Investors become nervous when markets do well, thinking that the inevitable “other shoe” is about to drop. This is normal and understandable. A key to becoming an “all the time” investor is appreciating the power of the collective market. Even more important, clearly understanding that there is no such thing as a future fact. Regardless of the scenarios we imagine might happen, these are postulations at best.
What We Learn from the Markets
Both positive and negative markets can render critical lessons. We know that the broad economic conditions, as represented by unemployment and economic growth, have been poor over the past 3 or 4 years. During this time, however, the stock market has moved sharply higher, although not in a straight line of course. The lesson here is that the economy and the markets are somewhat disconnected. That is the usual course of events, even though we want to think otherwise.
Stock prices ultimately are a function of what companies earn in profits. Currently, based on standard Price to Earnings (P/E) ratios, investors are paying about 18 times each dollar of profits versus the historic average of about 15. A broader view, coined by recent Nobel Prize winner Robert Shiller, looks at a longer period of earnings. This “Shiller P/E “ is about 24 versus an average of about 16. On the higher end for sure, but far from the peak in 1999 of 44. Remember that stocks compete for investment capital with other assets such as bonds. From that perspective, it might be argued that stocks are relatively cheap as bond yields have been paltry for a few years.
Half Empty or Half Full?
The preceding paragraph provides a little information, which might be troubling or it can be soothing depending on your perspective. For some, the information fits into their ideas about the market being “frothy”. For others, it just demonstrates the variability of markets . Daniel Kahneman, another Nobel winner has written, “Facts that challenge basic assumptions and thereby threaten people’s livelihood and self esteem are simply not absorbed. The mind does not digest them.”
Most of the “pundit class” and most of those in the financial services realm are served by investors stirring up activity…moving in and out of the markets. To obtain good long-term investment outcomes, these voices should be ignored. They have an agenda that conflicts with yours.
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