No. of Recommendations: 1
LOL, I watched Josh Brown and James Lebenthal arguing with each other about high valuations on CNBC's Power Lunch today. The argument got pretty heated. But then James said "Sometimes you're right, sometimes I'm right." And that, my fiends, is the correct observation.
I said to Jim (mungofitch) in an earlier thread that his preferred investment, Berkshire, is also hitting record highs, so why are we arguing? We should both be celebrating!
Higher valuations = lower future returns, it's basic math.
I totally agree with you that the market is expensive relative to traditional valuation measures. I also agree with you that the market could experience a correction of 10% to 15% at any time from these levels. Corrections like that have happened every 18 months, on average, since the 1980s. So it's a matter of when, not if.
How you're going to handle a hit like that is different for different people. People who are already retired early and financially independent (like me and many others here) should have a portfolio allocation that let's them sleep at night. This includes 5 or more years of living expenses in cash, income sources from SS , dividends and pensions, a good chunk in bonds, etc. The stock portion is there to combat future inflation and give you a higher safe withdrawal rate. If that portion, by itself, takes a 10 to 15% hit, I don't lose any sleep. But I don't know how others here would feel.
It would be great if, as you say, future returns were based on "basic math". Unfortunately, the stock market cannot be predicted using basic math. If it could, then mathematicians would be multi-millionaires. Simply short the market when the math formula tells you to, and go long when the math says so.
There's definitely a part of the market that is based on a company's future earnings streams. You can try to model that part mathematically using DCF. But there's another part of the market - namely, SENTIMENT (fear and greed) - which cannot be modeled mathematically.
I minored in math in college, so I can talk to you about things like heteroskedacticity all day. But that doesn't make me a better investor. Mark Minervini is a very wealthy 2-time winner of the US Investing Championships. He's a high school dropout, but he wrote 2 best sellers on how to find super-performing stocks in Stage 2 uptrends.
The Mechanical Investing board has spent 20+ years trying to come up with a system that minimizes severe drawdowns. These systems try to get you out just before a bear market and get you back in before the next bull. They now have 3 "bear catcher" indicators.
Here's the kicker: none of the 3 bear catchers (BCs) are based on how expensive the market currently is.
The first BC looks at the 200-day moving average of the S&P 500, the second one looks at the difference between the number of Nasdaq stocks hitting 52-week highs minus the number hitting 52-week lows, and the last one checks to see if the market hit a new high within the last 99 days. None of these indicators have anything to do with the market's P/E ratio.
Right now the BC signals are Green, Green and Green, indicating that we're in a Bull market, and should have our maximal allocation in stocks. In other words, make the hay while the sun is shining.
Wishing everyone good luck.
Mechinv
