Speaking of excess, Sentiment Trader recently did a great piece on the market’s Sharpe ratio. The conclusion of their report is worth considering.
“When the going gets easy for investors, it’s natural to let one’s guard down and become complacent. That’s a dangerous condition for all but the longest-term, long-term, unleveraged investors. Markets can be their most dangerous when they look the safest.
Using the Sharpe ratio as a proxy for how good it’s been for U.S. investors, we see above that there aren’t many times in history when it’s been better than the past six months, and there are signs that it’s ending. That can mean more volatility, but it doesn’t necessarily mean negative returns. The biggest takeaway has been moderate returns, with much more of a two-way market than investors had gotten used to in the months prior.”
Buyer Beware (by L Roberts)
The graph below hits on a theme we have been raising for a while. Stock market valuations are very high. The graph, courtesy of Elliot Wave Internation, combines seven standard valuation techniques to show that current valuations are on par with those at significant market peaks. Today’s Tweet of the Day shares another valuation chart with a slightly different message. It warns that valuations may be extreme for the largest market cap stocks, but many smaller stocks are trading with fair valuations.
Both graphs serve as a warning. Consequently, we advise you to pay attention to market fundamentals and technicals to assess how long high valuations can last. Furthermore, just because the market is expensive doesn’t mean every stock is expensive. Moreover, no rule says that current valuations can not get more expensive. However, if you are passive and do not pay close attention to market dynamics, now might be a good time to reduce your level of risk. Or, given plenty of stocks have fair valuations, now may be a time to consider rotating from the largest-cap stocks to those offering more value.
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