Jeff Miller | May 12, 2016 12:35AM ET
There is a general consensus that valuation indicators are not very useful for market timing. Despite this, the financial media and the blogosphere feature an avalanche of articles warning that the market is seriously overvalued. Your retirement account might drop 50% at any moment. There are countless worries in the world.
Many investors have been “scared witless” (TM OldProf) by this, missing out on a great opportunity. Is it now too late? What is the current potential for market gains?
Here are three things you do not know about valuation:
Conclusion
The bearish valuation theme has persisted for many years. It is usually invoked to claim that all indicators show an over-valued market. No other choices or ideas allowed! This is not a balanced analysis.
The consensus that valuation methods are not good for timing came years too late. It was only after the various bearish valuation indicators did not signal a buy in 2009. How many years will it take before investors catch up? Forget about changes in pundit opinion. They are all “locked in.”
The single greatest reason for the valuation error is the level of inflation and interest rates. And not the Fed-controlled rates, but the longer end that reflects market forces. Mr. Buffett, as usual, nailed it in his commentary, but few paid any attention. In an interview last August , he stated:
Buffett reiterated that he was a long-term investor, saying he expected prices to be “a lot higher” 10 years or 20 years from now.
He likened owning stocks to owning a home, saying that if homeowners expected prices to fall 5%, they wouldn’t sell their homes in hopes to buy it back for 5% less. They are locked in for the long haul.
He also stated, as he has on many other occasions:
What you can say now — [it’s] not very helpful – but the market against normal interest rates is on the high side of valuation. Not dangerously high, but on the high side of valuation. On the other hand, if these interest rates were to continue for 10 years, stocks would be extremely cheap now. The one thing you can say is that stocks are cheaper than bonds, very definitely. We’ve seen low interest rates now for six years or so, rates that we really wouldn’t have thought possible, particularly in Europe where they’ve gone negative. And that’s continued a long time, and of course we saw them continue for decades in Japan.
Do you think you should pay attention to What Mr. Buffett said fifteen years ago, or what he says now? Can’t he interpret his own indicator? Can you or I do better?
The same argument applies to Prof. Shiller, who is poorly served by the uber-bearish applications of his work.
My conclusion? Earnings prospects are important and remain my own principal focus for stock valuation. Stocks remain moderately attractive, despite the scary stories. Specific names are quite cheap, with low PEG ratios and great prospects. Develop a good shopping list!
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