made a fortune, and that cemented his reputation as a market seer. Burry was later portrayed as the central character in Michael Lewis’s The Big Short.
But in the years since, Burry’s predictions haven’t turned out as well. Five years ago, he spooked index-fund investors when he argued that they might have trouble accessing their funds. “The theater keeps getting more crowded,” he said, “but the exit door is the same as it always was.” That scenario never materialized.
Over the years, Burry has issued other warnings. During the 2022 downturn, he predicted that things could turn out “worse than 2008.” In early 2023, he summed up his thoughts in one word: sell. The market’s gone much higher since those warnings.
I don’t mean to focus only on Burry. Few investment prognosticators have reliable track records. But this presents a conundrum: We know that we can’t make predictions of any precision and yet, in formulating our financial plans, we need to make some assumptions about the future.
To do that, our only and best guide is to consult historical data, even if we know that the roadmap provided is necessarily imperfect. That’s why, as we begin the new year, I think it’s worth examining some of today’s key trends and thinking about where they might lead. We can look at two areas in particular where there’s considerable debate.
The main question investors are asking today: What should we make of the U.S. stock market? By virtually every measure, it’s expensive. Over the past 15 years, the S&P 500 has returned an average 14% a year, far above its 10% long-term average. As a result, the market’s price-to-earnings (P/E) ratio, based on estimated earnings, now stands at more than 21, significantly above its long-term average of about 16. According to another popular P/E measure known as the CAPE ratio, stocks today are more expensive than at any point in history other than 1929 and 2000. A projection by Clearnomics, based on today’s market’s P/E ratio, implies that stocks will lose an average 1.5% a year over the next decade.
By contrast, virtually every market outside the U.S. looks like a bargain. International stocks have significantly trailed their peers in the U.S. As a group, the P/E ratio of stocks outside the U.S. is just 13. To some, the conclusion is clear: Rational investors ought to shift their holdings toward these cheaper international markets. If these valuation figures are worth anything at all, it would be unwise to be complacent about the U.S. market.
That’s one point of view—but not everyone agrees. According to one very reasonable analysis, there’s good reason for domestic stocks to be so expensive. In short, it’s because the technology companies that dominate the domestic market are far larger and far more profitable than their international peers. It’s become a bit of a cliche to talk about the Magnificent Seven stocks that lead the U.S. market—Nvidia, Apple, Microsoft, Amazon, Alphabet, Meta and Tesla—but the fact is that most other countries don’t have even one company that’s in the same league as these seven.
Another factor that could justify the U.S. market’s lofty valuation: As a recent writeup points out, many economies outside the U.S. have been ailing more or less continuously since the 2008 financial crisis. Many countries in the European Union have struggled with sovereign debt issues and with stubbornly slow growth. These issues may be structural rather than temporary. Recall, for example, the violent protests in France a few years back when the government proposed shifting the retirement age from 62 to 64. For better or worse, attitudes toward work differ from country to country, and ultimately that flows through to corporate profits and thus to stock prices.
Which way will things go? Without the benefit of hindsight, no one can say. But as investors, it’s critical to be aware of—and to keep an eye on—this question.
A second, related question has to do with economic growth. Population growth is a key driver of economic growth because, in simple terms, a growing population provides a larger base of consumers. That allows companies to increase their sales and profits. But population growth in the U.S. has been on a troubling downward trend for decades.
Today’s population is growing at about half the rate it was 30 years ago. This trend is by no means limited to the U.S. If it continues, economic growth may be slower around the world, and it stands to reason that this could translate into lower stock market returns. It would also have other negative effects. For example, with fewer working-age taxpayers, government budgets could be strained, as would the Social Security system.
But again, this isn’t a foregone conclusion. In the 1990s, worker productivity boomed, a result of the internet’s widespread adoption. That led to rising wages, rising share prices and a vastly improved federal budget situation. In 2000, the government actually ran a surplus, albeit briefly.
Could something similar happen today? There’s some initial evidence that artificial intelligence has started to contribute to an uptick in worker productivity. This could be enormously valuable, because productivity improvements allow companies to increase profits, giving them the option to raise wages or to reinvest in their businesses. Either way, it would have a positive effect on the economy and on stock prices.
It will take some time to know how real this is and whether it’ll continue. But this too is a trend that’s worth keeping an eye on. If the second half of the 2020s ends up looking like the second half of the 1990s, the positive implications could be significant.
I’ll acknowledge that I may have raised more questions than answers, so where does this leave us? In a recent report, Cliff Asness, founder of AQR Capital, took a lighthearted approach to the question. His report was titled “2035: An Allocator Looks Back Over the Last 10 Years.”
In other words, it’s written from the perspective of an investor looking back over the 10-year period starting today. He reviews each asset class, from stocks to bonds to private equity and cryptocurrency. His conclusion: Markets change, but human nature doesn’t. His prescription: We should be wary of complacency, wary of storytellers and especially wary of any argument suggesting that “this time it’s different.”
What does this mean for investors? The key, I think, is to strike a balance in our thinking. Yes, markets can and do change. But we should also stay grounded, remaining mindful of basic economic rules that don’t necessarily change. Perhaps the most important thing is to ask whether our finances are organized such that we could withstand whatever outcome the market delivers.
Adam M. Grossman is the founder of Mayport, a fixed-fee wealth management firm. Sign up for Adam’s Daily Ideas email, follow him on X @AdamMGrossman and check out his earlier articles.
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The analysis I use is mostly subjective, in that I read voraciously and think hard about what is presented to me, and then it all lands somewhere in my brain. I augment it from time to time with real research. Over time my subconscious tends to identify for me the things that I should worry about the most.
IMHO, the biggest threats to our future well-being are a major war and a serious and rampant plague. The likelihood of either is small but certainly not zero for me, knowing my life expectancy, and the damage either would do to my portfolio is disproportionately high. I doubt I could ever recover completely. As for the stock market itself, I think I still have enough time left here on earth that my portfolio will mostly recover unless one of those events is a true cataclysm.
I struggle with stock market valuations because stock prices are affected by inflation in ways similar to currency. The Magnificent 7 today is actually not the same portfolio as the Magnificent 7 five years ago. The names may be the same, but what you own is different.
All other things equal, and thinking solely about stock pricing, a stock worth twenty dollars today is cheaper than an equivalent stock that was worth twenty dollars ten years ago, because that twenty dollars today is worth only a fraction of what it was ten years ago. Inflation gradually craters values for almost everything over time, and so sticker prices must go up. Is my breakfast cereal worth $4 a box today when it was worth $2 two years ago? If my dollar was worth twice as much two years ago as it is worth today, the answer might well be yes. (I don’t think that is true, by the way.)
In the end, we are left to jump from melting iceberg to melting iceberg, and our real job is to find the iceberg that is melting the slowest.
Is the dollar overvalued?
We look at other countries as having sovereign wealth problems, but what about us?
What happens when very few people control a majority of wealth and when the government is deeply in debt and openly considers defaulting?
We are in new territory.
Perhaps for history, we need to be looking at other countries, not the US.
We cannot feel too secure about this
“Perhaps the most important thing is to ask whether our finances are organized such that we could withstand whatever outcome the market delivers.”
Adam, a great article and I appreciate the link to Cliff Asness’ article “An allocator looking back 10 years”. Despite its hilarious tone it does send an important message.
Overall, your points are well taken and my preferred approach of “buckets” based on timing of when assets will be needed in the future still seems pretty solid for me. Don’t overthink it, don’t change course based on prevailing trends and have confidence in your plan to weather the future shifts of markets.
Hope for the best, plan for the worst.
If a market is overpriced, you still need an event that sets off the crash. I don’t mean the election of Donald Trump, or the war in the Ukraine, I mean an event that directly affects the financial markets. Some large group of companies or people can’t pay – that’s when everybody says uh-oh.
When a government cannot pay its debts so its currency is devalued, does this make stocks more valuable or less valuable?
Some readers might enjoy a weekly, informational email/blog from Charlie Bilello, that does a nice job on providing charts and graphs on various economic indicators. More data than commentary and presented in a pretty straight forward manner. Subjects covered change week to week. This weeks coverage includes a few charts on international vs domestic holdings and a nice comment at the very end about being humble (2024: The Year In Charts). The email I get is free and includes links to a video version (for those preferring that format) and another video segment entitled, “Signal or Noise”. Link provided below. I definitely would recommend going back a week or two where Charlie does a fine job debunking (by example) many commonly held “absolutes” regarding markets (Put These Charts On Your Wall: 2024 Version). Hope you find it informational and enjoyable.
bilello.blog
Perhaps AI will help international stocks more than US stocks due to the shorter human workweek internationally.
Your final sentence is timeless advice, and the details preceding it explain why.
Excellent work! Major points include “because the technology companies that dominate the domestic market are far larger and far more profitable than their international peers.” and factors related to economic growth in foreign countries and productivity.
Whether it should or not, I feel better now with having only 20% of stock in foreign markets.
Meanwhile I’m thinking of nudging our international allocation up. That’s what makes a market as they say. I suspect either path will turn out fine.
All of our Roth funds are in Vanguard Total International ETF (VT), so it’s set it and forget it. The allocation for domestic vs international/emerging markets is set by the markets’ collective opinion of value.
We balance our overall allocation of stock/bonds in our traditional accounts.
VT is Vanguard Total World Stock ETF — not International:
https://investor.vanguard.com/investment-products/etfs/profile/vt
Don’t want readers to get confused!
Good overview, Adam. The last paragraph sums it up well, although not necessarily simple to execute. The only constant is change and I’d state that we indeed are seeing and experiencing domestic and global events and responses that are, “different this time”, either in magnitude, breadth, etc. Great point made on the human behavior aspect, however.
Nice article, Adam. Thanks for the link to the Carlson article. I appreciate an honest admission of ignorance as a rationale for diversification.