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Feb 18, 2025 - It’s HARD to be pessimistic at / near market all time highs. But I’ve had “Risk Adjusted Returns” drilled into my head over a series of monthly classes by a hedge fund manager. OK, I can be overly conservative . . . I admit it. But I think it’s a wise idea to every so often take a step back and answer the macro question: “What makes stock prices rise?”.
Over the short / near term it’s all about supply vs demand, and that gets evaluated every hour of every day via the stock markets auction system (a.k.a. bid vs ask). It’s worth whatever somebody will pay for it.
Over the long term, it’s really about earnings (or the potential for earnings), both current and future earnings. And so, everyone has an opinion on that. Heck, that’s why the Wall Street folks hire stock analysts. And we know how well they do with future earnings forecasts (editorial sacrarium). I ran across a chart that (I feel) puts our current market in perspective with a forward 10 year focus.
It shows (based on history) that Higher total returns (say around 20%) are achieved at Low Price / Earnings ratios, while Lower returns generally happen at evaluated P/E ratios. This is the equivalent of “Buy Low, Sell High”. Which brings me to the question I sometimes ask an audience when I speak. I say, “Where is the risk? At the market top or bottom?”. Many don’t know how to answer. The easy response is ‘Where is the Top and Where is the Bottom?”. And yes, if we knew that the rest would be easy indeed. History would tell us that the longer markets go up and the higher the P/E ratio gets people are paying more and more for less/the same earnings. It’s getting expensive. Markets stop and correct when the FOMO factor (Fear Of Missing Out) stops and marginal or bad news hits that could effect earnings. We saw that briefly with the “Deep Fake” AI news. People were in a near panic to get out. Thankfully after a few hours cooler heads prevailed and the recovery started. But the message was clear. This market is highly valued. I’m NOT saying it can’t go higher, but we ARE at all time highs . . . . and perhaps with all-time risks as well.
I’m not using leverage / margin, and I’m keeping a close eye on holdings, giving a nod to diversifying into different sectors (i.e. not all tech). With an especial eye on where the exit door is. Now is a good time to ask: “What does my stock have to do in order for me to sell it?” (Actually, an exit plan is always good; I try to have it right after I take any position). Don’t get overwhelmed or discouraged. “If It Was Easy, Everyone Would Do It !” ....... Tom ......