It has been a while since I communicated my thoughts and observations on the investment markets and economy with our clients. My last letter came right after the pivotal national elections were over in November. My general encouragement at the time was (and remains) “Do not trade around elections”. Since then the S&P 500 – a measure of the value of the 500 largest publicly traded companies in the United States – has grown in value roughly 22%.
The most frequent question I hear from clients today – and the one I ask myself – is, “Are we in a market bubble?” In other words, are the prices of companies so over-valued today that the overall Market is due for a significant fall from grace? Perhaps. But, remember, asset bubbles are always announced and analyzed in the rear-view mirror. I loathe the click-bait financial headlines posted on various media and social media sites with quotations from “expert” prognosticators. “Mary Magnate Called 2008 Crash – Here’s What She is Doing with Her Money Today!”, “How the Rich Are Guarding Against the Impending Collapse!”, “Apocalypse Nigh – Financial Experts Warn”. I see at least one of these spurious headlines every day, in every market environment, and I would be dishonest if I said they didn’t cause me some amount of anxiety. I am convinced that, psychologically, we are hard wired to respond more to bad news than good. Fear is a stronger emotion than joy – sadly – and fear demands a response where joy does not.
What does this have to do with the bubble question? Well, it would be easy for us to talk ourselves into the belief that we are sitting on a huge asset bubble in investment markets and that our portfolios are on the verge of losing – big time. The S&P 500 is trading at a current P/E Ratio of 43.96 according to data provided at www.multpl.com – a higher P/E Ratio than it was trading at back in 2000-2002. (P/E stands for Price to Earnings – a measure of how much an investor has to pay for their share of the earnings of a company.) Surely, this is an indicator that assets are grossly over-valued! However, today’s high P/E Ratio may be more of a function of the abysmal earnings for companies over the past 12 months due to the COVID-19 Pandemic since the P/E Ratio is calculated on past earnings rather than future earnings (we do not know what future earnings will be). Prices for assets have increased dramatically over the past year: 1) Because they had fallen so dramatically at the beginning of the pandemic, and 2) In anticipation that future earnings will be much greater than they were last year – how could they not be?! Increased earnings alone could bring valuations down without the need for asset re-pricing (i.e. Market downturn), which is why I have been telling clients not to expect much in the way of investment returns over the next few years – earnings have to be given the chance to catch up to prices.
I have said this before, the “Market” is a big place. Not every corner of the Market is equal to the others. Some corners are grossly over-valued and arguably in bubble territory – looking at you Bitcoin and Tesla. While others look fairly valued – hello JPMorgan and Cigna. Am I saying we will not see a market downturn this year? No. Am I even saying we will not see a significant market downturn soon? Unfortunately, no, the Market tends to have a mind of its own. What I am saying is that it is hard to know – actually, no, it is impossible to know for certain what the Market will do next in the short-term. The only solution is to remain appropriately diversified amongst many types of investments, realize that you will experience ups and downs over the long-term – probably more ups – and maintain your investment strategy, especially when fear is telling you to do otherwise. You are not alone – please do not hesitate to reach out to us to discuss your unique situation.
*Investing involves risk including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss. Past performance is not a guarantee of future results. This material may contain forward looking statements and projections. There are no guarantees that these results will be achieved. It is our goal to help investors by identifying changing market conditions, however, investors should be aware that no investment advisor can accurately predict all of the changes that may occur in the economy or the stock market. The Standard & Poor’s 500 (S&P 500) is a stock market index containing the stocks of 500 American corporations with large market capitalization that are considered to be widely held. The S&P 500 is unmanaged and cannot be invested in directly.