"The individual investor should act consistently as an investor and not as a speculator."
- Ben Graham
Markets ended the year with a boom. A new President is heading to Washington, regulations are expected to ease, and we could see much needed corporate tax reform in 2017. We view these as positive and we’re not alone.
According to the American Association of Individual Investor Sentiment Survey, just 23.6% of investors felt bullish in the week before the election. Following the vote, the figure jumped to nearly 50% then settled at a still-high reading of 45.6% by year’s end.
Along with driving the indexes to new records, the euphoria led to a rush of cash into equity funds. For the first time in nine months, bond portfolios saw outflows while equity strategies were flooded with more than $58 billion in assets* during the weeks after the election. We’ve long believed stocks were a better bet for capital appreciation in a low rate environment and we welcome the reversal.
But while we share in the enthusiasm caution is required. The meteoric rise for equities has left valuations for many stocks inflated. The value of U.S. common stocks is near historic highs versus gross domestic product, as shown. The upshot is investors are paying more for each dollar of production generated by the nation’s businesses than at almost any period in the last 90 years.
Metrics for the Russell 3000® Index paint a similar picture:
- Price-to-earnings ratios are at 19.0x versus a historical average of 17.7x.**
- The Index trades at 1.8x price-to-sales, above a long-term average of 1.5x.**
These high valuations are particularly alarming given that the money flowing into equities has mostly gone to flavor-of-the-day passive products. Many of these index funds blindly buy stocks based on market cap with no regard to fundamentals. To us, that sounds more like speculating than investing.