Is the stock market overvalued? Wolfgang Münchau says it is in today’s FT. He cites some persuasive evidence, based on analysis by smart people: Professor Robert Shiller and Andrew Smithers. The U.S. stock market is overvalued by more than a third, we’re told.
Our own work suggests that caution looks increasingly prudent when it comes to risk exposures in asset allocation. But we’re not sure. To be precise, we’re not sure that a given quantitative profile of the market dispenses timely information about what returns will be in the immediate future. And neither does anyone else.
It’s tempting to thinking otherwise, but the future is always unclear. The good news is that the ambiguity oscillates with degrees of vagueness. But that alone isn’t enough. The challenge for investing is finding context and structure for managing asset allocation through thick and thin; through times when the future looks reasonably clear as well as during periods when the near term outlook for risk and return is murky.
The good news is that more than half a century of financial economics provides us with the tools and concepts for thinking clearly and productively about designing and managing asset allocation for the long haul, which arrives one day at a time. Different investors will come to different conclusions, but everyone should begin at a common point: the market portfolio.