Why Hasn’t the Market Crashed Like the “Experts” Warned?

The investment “expert” and pundit world is full of both permabears and permabulls.  Both sets of blowhards are pretty annoying because they refuse to change their outlook regardless of a change in conditions and nobody is there to call out every expert that’s been wrong.  There’s no story there pointing out all the people who make lousy predictions, but everyone tunes in to hear what “the guy who called the housing crash” has to say, even if all his subsequent predictions have been wretched (note Paulson’s hedge fund returns the past few years even though he’s the subject of the book ” The Greatest Trade EVER”).  They suffer from the worst type of confirmation bias because there’s a lot of money and influence involved with their lousy predictions.  Often times, only the most outrageous predictions get airtime.  When’s the last time CNBC gave a mouthpiece to a guy who said, “Well, I don’t really know what will happen and most likely, next year will be pretty much similar to last year”?  Occasionally John Bogle will get on and talk some sense, but he shares airtime with the idiot predicting Apple’s $1,111 share price target.  What’s especially insidious is that the thesis they lay out seems so convincing, and they back it up with “data”.  See ever since we were running around on the Serengeti Plain dodging predators, humans have sought to find patterns and warnings in everything.  As Nassim Taleb so eloquently pointed out (once you read Fooled by Randomness, you’ll never look at financial experts the same), from an evolutionary standpoint, it was much more beneficial to spot the leopard pattern and be right than to think you see a pattern, react to it and be wrong.  Being wrong and cautious took no energy, but being wrong and missing a leopard?  Well, your gene pool stopped there.  So, with that backdrop, when we read a post from a permabull with overwhelming data pointing toward a market crash, it certainly gives one pause.

Take all these compelling posts about how overvalued the market is based on bloated P/E ratios (a crash was imminent apparently…months ago before another double-digit gain we’ve seen in equities).  It makes complete sense to look back and various market corrections and say, “Aha!  You fools!  You were buying at the top, you should have sold!“.  In retrospect, this is completely true of the housing collapse.  We know now from hundreds, yes hundreds of years of history of housing prices in both America and England, that in general, real estate prices roughly trend with inflation.  The correlation is impeccable and during the runup of the 90s and 2000s, the valuations on real estate went so far from the trendline that it started to look absurd.  But if you had this thesis in 2003, it took 4-5 years to come to fruition.  The problem with doomsday predictions is not only that you might be wrong, but you never get the timing right.  And then, alas, when the crash finally happens (even if it’s years or decades after the call), an “expert” can say “I told ya so”!

But back to the central question.  Since we DO appear to be way over trendline for the price to earnings ratios of US equities and many so-called experts have called for a market crash to bring us back to reality, why hasn’t the market crashed?  After all, we reelected Obama, who’s supposed to be terrible for business with his Obamacare, handouts and tax increases.  We have continued conflict in the Middle East (whom the media has grown tired of covering), we are coming off the highest average gas prices in history in 2012, unemployment is going nowhere fast, and so on.  So you’d think we’d have had our market crash by now.

The answers are probably multifaceted and at the same time, the answers probably don’t matter.  All that matters is the reality that the market continues to run.  But here are some possible explanations:

• Interest Rates are Low and Going Nowhere – What these historical charts of P/E ratios to stock price returns don’t take into account is that there is nowhere left to go but equities.  Bonds are a bubble, real estate has deflated, cash is losing money to inflation and companies have cut so much out of their structure that even if they’re not growing their top line, they’re still growing their bottom lines and are flush with cash.  Credit is so cheap that the world is flush with cash.  Since most of it is fungible, naturally, it has to flow to equities with their dividend payouts and potential for capital appreciation.  All the other options are, well, just worse.

• Corporate Balance Sheets Have Improved Dramatically – As I mentioned above, even though the US consumer is suffering, businesses have found ways to do more with less.  I see this in my company.  Our top line is projected to be roughly flat for years, as the US and EU start getting tougher with pricing on medicines.  However, there’s growth in the emerging markets and constant rounds of cuts to keep costs down, thus improving profits.  If it’s not software and outsourcing (seriously, how much of your job could you outsource?), it’s robots (THE story of 2013).

• Directionally, We’re Improving – As hard as it is to believe with the idiots at the helm, we’ve removed much of the “uncertainty” around the fiscal cliff and we’re not seeing a dropoff in new car sales, new home sales, retail, etc.  While we’re using deficits to sustain our standard of living and some poor sucker of a generation will have to pay down the road, this generation is humming right along now (at least better off than we would be if we lived within our means as a nation; the false prosperity of $1 Trillion annual deficits buys a lot of crap).

I could go on, but none of that matters.  It’s just platitudes.  What does matter is whether you had the right investment strategy to begin with and whether you stuck to it.  Were you one of the ninnies who pulled all your holdings out of stocks during the financial crash and never went back?  Because “the stock market’s a scam?”.  Well, you left 100% returns behind.  Personally, I think rather than paying any heed to the blowhards on CNBC and what lousy personal finance magazines still exist (are they all out of business yet?), you’d be best off focusing your efforts on more passive strategies (check out ETFBase.com for low-cost ETFs in every sector and strategy imaginable) with the right time horizon and risk tolerance setting your asset allocation.  Trading in and out of stocks in your retirement plans based on what you heard on TV or read on a doomsday blog is a recipe for disaster.

While humans evolved to identify risks and react to many patterns with fear regardless of whether they are inert or real, have you evolved yet?