Don’t Just Do Something ... Sit There!

Patrick A. Labbe, CFA

Because investment returns are based on what happens in the future, successful investors spend a great deal of time thinking about the future.  However, it’s also important to consider other, more immediate factors, such as where things stand today.

You may have heard some pundits claim that stock prices are high, perhaps too high.  Those making these pronouncements often rely on very simplistic models that compare current prices to another factor, such as GDP or corporate earnings.  These models are pretty much in agreement that stock prices are currently above their levels of several years ago.  Higher multiples are exactly what you’d expect with the economy returning to growth following the Great Recession, and the S&P 500 gaining more than 200% since its March 2009 low.  It’s clear that higher initial valuations imply lower returns going forward and perhaps higher risks for investors, too.  After all, I would probably be justified in expecting higher returns with less risk if I could buy Wells Fargo at $16 per share rather than $56, all other things equal.  Still, concluding that stocks are less attractive today than they were six years ago is not the same as concluding that they’re overvalued and should be avoided.

Another factor we can gauge today is investor sentiment.  Historically, investor optimism is low near market bottoms and high near market peaks.  So are investors currently more worried about losing money, or are they more worried about missing out on gains?  A survey asked Americans to name the best place to invest money they didn’t need for 10 years, and just 17% said the stock market.  That was a distant third behind real estate (27%) and cash (23%).  And a recent Wall Street Journal article on mutual fund flows reported that investors sold more than $50 billion worth of U.S. stock funds in the second quarter while continuing to add to bond funds.  Overall, I’d say that while investor attitudes toward stocks have improved considerably since the Great Recession (a prolonged bull market has that effect), it’s also clear that many investors remain far more concerned with losing money than losing out on gains.

So where does this leave us?  I’d say it leaves investors where they are likely to find themselves much of the time:  market valuations aren’t extremely cheap or terribly expensive, and investors aren’t panicked or euphoric.  In this environment, prudent investors may do well to maintain expectations for more normal returns going forward, demand sufficient compensation for risks undertaken and remain patient.  It’s the sort of environment noted investor Howard Marks was talking about when he said:  “Patient opportunism—waiting for bargains—is often your best strategy.”