This post is the first of a few that will involve the idea of value and the implications of that idea in today’s market.
Do you believe the stock market is overvalued?
A “Yes” to the question above insinuates a few things. One being the belief that the market can be valued. Another being the admittance that price can differ from its true/fundamental value. Let’s work from this simple framework.
If the stock market can ebb and flow from being over or under valued, then the potential returns from owning stocks should vary as well. More importantly, the potential risks for owning stocks is a moving target. Said another way, there are better times to own stocks than others. This notion is far from “buy and hold” that states stocks should be bought at all times, no matter the price. We tend to believe that what we pay for something matters.
We believe that over valued markets are associated with lower potential returns and higher potential risks. A bad combination. We believe under valued markets are associated with higher potential returns and lower potential risk. A great combination. This has direct implications with how we believe portfolios should be built and maintained. In an environment of low valuation with higher expected returns and lower risks, buy and hold – all day everyday. The odds are stacked in your favor. But, when in an environment of high valuation, where expected returns are lower and risks are higher, the focus should shift.
Valuing the market should be used with this mindset. Certainty does not exist in the stock market and any model/indicator deployed should be used accordingly. Returns are only possible when risk is taken, but knowing if the juice is worth the squeeze, so to speak, can enhance investor outcomes.
What indicator do we use to gauge valuations? How does our focus shift from beta exposure to risk management? What tools do we use to adjust exposure? These are all questions we will explore in the next month or two. Today’s post was to get the idea of using valuations as a measure of odds more than anything else.