We are now in one of the most optimistic and bullish periods of stock market during the past 2 decades. If you talk to beginners, you will probably come to conclude as if nothing can wrong. Cheap money, central bank’s put option that supports continuous rally etc to name a few factors that wouldn’t let this market drop. However, if you have been trading, like me, for more than 10 years, your gut will probably hint you that markets are overstretched, over bullish and overvalued.
Value! Value is a personal conclusion and thus varies. But let me illustrate this with very simple math-
Assume a 6% discount rate, an initial $1000 investment and yearly $200 cash flow for next ten years, then Present Value of all the expected cash flow is $1,472. However, if you change the discount rate to 1% (from 6%), the present value of expected cash flow ballooned to $1,894!!! (you may do more simulations here). That’s a +28.6% jump in the value of the same investment just because of a change in discount rate. Voila! If it was expensive earlier, it might be cheaper today. It is no secret that we are living in an artificially lowered rates environment.
(FYI, If you are an OPN member, pls see the list of Value stocks that I shared in October 2008. It had my price targets as well and you may compare when these stocks reached their values and how are they doing after reaching that point).
So when valuing companies, you have to be “rationale” and facts based (which is why usually realized earnings over 10 years is mostly a better indicator than speculation on earnings for next 10 years). This is like buying a house just because the mortgage rates are artificially low. As a prudent investors you may have to analyze (besides the “yield” and “potential” appreciation) if you can hold on that property when the rates finally rise to the mean (at least). I personally don’t think markets, at current levels, are offering value that offers a margin of safety.
It is now a public knowledge that central bankers are buying the stocks. I don’t know if they are really skillful in value investing and if they should be taking those risks. It’s hard to think of reasons other than driving the markets up. But one thing is really interesting, if they were to start selling, who will they sell to? Are they really smarter? And when that selling emerge, it will be “interesting” to say the least. However, I shall leave that thought for you to draw your own conclusions.
During the past 15 years, US markets rallied almost 100% 3 times and pulled back almost 50% 2 times. That’s plenty of opportunity! Check the chart below. And those opportunities surfaced due to numerous crises that markets went through.
A Bubble, as shiny and attractive as it may be, is still a bubble. There are lot of talks that we might not be too far off before the next crisis hits. The key question is “when”? I also don’t know when and I don’t think anyone has that crystal ball. But what I know is that crisis creates an opportunity.
Use your experience, knowledge to rationally value things around you. Some questions that might be of help are-
- Can you spot asset crises that are waiting to surface? are you prepared?
- What have you learnt from the past financial crises?
- Do you have the necessary skills that will be needed to benefit from the next?
- Do you have the required patience?
- Can you control the emotions to not chase the asset bubbles but rather prepare to benefit when it bursts?
In spite of all the gloominess and bleak forecasts, there are opportunities and there will be even more. Remember, opportunity dances with those who are already on the dance floor.
If you like this article, pls share it with you friends. Also let me know your comments, feedback or suggest topics. I will be glad to pen my thoughts based on my experiences.
Profitable Trading, OP