I breathed a sigh of relief when I awoke this morning to a strong day on the markets. Yesterday I caught a brief glimpse of the Lang and O’Leary Exchange, when they brought on this investment banker to explain why he feels the stock market is overvalued by 20%. For starters, he is estimating a parameter that cannot be accurately measured. You could look at price to earnings ratios or equity/asset ratios and make an estimation as to the fair value of a stock, but since expectation of future performance (which cannot be reliably predicted) is also represented in the price of a stock, the aforementioned ratios cannot be used exclusively to draw the conclusion that stocks are overpriced. If we expect markets to completely rebound in another year or two, then that expectation is priced into the value of the stock whether or not today’s assets and revenues justify it. What he calls overvalued, I call tomorrow.
"The sun will come up tomorrow!"
To my "friends" over at the CBC, be “O’Weary” about inviting on a guest who is the Chief Economist at an investment bank to offer an expert opinion. He is just as likely to promote the positions of his investors as he is to tell the general public the truth. This "expert" admitted that he did not predict the 6 month incline of the market, therefore when he says that the market is overvalued by 20% he is validating his initial opinion. When he said the market would stay flat and it went up by 20%, rather than admit a mistake he simply begins promoting the idea that the market is 20% overpriced. If he is an investment banker, then he has rich clients whose money he invests with. Some of those clients may not be happy that their "expert" did not play the rising tide, and thus he has to sell the notion that the market is overvalued by the same error rate of his initial prediction to pacify his weary investors.
Basically all economists are all over the map right now in terms of predicting the future. Just because some guru in New York was right last time, that does not guarantee he will be right this time. There is more volatility than anyone can predict. Everyone knew there was a housing bubble and a credit bubble inflating at the same time, when far too much money was being handed out in loans. To compound the fracture, firms like Lehman's were buying these toxic assets and leveraging them into even more risky asset packages. They were building a great pyramid on top of a house of cards. That was the biggest mistake of the last downturn, a mistake that the majority of banks should be able to avoid making a second time. The popping of bubbles is a healthy component of our economy.
I will say that I want to see interest rates go up. Interest both the cost of borrowing and the benefit of saving. With rock bottom interest rates, we are making it easy to borrow and less rewarding to save. Sure there are benefits to easing the credit markets, but let's not get carried away here. Borrowing too much got us into this mess in the first place. Lowering the cost of borrowing down to zero seems inherently dangerous given what just happened.