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Nosebleed P/Es and Warren Buffett: The Anatomy of an Exhausted Bull

Real Investment Advice  ( Original )
MAR 27, 2018

Warren Buffett once said “Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can't buy what is popular and do well."

How popular is the stock market right now? Leverage, margin, sentiment, P/E levels…historic highs across the board. Buffett himself is sitting on more and more cash because he can’t find stocks to buy because he thinks they’re too expensive.

It’s very difficult to discipline yourself to sell close to a market top when it seems like the market is bulletproof and will simply rebound and go up forever. Selling seems crazy since you just know the market will always end up higher. This is exactly when to sell.

The math on forward return expectations, given current valuation levels, does not hold up.  The assumption that valuations can fall without the price of the markets being negatively impacted is also grossly flawed. History suggests, as shown in the next chart, that valuations do not fall without investment returns being negatively impacted to a large degree.

Momentum driven markets are hard to kill in the latter stages particularly as exuberance builds. However, they do eventually end. That is unless the Fed has truly figured out a way to repeal economic and business cycles altogether.

As we enter into the ninth year of economic expansion we are likely closer to the next contraction than not. This is particularly the case as the Federal Reserve continues to build a bigger economic void in the future by pulling forward consumption through its monetary policies.

As Seth Klarman from Baupost Capital once stated:

“Can we say when it will end? No. Can we say that it will end? Yes. And when it ends and the trend reverses, here is what we can say for sure. Few will be ready. Few will be prepared.”

ORIGINAL SOURCE: This Cycle Will End – The Simple Math Of Forward Returns by Lance Roberts at Real Investment Advice on 3/26/18