Investor sentiment has improved dramatically since the U.S. stock market's March 23 lows. The S&P 500 has risen over 50%, while the VIX (which measures fear among investors) has fallen by over 50%.
A rising stock market can cause some investors to abandon their value investing strategies. They may determine that price is less important when investor sentiment is buoyant and companies are delivering higher-than-expected financial performances.
However, I think that value investing is just as important now as it ever has been. Following the advice of value investors such as Baupost Group co-founder Seth Klarman (Trades, Portfolio) could lead to an efficient allocation of your capital in this bull market.
Maintaining a value investing approach
The stock market's recent rise could continue over the short run. However, the S&P 500's past performance shows that its gains have never continued uninterrupted. Therefore, at some point over the long term, the current bull market will be replaced by a bear market.
When this takes place is impossible to predict. There are an infinite number of variables that could cause it to happen at any point in future. Therefore, it is prudent to maintain a value investing approach to prepare for the next market downturn. This approach will potentially restrict your losses in a bear market, since your portfolio will not contain overvalued holdings that could be among the hardest hit stocks in a bear market.
As Klarman once said, "In a rising market, everyone makes money and a value philosophy is unnecessary. But because there is no certain way to predict what the market will do, one must follow a value philosophy at all times."
Buying mispriced securities
Even though the stock market is trading close to a record high, some companies have low valuations. For instance, outside of the large-cap technology sector, many businesses are unpopular among investors at the moment due in part to an uncertain economic and political outlook.
As a result, opportunities to buy quality businesses at low prices continue to be available even though the S&P 500 is experiencing a bull market. They could represent an efficient allocation of your capital even though they face difficult short-term futures. For instance, they may trade at a discount to their intrinsic value and have a wide economic moat that can provide them with growth opportunities in the long run.
In my opinion, value investors should seek to buy mispriced securities during bull markets and bear markets alike. As Klarman once said, "If only one word is to be used to describe what Baupost does, that word should be: 'Mispricing'. We look for mispricing due to over-reaction."
Holding cash in a bull market
A value investing approach may mean that you hold part of your portfolio in cash during bull markets. For example, you may struggle to find undervalued stocks within your circle of competence. Rather than buying overvalued stocks, or businesses that you do not fully understand, having cash waiting to be deployed in the future may represent a more efficient allocation of capital.
Holding cash could mean that you are in a strong position to react to falling stock prices in the future. You may not need to liquidate existing holdings to quickly take advantage of value investing opportunities that prove to be temporarily available.
Klarman has always been comfortable with holding cash for extended periods when necessary. As he once said, "The inability to hold cash and the pressure to be fully invested at all times meant that when the plug was pulled out of the tub, all boats dropped as the water rushed down the drain."
Read more here:
- Howard Marks: Approach Bull Markets With Caution
- Warren Buffett: 3 Investment Principles for Bull Markets
- Charlie Munger: Seize Rare Investing Opportunities Today
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