Currently, some equities in the market look fairly valued based on their growth potential and cash generation. However, other sections of the market look quite frothy. Therefore, it could be argued that not all of the market is in a bubble.
This is especially true outside the public equity markets.
Borrowers are getting away with low interest rates and a lack of protection for creditors in the credit market. Meanwhile, private companies seem to be able to raise money at the drop of a hat at vastly inflated valuations despite having no technology.
The euphoria seems to have died down in some parts of the public equity market.
For example, increased regulatory scrutiny has helped deflate the special purpose acquisition company boom. As a number of these deals have also spectacularly failed to meet expectations, investors have started to cool on the sector. The speculative frenzy in so-called "meme stocks" also appears to have died down.
Still, the market overall looks quite bubbly, and that is concerning. The problem is, I have thought this before and have been proven wrong. I am not the only one. Economists and analysts are continually predicting booms and busts. Only a handful ever get it right.
Focus on the fundamentals
Based on my experience of covering successful investors, I have concluded that the best way to navigate these uncertainties is to focus on what I know.
I cannot predict what the future holds for the stock market and neither can anyone else, so I will not try.
However, I can focus on finding good companies at attractive prices and investments that I understand, which I will not sell at the first sign of trouble.
I have based this approach on Seth Klarman (Trades, Portfolio)'s advice. The manager of multibillion-dollar hedge fund Baupost Group has lived through multiple investment environments throughout his lengthy career.
In the late 1990s and early 2000s, Klarman's Baupost bucked the market trend. It lagged the market as the dot-com bubble took off and outperformed as the market collapsed.
Throughout this period, rather than getting caught up in the market euphoria, Klarman stayed focused on what he knew, which was finding undervalued equities.
He explained his mentality in Baupost's 1997 letter to investors:
"In investing, nothing is certain. The best investments we have ever made, that in retrospect seem like free money, seemed not at all that way when we made them. When the markets are dropping hard and an investment you believe is attractive, even compelling, keeps falling in price, you aren't human if you aren't scared that you have made a gigantic mistake. The challenge is to perform the fundamental analysis, understand the downside as well as the upside, remain rational when others become emotional, and don't take advice from Mr. Market, who again and again is a wonderful creator of opportunities but whose advice should never, ever be followed."
Stay with value
This advice is just as relevant today as it was two-and-a-half decades ago. Investing in stocks and shares is an imprecise art. We will all make mistakes, and will often find ourselves fighting against the market.
This is part of the process. It is vital to keep the bigger picture in mind. The real money is made not by trying to guess which stock is going to be the market's next big winner and following the rest of the herd, but by seeking undiscovered opportunities. By the time the rest of the market catches on, it could be too late.
This requires a considerable amount of patience and confidence. One has to have done enough research to hold through the troughs and peaks. This is even more important when it looks as if the rest of the market does not care.
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