See, this is real simple.
When you buy into a market that looks like this….
… you’re asking for trouble.
And even if you don’t immediately get trouble in the form of a pullback – or worse, a massive drawdown – the reality of the situation is that you just bought yourself some stocks that, depending on the metric, are more expensive than they’ve ever been in history.
So you know, it’s reasonable to assume that if you go out and you make a decision like that, your long-term relative returns will be constrained by the fact that you paid too much when you got in.
That’s so obvious it’s almost tautological, but given the rampant dip-buying we’ve seen over the past 9 or so months, a lot of people don’t seem to have a very good grasp on it. So here to help is SocGen.
Such a strong equity market performance and a continuing build up in corporate debt, coupled with somewhat sluggish profits growth, has pushed stock valuations up to historical highs. We tend to favour un-weighted (median) valuations, but most other measures paint a similar picture. The question then is does valuation matter? The answer depends on your objective. If you are aiming to time markets, valuations have little predictive power; lower quality stocks with lower valuations tend to fall most in an economic downturn. Higher stock valuations also do not equate to a higher probability of loss. Higher valuations do however have a very good record of predicting future returns. If you think an excess total return over bonds over less than, say, 2.0% (i.e., less than the dividend) is sufficient compensation for holding much riskier equities then today’s valuations might be okay; if you think equity deserve a risk premium then you have a problem.
Any further questions?