Stock Valuations are Too High. I Would Exercise Caution.

(Last Updated On: March 19, 2017)

For the last several months I have become increasingly concerned that stock valuations are too high for many publicly listed companies on North American stock exchanges. In fact, the last time I made equity investments of any significance, valuations were much, much more favorable.

I admit it has been increasingly frustrating to watch stock prices repeatedly set new highs while I sit on the sidelines. Whenever I find myself thinking “This time it is different”, however, I remind myself of Warren Buffett’s following pearl of wisdom:

“The stock market is a no-called-strike game. You don’t have to swing at everything. You can wait for your pitch.”

I do not have an innate ability to predict in which direction the market is headed. The lack of clarity on Trump’s policies and the extent to which his policies will be accepted by Congress suggests to me, however, we should exercise caution.

I am concerned Trump’s proposed radical changes he wishes to make to long standing trade agreements will reverberate throughout the world economy. If he wishes to play hardball, it is almost certain the world’s other economic powerhouses will reciprocate. If this happens, all bets are off as to what will happen to our North American economies.

Trump has indicated the need to boost infrastructure spending to generate working class jobs. At the same time he wants to cut taxes. If you reduce revenue and increase expenses, where does the money come from? Debt.

Rapid economic growth leads to aggressive interest rate hikes. If the US debt level increases, higher interest rates kick in, and low interest rates continue to exist in other developed countries, you will end up with a stronger US dollar. A stronger U.S. dollar puts pressure on overseas profits and creates headwinds for emerging market economies.

This would place the Fed in the predicament where it has the difficult choice of deciding whether to:

  • keep a loose monetary OR
  • tighten to quell inflationary pressure.

What does this all mean to us as investors? Caution!

An increasing number of traditional assets investors are seeking refuge for predictable cash flow, dividends, or distributions. These assets have been bid up to the point where returns are no longer considered attractive or safe.

If Trump comes through with his plans to boost infrastructure spending and tax reductions, we could expect pressure on valuation multiples and the earnings growth expectations.

I have witnessed my share of market sell-offs. One thing I have come to appreciate is the need to beware of chasing hot trends. Trends have a finite duration.

Let’s be careful out there!”.