"ANIMAL SPIRITS", the SNAP IPO, and CalPERS

The Standard and Poor's 500 Index ("the Index") flirted with 2400 last Wednesday.  At that level,  the Index became 80% overvalued according to Shiller's CAPE Index. He uses a mean P/E multiple of 16.7 to determine fair value. That is the mean over 145 years.  I use a mean P/E of 19.6, the mean over the last 50 years. According to my approach, the Index is 50% overvalued.  No matter how you slice it, the Index is way overvalued. If the Index reverted to fair value immediately, according to my valuation approach, it would  decline by a third to roughly 1600.

As I have written in previous posts, whenever the CAPE becomes ten percentage points more overvalued, it triggers an automatic rebalancing of my equity exposure back to 30% of my financial assets.  Accordingly, yesterday I rebalanced.

Recently, the phrase "animal spirits" has appeared frequently in investment news letters.  "The animal spirits are behind the stock market melt up since the Trump victory." "This is only the beginning of the last phase of the bull market that began eight years ago this month."

This week's SNAP IPO is evidence of this phenomenon. It is the first large tech company to go public in quite some time. The offering was priced at what I would euphemistically describe as "full" and then appreciated 50%!  Shades of 2000 when the dot.com bubble burst--when Professor Shiller published his book "Irrational Exuberance" almost exactly at the top of that bull market.  (That effort won him the Nobel Prize for Economics.)

Furthermore, the percentage bulls at Investors Intelligence reached its highest level since 1987!

Another example of a pricey stock market is that CalPERS, the California public employees retirement fund, one of our country's largest institutional investors. recently reduced its long-term expected  return on its assets from 7.5% to 7.0% and announced this week that it would reduce it again! (According to my calculation, a conventional 60% stock/40% bond portfolio would, at best, return 2% during the next five years if a reversion to stock and bond market means occurred during that period.)

Unfortunately, the "animals" are the retail investors, many of whom have missed the entire move in the Index from 666 in March, 2009 to roughly 2400 last Wednesday.  It is a shame that, historically, the retail investor tends to buy at the tops of bull markets  and sell at the bottoms in bear markets. (This is borne out by mutual fund inflows and outflows.)  This behavior wreaks havoc with baby boomers' retirement funds.

Yes, the animal spirits could propel the Index higher from here.  I look upon such a happening as an opportunity to rebalance again. This raises the question "How overvalued must the market be to warrant your selling your entire equity position?"

If the Index soon reached 3200 (up a third from here) and the U.S. Treasury note yield reached 4% (it is now at 2.5%),  I would liquidate the entire equity position and buy the Treasury note.  While such an overvaluation did occur in 2000 when the Index reached its most overvalued in at least a century,  I attach a de minimis probability to that event,  (See my recent post entitled "WAITING FOR GODOT" for why I think so.) Meanwhile, for financial planning purposes,  I assume that the Index valuation reverts to its mean P/E of 19.6; and I take a "haircut" of one-third off the current equity valuation for a more accurate view of reality.  I find this especially useful for long duration accounts such as my grandchildren's Section 529 college savings plans.