Adam Sarhan MarketWatch Quote: The price may not be right in this stock market — think like Buffett

Market WatchAugust 7, 2013, 11:37 AM

As Wall Street looks down the barrel of a third day of losses, the wall of worry is being precariously scaled once again, this time with Jones Trading’s Michael O’Rourke saying investors are involved in a “lunge for exposure” and may be paying too much for stocks right now.

“We believe in the saying that something is ‘well bought if it’s half sold.’ ” This means purchasing an asset at such an attractive price that it could relatively quickly be sold at a profit, in which case you probably will not want to sell it for some time,” explains O’Rourke in a note to clients.

This is a strategy that often has worked for legendary investor Warren Buffett, he notes:

“As the quintessential ‘buy and hold’ investor, throughout his career Buffett swooped in and made his largest, most aggressive purchases during ugly environments [and] then moved to the sidelines.  In so many repeated cases, the purchases where done so well there was no need to worry about the sale, and in many cases he never has sold.  It is an example of why paying the right price is so important.  Likewise, paying the wrong price can be devastating.”

He’s got some suspicions that prices aren’t exactly right, right now, giving three reasons he sees risk as far outweighing opportunity:

  1. Negative repercussions from $1 trillion in fiscal stimulus over a period of 4 1/2 years.
  2. Since 2000, the rate of economic growth has been half that of the previous 70 years, meaning that paying above the historic multiple for the market is unwarranted.
  3. Earnings have recovered and hit new highs, but growth is low-quality and unsustainable, unless the economy picks up.

He’s not the only one out there who has fresh doubts. ConvergEx’s chief market strategist, Nicholas Colas, has echoed those concerns over valuations and extended stocks. He says the S&P 500 is being valued at $110 a share but likely to end up around $108 or $1o7. And for numbers that are coming down and companies that aren’t putting out improving revenue figures, he doesn’t want to be paying valuations of 16 or 17 times earnings:

 ”It’s really hot, fast money in the U.S. market currently.”

Jones Trading’s O’Rourke goes on to say that while he’s no bond-market fan, he’s “still stunned” to see investors moving “safe assets” into “‘risky assets at all-time highs,”  likening the wave of money going into equity ETFs as a “blind buying”:

“While this rotation is driven by the relative-value argument, it is likely that even if equities do not continue to rise each passing week, their relative inexpensiveness to bonds will be whittled away.  It is interesting that people overlook that in 2007 as the market peaked, stocks were at their most attractive level compared to bonds (the Fed Model) since 1980. Likewise, paying the wrong price can be devastating.”

Not surprisingly, not everyone agrees on which way the wind is blowing. Count Barclays, which lifted its S&P 500 earnings forecast for this year and next, among those not buying the overreaching-market argument. And Rockwell Global Capital’s Peter Cardillo who says, sure, valuations are approaching high levels, but they’re not overinflated:

“If you look at yields, dividends are still beating bond yields and so that’s a major factor. I think the market is going higher. Obviously one needs to be selective there’s no question about that. I would be selective stick to solid companies that are paying solid dividends.”

Spotlight Investor’s Stephen Pope says a high P/E for the S&P 500 is “not an indicator of a bull market, but may show up when investor enthusiasm overreaches reality.” He also says that investors should question what’s causing a huge S&P P/E when they see it:

“When a market index or individual stock shows a dramatic price gain without a corresponding increase in earnings, the result is very high P/E. A selloff when the S&P 500 P/E is in a moderate range may mean nothing more than a reaction to current events and not the beginning of a protracted down market.”

Last word goes to Sarhan Capital’s Adam Sarhan, who believes valuations remain attractive for stocks, with the S&P 500 near its historical norm, which, he says, “means the market still has a long way to go before it becomes ‘overvalued’ by most standard valuation metrics.’” He also says that history shows nearly every major, historical top for the market has happened when the S&P 500′s P/E ratio was at least in the high teens, if not the low 20s, and we’re not there yet.

– Barbara Kollmeyer

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Source: http://blogs.marketwatch.com/thetell/2013/08/07/the-price-may-not-be-right-in-this-stock-market-think-like-buffett/

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