Why this bull market still has room to roam

By Barrack Yard Advisors

The stock market bounds from strength to strength. And despite qualms by some about current valuations in the U.S., we do not believe we are at bubble levels yet. Long term, the implied rate-of-return remains on the plus side.

This is unlike the very late 1990s when stocks were priced to deliver negative returns. We think this bull market still has staying power.

 

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Valuation explained

To understand why it is worthwhile to think about valuation in a more sophisticated way.

The future rate-of-return for any long-held asset is tied to its starting valuation, to the price paid at entry. This is because an asset's real value is simply a function of the cash it will generate over time. Determining how to value those future cash flows is a function of many things, including the general level of interest rates.

Think of it this way. If there are two properties of a similar nature, the one that generates more net income over time should be worth more, once differences in sustainability of the income stream and in growth rates are taken into account.

After all, which would you rather own, a property with net income of $10,000 per month or one generating only $1,000?

We are able to approximate long-term returns for individual assets and for entire markets because both the cash produced from an asset, and the growth of that cash flow, are finite. In addition, most markets eventually revert to some sort of long-term mean.

In the short-term, valuations can be irrelevant as collective thinking and momentum propel markets to soar higher, or plunge lower, as the case may be. Markets can seem to take on a life of their own and the old lessons are forgotten. Eventually market sentiment and trends reverse themselves, such as when prices fall after a big market surge, and many investors panic since they are not clear on the reason they own stocks.