Bubble Trouble

Jahnke, William
August 2002
Journal of Financial Planning;Aug2002, Vol. 15 Issue 8, p38
Academic Journal
This article discusses why there is a need to reevaluate assumptions made by financial planners on current asset allocation. Most financial advisors engage in active stock selection and reject the idea of active asset allocation. This specious argument supporting active stock selection and rejecting active asset allocation is that the stock market is micro-inefficient while the pricing of asset classes is macro-efficient. There are two things in common in each of the foregoing approaches to forecasting the equity risk premium. The first is that the end-of-period price/earnings ratio is assumed to hold in the future. A second thing in common with the foregoing approaches is that historical earnings growth rates will be met or exceeded in the future. Trends in globalization, legal costs, insurance rates, pension fund costs, security costs, accounting rules, regulation, taxation and the share of the pie demanded by intellectual capital all tend to pull down profit margins. Even the acceleration in the rate of technological change, and the expansion of information technology with its greater transparency in pricing, do not necessarily bode well for corporate profitability. One of the questions dogging investors and advisors is whether the stock market bubble of late 1990s not already affecting the market. The answer to that question depends on the relationship between expected returns and required returns.


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