“How do you feel about stock market valuations?” asks a friend.
Many have asked this question following the Dow Jones Industrial Average crossing 21,000 earlier this month. I thought I would share my answer with all of you in a brief note rather than wait until the quarterly letter.
Stock market valuations have indeed risen since the election of President Trump, rising nearly 8% from 16.8 times forward 12 months (FTM) earnings before the election to 18.2 times FTM earnings recently. However, it is important to keep in mind that your portfolio and the market are not the same thing. Our All Cap Portfolio is trading at only 16.3 times FTM earnings.
In my opinion, simply looking at the valuation of a portfolio is not a good way to measure the risk of a portfolio. One type of risk that many people don't think about and which we take very seriously is mean reversion risk. Mean reversion risk is the risk that a stock go back to the valuation it has tended to trade at in the past. Simplistically, a company that has tended to trade around 10 times earnings over the past decade that is now trading at 16 times earnings may be more risky than a company that has tended to trade around 16 times earnings over the past decade which is still trading at 16 times earnings.
If the S&P 500 were to revert to its 5 year median multiple, it would decline 13.1%. If our portfolio were to revert to its 5 year median multiple, it would increase about 2.2%. So in answer to the question, I feel a touch nervous about stock market valuations. But, I feel very good about the valuations of our All Cap Portfolio.
Integre Asset Management Disclaimer – 3/14/2017
Past performance may not be indicative of future results and every investment program has the potential for loss as well as profits. This material is presented solely for informational purposes and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security or fund interest or any financial instrument. No recommendation or advice is being given as to whether any investment or strategy is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All material has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy of, nor liability for, decisions based on such information. All information is current as of the date of this material and is subject to change without notice. The views expressed in this presentation are subject to change based on market and other conditions. Any views or opinions expressed may not reflect those of the firm as a whole. Additional information can be provided upon request.
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