This is a preview of an upcoming column.



“The four most dangerous words in investing are: ‘this time it’s different.’ ”  -Sir John Templeton

What do these words actually mean to investors today? As of late, more than a few pundits have been misinterpreting their meaning. With a wave of a hand, they dismiss data and fundamental metrics that are in fact very different – sometimes, by a lot. When a significant input to corporate earnings is several standard deviations away from its historical mean, that is different. This is not what Templeton was referring to. This misinterpretation has been costly.

What does ‘this time it’s different actually mean?

Stated simply, Valuation always matters. There is no new paradigm that will ever change that. What you pay for a stock or index will ultimately determine the return it generates over time.

What is never different is the behavior of investors. It is always driven by greed and fear. That is simply human nature at work.

We all understand the basic formula for valuation: Price relative to earnings, or P/E ratio. And as I noted yesterday, there are many ways to measure valuation. “Stocks can be defined as cheap (the rule of 20, which adds the inflation rate to a stock index’s price-earnings ratio) or fairly priced (forecast P/E), somewhat overpriced (12-month trailing P/E) or wildly overpriced (Shiller’s cyclically adjusted P/E).”

What Templeton was not suggesting was for investors to ignore the many factors that actually impact valuation. Metrics such as GDP, Unemployment, Inflation, Interest Rates can move to extremes, and this should be noted. He was not suggesting these factors should be ignored because they are “different” than they were previously. Rather, he was warning that you should check your own behavior if you believed a new era was upon us and that valuations no longer mattered.

Should one ignore inflation rates of 12% or bond yields of 2%? Of course not.

This is a nuanced but important difference.

In 1974, the P/E ratio of the S&P500 was 7.33, but inflation was running at 11% and the 10 Year bond yield was 7.4%. Real returns were negative. Should investors have ignored that different data? By 1981, P/E ratios were about the same, but risk free yield of the 10 year was over 15%. Some investors of that era dismissed the fundamental differences. Those investors in the early 1970s who bought stocks because they were cheap were surprised when they got much cheaper. Real returns in the decade of the 1970s reflected a near 75% loss.

Identifying when metrics that matter change is very different than recognizing when the collective madness of the crowd no longer believes valuation makes a difference.

This is an enormously important difference.


More on this tomorrow . .  .
Update: Sunday’s column is posted here


Category: Investing, Psychology, Valuation

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

5 Responses to “Preview: What Does “This Time Is Different” Really Mean?”

  1. Frilton Miedman says:

    Atop factoring rates, I wonder if there shouldn’t be a broader metric that more accurately measures consumer buying power, i.e. – wages, net worth and household debt to income ratio, in conjunction with rates.

    I say this for the fact that despite incredibly large excess reserves & rock bottom rates, banks aren’t putting that money to use as they always have, there’s apparently no demand for it.

    To me, it would seem businesses should be borrowing like crazy with rates this low, but they aren’t, which leads to velocity of money, which is at the most repressed levels since the Fed started tracking it. (I can’t completely blame some of the wingnuts for ranting over pending “hyperinflation”)

    I just think most economists, and economic schools, are too “tunnel visioned”…I can appreciate that at least Yellen has had the temerity to go outside that box and openly discuss income & wage growth as a problem.

  2. BR,

    how is this: “…Real returns in the decade of the 1970s reflected a near 75% loss…” calculated?

    I’m Not saying that the “#” should be ~76%, 74.2%..or, some other..

    I’m asking “How?” do you derive it? is it some compounding of (USGov reported) annual CPI #? or some other contrivance?

    also, is it measured in U.S. ‘Dollars’? or, differently, “Basis which?” (?)

  3. Aaron says:

    “Rather, he was warning that you should check your own behavior if you believed a new era was upon us and that valuations no longer mattered.”

    Or as Ice Cube once rapped, “You better check yo self before you wreck yo self”! Word is bond, yo’…no pun intended!