"Valuations don't matter!" proclaim the same fools (motley and otherwise) who gave us the New Era, the Internet stock bubble, 100 P/E ratios and daytraders. The sorriest part of their proclamations is that they still have an audience to fleece with such irresponsible nonsense. Look at what happened the last time they said valuations didn't matter!
Valuations matter all right. Maybe not in the very short run. But in the long run, valuations matter. They always revert to some rational level. Always have and always will.
I begin with this little tirade because the chorus of those dismissing the importance of valuations has reached deafening proportions lately. I will not name names. If you follow the financial press, you know who they are.
I am not suggesting that the current rally will crumble into a bear market tomorrow. Over the short term (say, any six-month period), stock movements can be very unpredictable, a volatile mixture of emotion, momentum, seasonality and fundamentals. The right combination of liquidity and psychology often triggers movements of stock prices well above rational valuation levels.
The current market rally may have more short-term upside than the shorts can stomach. It might even continue through year-end. But just because stocks often trade through fair valuation levels, that does
mean valuations are irrelevant.
For stocks to rally considerably higher from here, profit levels must soar, or valuation multiples must expand. Neither development is likely. Remember, most market commentators who recommend purchasing stocks at today's prices did not maintain the irrelevance of valuations in September with the
at 1400! Those encouraging investors to join the "new bull market" seem to forget that one has already occurred! The cap-weighted indices remain very expensive, and their valuations discount significant earnings recovery, very low interest rates and little to no event risk.
At best, the market could sustain mid-single-digit percentage gains over the next few years. Sustain is the operative word in that sentence. At worst, the bear market could resume, and stocks could get significantly cheaper. For those who heed valuations, the two nastiest bear markets (one in the 1930s and one in the 1970s) bottomed at around 40% of revenue. The S&P Industrials trade for 160% of revenue today.
In the grinding market I forecast for the foreseeable future, buying and selling stocks properly will be the only way to make money. Forget buying and holding tech. That will not work. Stocks will need to be purchased after steep declines and sold after significant rallies. Stocks that have popped 50% to 100% are not "just getting started," as they were in the late 1990s. Price reversal strategies will work better than price momentum ones.
Considering the significant short-term price spikes in most shares, as well as their high valuations and still-bad fundamentals, it's hard to recommend any long ideas. On the buy side, I would keep searching the mid- and small-cap universe for cheap businesses with decent balance sheets. Very few large-cap stocks, even value stocks, possess those qualities.
On the sell side, I would trim expensive stocks that have rallied on the hope of fundamental improvements. This would include most tech sectors, as well as some large retail and mega-cap industrials. Business will improve in these sectors, but not enough to justify current valuations. Most large-cap defensive names seem fully priced with sloppy fundamentals. They can be sold too.
Robert Marcin is the principal of Marcin Asset Management, a private investment firm. Formerly, Marcin was a partner at Miller, Anderson & Sherrerd and a managing director at Morgan Stanley, where he managed the MAS Value fund (currently Morgan Stanley Institutional Value). At the time of publication, Marcin had no positions in any of the stocks mentioned in his column. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Marcin appreciates your feedback and invites you to send it to