The prices of stocks, bonds and real estate, the three major asset classes in the United States, are all extremely high. In fact, the three have never been this overpriced simultaneously in modern history.
What we are experiencing isn’t caused by any single objective factor. It may be best explained as a result of a confluence of popular narratives that have together led to higher prices. Whether these markets will continue to rise over the short run is impossible to say.
Clearly, this is a time for investors to be cautious. Beyond that, it is largely beyond our powers to predict.
Consider this trifecta of high prices:
- Stocks. Prices in the American market have been elevated for years, yet despite periodic interruptions, they have kept rising. A valuation measure that I helped create — the cyclically adjusted price earnings (CAPE) ratio — today is 37.1, the second highest it has been since my data begin in 1881. The average CAPE since 1881 is only 17.2. The ratio (defined as the real share price divided by the 10-year average of real earnings per share) peaked at 44.2 in December 1999, just before the collapse of the millennium stock market boom.
- Bonds. The 10-year Treasury yield has been on a downtrend for 40 years, hitting a low of 0.52 percent in August 2020. Because bond prices and yields move in opposite directions, that implies a record high for bond prices as well. The yield is still low, and prices, on a historical basis, remain quite high.
- Real estate. The S&P/CoreLogic/Case-Shiller National Home Price Index, which I helped develop, rose 17.7 percent, after correcting for inflation, in the year that ended in July. That’s the highest 12-month increase since these data begin in 1975. By this measure, real home prices nationally have gone up 71 percent since February 2012. Prices this high provide a strong incentive to build more houses — which could be expected eventually to bring prices down. The price-to-construction cost ratio (using the Engineering News Record Building Cost Index) is only slightly below the high reached at the peak of the housing bubble, just before the Great Recession of 2007-9.
The end of the September in the stock market was a time of volatility, accelerated hedging and economic unease. It did not, however, spur an extreme reordering in trader sentiment, and to some of Wall Street’s old guard that’s worrisome.
Wall Street has been a booming place over the past year and a half even as the wider US economy has suffered — a trend that an entire generation of young investors has both noticed, and cashed in on.
Known as the YOLO generation — after the saying “you only live once” — the good fortune these new entrants to stock trading have had is sometimes viewed with skepticism by older investors who have seen the market boom and bust in the past.
There’s also the fact that young traders are some of the most eager proponents of soaring “meme stocks” like GameStop and AMC.
Outsiders may dismiss investors under the age of 35 as dangerously optimistic, but they generally see themselves as better informed than their elders and ready for anything — even a crash.