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6/16/14

Stock Market: Are Stocks Overvalued? The Uncertain Certainty Of Known Unknowns

Being a stocks-for-the-long-run kind of guy, I normally hate questions like this, since almost no one can make these short-swing calls profitably.  The people who make money in the stock market are the ones who buy and hold and take their lumps along the way. That’s the whole game in one sentence.

In the aftermath of the financial panic of 2008, global central bankers – feeling called to play their part on the world-historical stage and above all not wanting the planet to fall into Great Depression 2.0 on their watch — flooded the world with liquidity in an effort to combat deflation and save the financial system from itself.   This was what I was taking to Carolin about: how the great Godzilla of global deflation that stomped on Tokyo now threatened to come ashore in Brussels and topple the Eurozone.

Since central bankers have grabbed the controls, we no longer inhabit a “natural” economic environment, but instead live in a hot house terrarium where Ph.D.s pull the strings.

Problem: In this new looking-glass land, we don’t know what the conventional metrics mean.  Are stock prices justifiably high, or is their value in fact unknown, because we don’t know what the rate of interest is?

When interest rates turn so many other gears in the machine, it is hard to tell what is an artifact or an epiphenomenon – for investors, and now, ironically, for the central bankers themselves as they try to read and interpret the dials.  We — and they — don’t have a set of equations to translate from the domed Astroturf on which we now find ourselves back to the green green grass of the natural world.  We invest in a Heisenberg world of uncertainty. There is always risk and uncertainty, of course — this is the stock market we are talking about, after all — but this is the uncertain certainty of known unknowns.

For Exhibit ‘A’, consider the low volume and low volatility.  Imagine the Grand Bazaar in Istanbul, normally vibrant with thousands of buyers and sellers haggling over goods.  Then one day you go and there are only a few hundred people around, talking quietly.  Is that a good sign, because the market has settled down?  Or does it feel ominous?

To give credit, the central bankers have forestalled another great global depression.  They have bought time.  The predictions of their worst critics have not come to pass.  We are not awash in runaway inflation – unless the bubble is in now in risky assets like stocks, bonds and real estate, where we just don’t recognize it as such.

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