Timing the stock market is impossible. Unforeseen events have historically catalyzed its upward and downward movements. As such, predicting how it will perform in the future is not a sound basis for apportioning capital within a portfolio.
However, the stock market’s gain over the past 18 months could mean there is less scope for capital growth than there has been in the recent past. Indeed, the S&P 500 is up 100% since March 2020 and the Dow is around 90% higher over the same period. This compares with an average gain during previous bull markets of around 110%.
Moreover, a number of stocks now trade on earnings multiples that are significantly higher than their long-term averages. Certainly, factors such as low interest rates and a rapid rate of economic growth can help to justify higher share prices. But, as ever, the macroeconomic, monetary and fiscal outlooks are likely to change. This may mean that some of today’s richly valued shares offer less upside because their prices fail to factor in potential risks.
Marks' view
Today’s situation, where many investors are buying overvalued shares, reminds me of a quote from Oaktree Capital cofounder Howard Marks (Trades, Portfolio), who said, “What the wise man does in the beginning, the fool does in the end.”
I am not suggesting that investors who buy stocks today are fools. However, I believe there are periods in the stock market cycle that offer a wider range of buying opportunities than others.
For example, corrections and bear markets cause high-quality companies to trade at low prices. Buying stocks then, rather than after a significant rise for the stock market when many shares trade at historically high prices, seems to be a more logical approach. It means that investors can obtain a wider margin of safety that factors in potential risks and provides greater scope for long-term rewards.
A "wise" strategy
Of course, Marks’ view could also be applied to the idea of selling shares. Not only could it be argued that "wise" investors buy shares before "fools" follow their lead, they may also dispose of overvalued stocks before many of their peers.
Such investors may prove to be wrong in the short run. They may hold cash for many months and earn a near-zero return while their peers enjoy a continued bull run. However, history suggests the next bear market will occur at some point in future. Sellers of shares during a bull market, while their peers are still buying, will be in a prime position to capitalize on lower valuations prompted by a bear market.
Ultimately, they may end up being ahead of the curve. In the long run, they could even be viewed as investors who have significantly greater wisdom than their peers.
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