Stock Market Valuation Concerns?

Value investing has shrunk in popularity over the years. It’s just not as sexy as taking a swing on hot growth stocks...or using computers and technical analysis to find stocks breaking higher right now.

However, there is no way to escape that value is a large part of the investment equation. Just a matter of when the bell rings and it becomes the center of the conversation. Indeed, that may be happening now.

Thus, our focus today will be to review current market valuation concerns and how to get our portfolios on the right side of the action. 

Market Commentary

Yes, there are market valuation concerns. That makes a lot of sense after the 35% rise the past 5 months from the depths of the April correction that had us teetering on the edge of bear market territory.

Meaning not only have recouped the 20% fall from the previous high...but we have pressed on to a new all time at 6,508. I sense that will form a market top for the time being allowing investors to digest recent gains.

(Yellow = 50 Day MA, Orange = 100 Day MA, Red = 200 Day MA)

As shared in the August 20th Zen Investor webinar, I see us settling into a range for a while with 6,500 forming the top and something around 6,200 forming the bottom. That is a fairly typical 5% trading range for stocks to comfortably take a breath after the recent sprint from April lows.

The main reason for this is that valuations are getting stretched at this level while earnings growth prospects are not impressive enough to support a “rational” rise in prices.

Yes, the market often has bouts of irrationality. Like the famed “irrational exuberance” of the tech rally of the late 1990’s bemoaned by Fed Chairman Greenspan.

He was laughed at for a while as prices went higher and higher. Yet in time was proven 100% correct as prices came tumbling down over the 3 year stretch starting March 2000.

This fits in with my narrative from the intro. That value is not as popular these days and is often scoffed at my momentum players. Yet in time valuations ALWAYS matter leading to hard lessons learned by those who did not take heed.

Before we get into specifics, I want to be clear that I do not believe that the entire market is overvalued. Nor do I see a bear market coming.

Meaning the bull market stays in place. Yet I think there will be major rotations away from overvalued groups towards undervalued.

Our goal is to be on the right side of that rotation which I believe to be the case with the Zen Ratings heavy reliance on 21 different valuation factors.

Back to the conversation of the valuation issues with the overall market. This chart shared with you before about the PE for groups based on market cap tells a very clear story:

Here we see that Mega Caps are obscenely overvalued on any historical basis and will likely be underperformers in the years ahead til rectified.

Large Caps overall are on the high side of historical norms. Not a bubble...but hard to make a case for it to move much higher. More on that in the Earnings Yield conversation further below.

Gladly we find that small and mid caps are not just a better value than their large cap peers. Also they are attractively priced versus the long term averages. This points to these two groups being solid outperformers going forward.

In fact, that outperformance seems to have already started this past month:

Just one more thought to solidify this valuation story. That being a discussion of the Earnings Yield of the market also calling current valuations into question.

Many also call this the “Fed’s Stock Market Valuation Model” as it been around for many years as a very straight forward way of determining if you should be in stocks or bonds.

The bigger the gap between the S&P 500’s earnings yield and what someone can get from the 10 year Treasuries...the more attractive it is to be in stocks. This was a BIG driving force behind the longest bull market in history starting 2009 through 2020 fueled by ultra low bond rates which made stocks the best game in town.

In fact, we often called that the TINA stock market where “There Is No Alternative” to owning stocks.

Yet as we stand now that gap has greatly narrowed to where it is a fairly equal proposition to be in stocks versus bonds. This story for stocks improves if any future Fed rate cuts really bring down long term bond rates. Yet I suspect that will not be the case given long term concerns about government debt that will keep rates around 4% or higher in the future.

So if stock valuations for large caps are getting stretched, then it means the group should underperform. Or at least have very mild performance.

Add up all the above and you understand why I have been pounding the table on a VERY overdue rotation to small and mid caps.

Again, that party may have finally started in August and should keep going for a while as small caps would have to outperform by 37% to match the current valuation of large caps.

Gladly our portfolio is already heavily tilted to small and mid caps. But not just any small and mid cap stocks.

We are focused on those that pass the stiff test put before them by the 115 factor analysis of the Zen Ratings where the emphasis is healthy growing companies that are attractively priced. That combination always has...and always will lead to outperformance.

To be clear, as the rotation to small and mid caps takes place it will not be smooth. Meaning there will be stretches of outperformance followed by ample profit taking. Kind of 2 steps forward and 1 step back.

Yet the more that cycle rinses and repeats the more profit will show up in our portfolio and on your computer screens. I have little doubt this is the best path forward. 

What To Do Next?

Discover the Zen Investor service that relies upon my 45 years of investing experience. 

During that time I have learned vital lessons from 7 bear markets…8 bull markets and just about everything else the “Mr. Market” can throw at us. 

I use this knowledge to create a detailed investment plan. Then lean into our proven Zen Ratings quant model to select the best stocks given their average annual return of +32.52%. 

In total the Zen Investor portfolio now has 20 top stocks that are hand picked for today’s unique market landscape. That includes a heavy allocation to small and mid caps that are primed to outperform.  

Plus 2 new stocks I just added in early September with stellar upside potential. 

If you are curious to learn more, and want to see my current top 20 stocks, then please click the link below to get started now. 

Discover the Zen Investor & Top 20 Stocks >

Wishing you a world of investment success!

Steve Reitmeister…but everyone calls me Reity (pronounced “Righty”)

Editor of the Zen Investor

What to Do Next?

• 77 Best Stocks NOW! >
• See All “A” Rated Stocks with +32.52% Average Annual Return >
• 2 New Stocks to Buy from Steve Reitmeister >

Want to get in touch? Email us at news@wallstreetzen.com.