Although U.S. stock valuations are stretched, economist and leading authority on behavior finance Andrew Lo says this can continue for years due to growing demand for equities by retirement funds,” says a recent article in MarketWatch.
Lo is director of the MIT Laboratory for Financial Engineering who also helped establish the new Office of Financial Research under the U.S. Treasury Department. In a recent interview, he asserted, “Having a large number of passive investors buying and holding index funds for the next 20 years will cause the market’s value to continue to rise.”
But the issue of whether the stock market is overvalued is not a simple one, according to Lo, who argues, “I would need to know who all of the buyers and sellers are. How many pension funds, foundations or hedge funds are looking to buy? How many use active equity managers and on what time horizon. I need to measure the flora and fauna of the financial ecosystem,” he said. Lo added that the bulk of analysis doesn’t properly value the market because it fails to account for the short- and long-term dynamics. He says, “In the words of Benjamin Graham, in the short run the stock market is a voting machine and in the long run it’s a weighing machine.”
But Lo isn’t suggesting that a pullback can’t happen, according to the article, and believes that “investors should approach the market always aware of the possibility of a massive selloff.”