I’ve noticed lately that way too many investment managers, analysts and economists interviewed by the financial media are saying the same exact thing: they think that stocks are fairly valued with the P/E ratio of the S&P 500 right at its historical average. Why is it that it seems people just regurgitate the same stuff everyone else says? No originality. It’s what psychologists call “groupthink” which stems from an internal fear that other people are always smarter than we are and it’s better, easier and less of a conflict to just go with the flow of the group. Following the pack is the reason markets push to the extremes from a snowball effect.
I’ll go out on a limb – using traditional valuation metrics, I think most stocks are grossly overvalued right now. With that said, I also think US stocks will continue higher. It’s not because they’re fairly valued making them a good buy, but rather, it’s because the distortions that are forcing investment money into the stock market are not correcting and might even be getting worse.
While we’re ending at the same conclusion of being bullish on stocks right now, the difference is how we arrived at our conclusion. If you want to understand where markets are going, you have to follow the money and understand what variables are causing it to move. It doesn’t matter how undervalued you might think an asset is. The true value of something is what someone else is willing to pay you for it. Using the rearview mirror of valuations based on last year’s earnings relative to the historical average is useless and will never provide warning signs to reduce your exposure to stocks.
Nick