What Not to Buy in Today’s Stock Market
Dear reader, if you are overcome with fear of missing out on the next stock market move; if you feel like you have to own stocks no matter the cost; if you tell yourself, “Stocks are expensive, but I am a long-term investor”; then consider this article a public service announcement written just for you.
Before we jump into the stock discussion, let’s quickly scan the global economic environment. The health of the European Union did not improve in 2016, and Brexit only increased the possibility of other “exits” as the structural issues that render this union dysfunctional went unfixed.
Japan’s population has not gotten any younger since the last time I wrote about it — it is still the oldest in the world. Japan’s debt pile got bigger, and it remains the most indebted developed nation (though, in all fairness, other countries are desperately trying to take that title away from it). Despite the growing debt, Japanese five-year government bonds are “paying” an interest rate of –0.10 percent. Imagine what will happen to its government’s budget when Japan has to start actually paying to borrow money commensurate with its debtor profile.
Regarding China, there is little I can say that I have not said before. The bulk of Chinese growth is coming from debt, which is growing at a much faster pace than the economy. This camel has consumed a tremendous quantity of steroids over the years, which have weakened its back — we just don’t know which straw will break it.
S&P 500 earnings have stagnated since 2013, but this has not stopped analysts from launching their forecasts every year with expectations of 10–20 percent earnings growth . . . before they gradually take them down to near zero as the year progresses. The explanation for the stagnation is surprisingly simple: Corporate profitability overall has been stretched to an extreme and is unlikely to improve much, as profit margins are close to all-time highs (corporations have squeezed about as much juice out of their operations as they can). And interest rates are still low, while corporate and government indebtedness is very high — a recipe for higher interest rates and significant inflation down the road, which will pressure corporate margins even further.
I am acutely aware that all of the above sounds like a broken record. It absolutely does, but that doesn’t make it any less true; it just makes me sound boring and repetitive. We are in one of the last innings (if only I knew more about baseball) of the eight-year-old bull market, which in the past few years has been fueled not by great fundamentals but by a lack of good investment alternatives.
Starved for yield, investors are forced to pick investments by matching current yields with income needs, while ignoring riskiness and overvaluation. Why wouldn’t they? After all, over the past eight years we have observed only steady if unimpressive returns and very little realized risk. However, just as in dating, decisions that are made due to a “lack of alternatives” are rarely good decisions, as new alternatives will eventually emerge — it’s just a matter of time.
The average stock out there (that is, the market) is very, very expensive. At this point it almost doesn’t matter which valuation metric you use: price to ten-year trailing earnings; stock market capitalization (market value of all stocks) as a percentage of GDP (sales of the whole economy); enterprise value (market value of stocks less cash plus debt) to EBITDA (earnings before interest, taxes, depreciation, and amortization) — they all point to this: Stocks were more expensive than they are today only once in the past century, that is, during the dot-com bubble.
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I am the CEO at IMA, which is anything but your average investment firm. (Why? Get our company brochure here, or simply visit our website).
In a brief moment of senility, Forbes magazine called me “the new Benjamin Graham.”
I’ve written two books on investing, which were published by John Wiley & Sons and have been translated into eight languages. (I’m working on a third - you can read a chapter from it, titled “The 6 Commandments of Value Investing” here).
And if you prefer listening, audio versions of my articles are published weekly at investor.fm.
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