Price is what you pay. Value is what you get.
-Warren Buffett
Here’s a chart showing the relationship between the S&P 500’s Price-to-Earnings (P/E) ratio and annualized returns over the next 2 years. It simply shows that your expected return is high when you buy something cheap, and low when you buy something expensive.
On a similar note, here is a link to John Mauldin’s weekly newsletter titled Thoughts from the Frontline from this past weekend. It dives into the current state of US stocks from a multitude of different valuation perspectives.
I still believe the US stock market as a whole (broad-based averages) is quite overvalued and it pays to select individual names that are positioned well and buy them when trading at fair prices. But whether you research and invest in individual stocks or simply use funds, the takeaway is the same – you want a large margin of error when making investments which means buying as cheap as possible. That’s easier said then done in this market so sometimes the best course of action is to be patient. A lot of retail (non-professional) investors often run into trouble because they make decisions emotionally. If you “feel” like you’re missing out on gains and need to jump in on the action, you’re probably making a mistake. If stocks are falling and you “feel” like the sky is falling and you bail on an investment, you’re probably making a mistake. Investing isn’t too different from a game of poker – you want to “play the player.” If you’re feeling one way, most other people are too. So let them fall victim to their emotions and make the wrong decision. I would say that 9 times out of 10 you’re better off doing the exact opposite of what you’re feeling in the markets.
My advice is to simply take a step back and think for a minute about what you’re doing – What are you buying? What valuation are you paying? What are the risks? What might change in the year ahead that the market isn’t expecting? Are positives already priced in? What if growth comes in at half of what you’re expecting? What’ your timeframe? If you can answer questions like these and still feel very confident in making the investment, then buy it. If not, then wait. The markets aren’t going anywhere. There will be plenty of opportunities in the weeks, months and years ahead. Just something to keep in mind as the Trump narrative behind this rally quickly turns into the Greater Fool Theory.
-Nick