The stock market looks expensive when you take an
intermediate term view (3 to 10 years).
That sounds a tad frightening, but don’t let the long view lead to
short-sighted decisions in your equity portfolio - at least for the next 12 to
36 months.
A recent MarketWatch
article, by Mark Hulbert points to indications of long-term overvaluation
and asserts the following:
- Stock market is not at all-time high in real terms and is 24% below the peak.
- CAPE (i.e. long-term Price to Earnings, a longer-term valuation metric) suggests weak market returns over the next 10 years (close to zero in real terms).
- Despite CAPE being rich, it doesn’t mean markets will move in a straight line down and the recent rally (I assume since the 2009 bottom) can continue.
I believe we run similar in-house
models to Mr. Hulbert, and while I tend to agree, they do need some context:
- This suggests the market still has more room to run.
- Other valuation models we run indicate a similar trend. But over time market valuations have trended up, suggesting the decline may not be as severe as the average would dictate.
- The market can stay overvalued for quite some time and the conditions appear to be in place them to do so. I actually just heard famed investor Joel Greenblatt mention the market is cheap on his free cash flow measure, a shorter-term metric, and this is confirmed amongst sell side research we use. Also, momentum metrics can help determine when a change in the market is afoot.
So I am on board with the contention the market will revert
to the mean as this market cycle ends, leading to a correction, which very well
could be larger than anticipated by most.
But I also think there needs to be some perspective around it – don’t miss the upside while you wait for
the mean reversion.
The takeaway is to make sure you and your advisor are aware
of the longer-term trends and the likelihood of mean reversion, but don’t avoid
stocks altogether. Just have a plan to
mitigate the risk when the upside trend starts to reverse.
Past performance is no guarantee of future results. The views and opinions expressed
herein are those of the author(s) noted and may or may not represent the views
of Capital Analysts, Inc. or Lincoln Investment.
