Set It and Forget It - Don't Fear the Market Run-Up - S&P 500 (INDEXSP:.INX)
The New Year brings a natural reflective response to most people, and with regards to investments and stocks in particular a common question lately is whether to stay in the market given its run over the past 4 years. I believe assets invested in the market should stay in the market” almost” all of the time. The result of this philosophy is simple; I tune out the majority of talking heads constantly talking about the coming crash. While the Bearish type commentators sound convincing at a point in time, when one examines their records across time most of them are massive losers. Investors that tend to try to move in and out of the market tend to directly or indirectly lose significant wealth.
I understand that pull to time the market is just too great for many people, so I will share two charts I use to make sense of market valuations and provide discipline to any thoughts about reducing market exposure when things get scary. Taken together, my conclusion is – The market does not look particularly attractive, but it is not over-valued to the point that warrants adjusting target exposure levels.
The first chart displays the implied sales growth embedded in the market price for stocks with market capitalizations over $6 Billion, or what is commonly considered to be “Large Cap” stocks, and compares those expectations to the sales growth these stocks have delivered over the past three years.
The main takeaway from this chart is simple – the market has priced the typical Large Cap company to grow its sales at just under 10%, while over the past three years such companies have grown at just over 10%. From this perspective, I conclude the market is fairly valued.
Another perspective that I like to incorporate into creating my market view is to evaluate the intrinsic value of each company relative to its traded price and determine if the market is over or under valued from a bottom up perspective. This is displayed in the following chart.
Going back to 1996, using this approach we see two distinct “bubble” periods – the tech boom of ’99 and the mortgage crash of ’08. In each instance, market valuations deviated from the intrinsic value of companies by 60% in each instance. In mid-’09, we issued a study titled “Then and Now” which contrasted the extreme opportunities available to investors in 2009, relative to the train wreck awaiting investors in late 1999 and concluded that the stock market presented a generational opportunity to amass wealth by being long++ the market. Today, market valuations slightly exceed intrinsic values, but not by enough to warrant any significant actions.
Earlier I mentioned that market calls should “almost” never be made. I call that the Max the Miracle Worker rule. Max from Princess Bride could bring those that were “almost” dead back to life. Similarly, I begin to get excited about overall market adjustments to portfolios when we see extreme readings on our various macro metrics, for the intrinsic value chart above, I would need to see market prices exceed the intrinsic value of individual stocks by over 15%. For now at least we are not close that figure, until then I would continue to just “Set It and Forget It”.