A quick note on John Mauldin’s latest. This is another great piece from John. The role of valuations – what investors are willing to pay for a dollar of earnings – is critical in the stock market. More important than the earnings themselves. Another very important point is the difference between secular bull and secular bear markets. Something that is, too often I think, lost on both investors and their advisors.
In a secular bull, such as we had from the early 1980s to 2000, everyone can be an investing genius (unless they try to get too cute – there’s always a way to screw it up). Just pick a few blue chip stocks or a plain vanilla index fund, hold onto them, buy more shares on every dip… and voila: after 10 – 15 years you’ve got a pretty handsome portfolio.
This was our experience, so this was the mentality that set up so many investors for the disappointment of the past decade. The mutual fund industry, and sell side advisors, assured everyone that this was how it would be, forever. Can’t time the markets, stay the course, blah blah blah. In a secular bear market, this “wisdom” is a recipe for investing failure – except for advisors and fund managers who get paid whether you win or lose.
In a secular bear, as the data show, there are big gains to be made, but severe declines along the way. Since the bursting of the stock bubble in 2000, we’ve had a few nice rallies and some terrifying meltdowns. To invest successfully, you’ve got to be able to move in and out, be decisive and be quick about it. Otherwise, stay out of the market and keep your money somewhere safe.
As John showed us, valuations were a big piece of the puzzle. The long stock bull market was driven by strong demand that pushed share prices up. Yes, corporate earnings grew smartly during the broad economic expansion. What we need to recognize as well, is that a big part of that rise in share prices came from “multiple expansion” or rising P/E ratios – investors were willing to pay more for a dollar of earnings. Today, we have to ask whether investors are willing to pay as much for that dollar of earnings.
Because this really comes down to the demand for stocks, at a basic level we can restate the question as, “is there still a strong demand for stocks?” For a hint, we can look at things like exchange volumes, but high frequency trading bots have made that data less reliable. We might look at other evidence like stock mutual fund flow stats published by ICI. What this shows is that demand is not so robust. Not terrible, but not the stuff raging bull markets are made of.
Stay alert if you’re going to venture into these markets. We’re in a secular bear, and if John is right – I think he is – it’s going to be around for a few more years. There will be opportunities to capture gains, but it’s going to take some effort. Picking a few blue chip stocks or couple of good funds and sitting on them may not work as well as it did in the 80s and 90s.