Bubble talk is on the march these days, and for an obvious reason: trailing return is high. But as I’ve discussed before (see here, for instance), I prefer to describe the ebb and flow of market prices as a reflection of fluctuating expected return. On the surface it’s a cosmetic distinction. But managing portfolio risk in a productive way requires looking at markets as offering a constantly changing menu of risk premiums. It’s more exciting to think in terms of bubbles, but such a focus can be distracting when it comes to our primary objective of earning a satisfactory return across a multi-year span. The reality is that we’re usually making decisions amid shades of gray vs. stark, clear extremes. Accordingly, our investment process should reflect this reality.
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