Market Valuation Update – September 2, 2010

I have updated all my market valuation data as of the close on September 1, 2010. I make no attempt to time the market using these valuations. These are simply another set of tools to try to, “Be Fearful When Others Are Greedy And Greedy When Others Are Fearful.”

As these indicators rise, you should be increasing cautious about committing capital. Conversely, you should look for periods such as March of 2009 to commit funds. Obviously, nobody can predict WHEN extreme price levels will reoccur. What is certain is they WILL reoccur.

Currently, stocks are attractively valued compared to bonds. What is unusual here is the extremely low yields that investors are accepting from bonds. These seem to indicate that many market participants are fearful and uncertain. The good news for investors is that it is quite easy today to put together a basket of high-quality stocks with an earnings yield materially higher than that of the S&P 500 and double that of high quality corporate bonds. Plus the yield on the basket of stocks can be expected to grow over time.

The Bottom Line and a Word of Caution

The market as a whole is not compellingly undervalued. But, given the low yields on bonds, the odds seem to favor equities. As a final word, never invest without a clearly identifiable margin of safety. Think about the downside first. What could go wrong? What are you missing? Why are people willing to sell me this stock if it’s so attractively valued? Are they selling because they have better information or are they acting irrationally? If you’re not sure, take a pass. Buffett has said on more than one¬†occasion¬†that many have recognized the same values he has seen and acted on them. What is different is that those same investors have taken undue risks and invested outside their circle of competence thereby diluting – or destroying – their overall returns.

Share

3 thoughts on “Market Valuation Update – September 2, 2010

  1. Daniel

    My concern with “a basket of high-quality stocks with an earnings yield materially higher than that of the S&P 500 and double that of high quality corporate bonds”, is that if interest rates spike up these stocks will get trashed.

    Reply
  2. Greg Speicher Post author

    Daniel. Thanks for the comment. You raise a legitimate concern as all assets will be repriced lower if interest rates rise. If the stocks you purchase (the basket) have a yield that is double that of bonds and growing you have a margin of safety. Also, if you bought businesses with pricing power and durable competitive advantages, they would be in a position to raise prices and better cope with a high interest/high inflationary environment.

    Finally, don’t confuse short-term volatility with real risk. The market might go down if rates go up, but if the basket of stocks still has a yield advantage over bonds based on your cost, you should do well in the long-term.

    Reply
  3. Matt

    Daniel doesn’t your concern apply *at all times* in the stock market? Can you name me a single case in the history of markets where there was not a potential scenario where stocks could “get trashed”? There is never a “safe” time to invest, in terms of there being no quotational risk. Even if you invest at a PE of 5 after a 75% bear market decline in the S&P 500, who is to say it won’t go to a PE of 4 or 3, and hand you a whopping short-term loss?

    If you allow the risk of short-term quotational fluctuation to keep you away from investing at 15%+ rates of return, then you will simply never invest in any risk asset. It’s that simple.

    Ask yourself this – if someone auctioned a suitcase full of $10,000, would you be afraid to bid $5000 because someone else might only bid $3000 tomorrow? The same principle applies in stock investing. If you buy $10k for $5k, you might only be able to sell it for $3k tomorrow or next month. But in the long run you are going to be able to sell it, at some point, for close to $10k.

    Reply

Leave a Reply

Your email address will not be published. Required fields are marked *