Warren Buffett recently wrote, “Prices are sky-high for businesses possessing decent long-term prospects.”
Taking a look at the current Shiller PE Ratio, it is trading at 31.4x whereas its historical mean is 17. The historic high is 44 in 1999. The main benefit of looking at the Shiller PE is that it is one of broad valuation metrics that can help you determine the amount to be invested into equities based on the relationship between the price you pay and the value you get in return in the form of earnings.
When the CAPE ratio is high, and other valuation methods are high, it’s usually a signal to trim your exposure to stocks or invest elsewhere where markets are cheaper.
As Mr. Buffett has famously said, “the price you pay determines your rate of return.” Currently this suggests that investors will be expecting rather low ROI over the coming years.
The “Triple B” problem –
A few weeks ago I was listening to one of my favourite podcast “The Market Huddle” and one of the speakers, Kevin Muir, mentioned that the number of issuers in the investment grade market ranked BBB has never been higher.”
Investment grade debt is corporate debt rated BBB or higher. If a debt security drops below this level, it is no longer investment grade, and gets relegated to the high-yield or junk bond status. The important thing to note is that once you reach that point, most of the financial institutions can no longer invest in them. Therefore it is important for companies that rely on this funding to maintain at least a BBB rating.
What this also means is that more and more companies are just one downtick away from junk status and god knows what will happen when there is a slight weakness in the economy. I foresee that these companies that are willing to do whatever it takes to maintain investment grade rating will reduce their spending and cut down on their capex expenditure. If this happens, I’m afraid that it will only lead to a weakening economy due to weak capex spending.
IPOs with Negative Earnings –
2019 is a year where we will expect to see IPOs by internet giants like Lyft, Uber and Pinterest. What most of these companies have in common is that they have lost money 12 months leading to the IPO. Moving ahead, the proportion of these companies will only increase.
While the value of IPOs in 2018 is not as high as it is during 99/00, take note at the composition…
There’s an especially compelling case to be made for adopting a value investing framework today. I believe that in the current environment, the general market risk is quite high. If you wish to stay invested, it is important to do so by utilizing a value investing approach. As they say, “Defense wins championships“, value investing today enables us to be flexible and be offensive and defensive at the same time.