Advice for an overvalued market

By Guest |  13-11-18 | 
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Morningstar invites thought leaders from the investment community to share their insights. Views expressed are personal and should not be construed as investment advice.

Vitaliy Katsenelson, Chief Executive Officer at Investment Management Associates, wrote a post titled The average stock is overvalued somewhere between tremendously and enormously.

Below are a few takeaways from that post.

This time it is different

During the 1999 bubble, I vividly remember the “This time is different” argument. It was the New Economy vs. the Old Economy. The New was supposed to change or at least modify the rules of economic gravity. The economy was now supposed to grow at a much faster rate.

In reality, economic growth in the U.S. over the past 20 years has not been any different than in the previous 20; in fact, it has been lower. From 1980 to 2000 the U.S. economy’s real growth was about 3% a year, while from 2000 to now it has been about 2% a year.

Does the market trigger a recession?

Did the stock market decline cause the recession, or did the recession cause the stock market decline? The answer is not that important, because no one can predict a recession or a stock market decline.

Justifying buying overvalued stocks

An argument can be made that stocks, even at high valuations, are not expensive in context of the current incredibly low interest rates. This argument sounds so true and logical. However, there is a crucial embedded assumption that interest rates will stay at these levels for the next decade or two. In truth, no one knows when interest rates will go up or by how much. But as that happens, stocks’ appearance of cheapness will dissipate.

Buying overvalued stocks because bonds are even more overvalued has the feel of choosing a less painful poison. How about being patient and not taking the poison at all?

Buying expensive stocks hoping that they’ll go even higher is not investing, it’s gambling.

It’s great to make money, but it is even more important not to lose it.

The market doesn’t need to collapse for us to be buyers. The market falls in love and out of love with specific sectors and stocks all the time. 

Focus on what you can control

Timing the market is impossible. I don’t know anyone who has done it successfully on a consistent and repeated basis. In the short run, stock market movements are completely random — as random as you guessing the next card on the blackjack table.

In contrast, valuing companies is not random. In the long run stocks revert to their fair value. If we assemble a portfolio of high-quality companies that are significantly undervalued, then we should do well in the long run. Yet in the short run we have little control over how the market will price our stocks.

We don’t own the market. Though the market may be overvalued, our portfolio is not.

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