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Valuation expert Damodaran says he 'doesn't get’ Shiller’s portfolio advice

  • Yale's Robert Shiller says investors ought to diversify into Europe.
  • NYU's Aswath Damodaran says global diversification won't help.
  • Damodaran explains why he avoids market timing.

If you're anxious about stocks in the U.S., don't expect global diversification to save you.

That's what Aswath Damodaran, professor of finance at New York University's Stern School of Business, warned in a Thursday interview on CNBC's "Trading Nation."

Damodaran was responding to the point another prominent finance professor, Robert Shiller of Yale, made on the show the week prior. Shiller was presenting his now-familiar case that U.S. equity valuations have gotten a bit out of hand.

Valuations are sufficiently high that the market "looks dangerous now," Shiller said. He did not suggest pulling out of stocks, but did advise: "It's right now a good time to look at one's portfolio and ask if it's diversified enough. There's Europe over there, there's Asia over there, and I think most Americans are not well-diversified globally."

A high level of valuation engendered by great enthusiasm is "primarily a U.S. effect, and you can solve that problem by diversifying around the world."

Damodaran, known as a foremost expert on corporate finance and valuation, doesn't quite see things that way.

"The part I agree with is that we should all be more diversified. But the part that I don't get is, how is diversification going to protect you if there's a market crash?" he asked rhetorically, when presented with Shiller's comments.

"It's not the 1980s, where the U.S. market can be down 40 percent and the European market is going to be up 10 percent. If we [in the U.S.] are going to crash, we're all going to crash. Being diversified is not going to bail you out," Damodaran said.

Indeed, diversification notoriously does least when investors need it most — a statement that is becoming more and more true, as the world becomes increasingly global both in terms of trade flows and capital flows. If the U.S. falls into a recession, it is likely to hurt many exporting companies based in other countries.

And as investors look to preserve their remaining money after a crash — or are forced to sell assets that would otherwise be unaffected in order to raise funds — global equities may feel the pain.

In 2008, for instance, the Euro Stoxx 50 index plunged 44 percent — thus faring worse than the S&P 500. And the 100-session correlation of daily moves between the two indexes rose from 0.3 in early 2008 to above 0.8 in late 2009. In hindsight, it is clear that investors who diversified into European stocks in anticipation of a U.S. crash didn't do themselves much of a favor.

"The only way you can mitigate your losses is by getting almost entirely out of financial assets," Damodaran said. The problem, however, is that "the cost of staying out of the market is often greater than whatever you might benefit by staying out of the next crash."

Given this philosophical backdrop, Damodaran has little choice but to be sanguine.

"There's always a correction coming; it's only a matter of time," he said. "The real question you have to ask yourself is: Is it worth it to actually reallocate your portfolio to try to avoid that correction when you don't know when it will come, how it will come and what form it will take?"

"I have never been able to make that prediction solidly enough to reallocate my portfolio," Damodaran continued. "Maybe there are others who are better at timing the market than I am, so I'm not going to stop other people from making their own judgment. But for me, market timing has never worked."

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Trading Nation is a multimedia financial news program that shows investors and traders how to use the news of the day to their advantage. This is where experts from across the financial world – including macro strategists, technical analysts, stock-pickers, and traders who specialize in options, currencies, and fixed income – come together to find the best ways to capitalize on recent developments in the market. Trading Nation: Where headlines become opportunities.

Brian Sullivan

Brian Sullivan is co-anchor of CNBC's "Power Lunch" (M-F,1PM-3PM ET), one of the network's longest running programs, as well as the host of the daily investing program "Trading Nation." He is also a frequent guest on MSNBC's "Morning Joe" and other NBC properties.

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