Warren Buffett and Berkshire colleagues are publicly complaining about the absence of stock bargains. What they should be saying is that broad-based equity investors were wrong to cheer the Federal Reserve’s economic downgrade and subsequent continuation of its money-printing, bond-buying program; in particular, lower economic forecasts by the Fed will likely be accompanied by reduced revenue and lower earnings at the corporate level.
Nevertheless, investors are now conditioned to believe that stocks are the only place for one’s money. Many participants have learned to view bonds with disdain since “taper talk” began in late May; they view bonds as too risky because of the threat of future tapering/rising rates or because of the paltry reward (ultra-low yields) relative to the risk.
What’s missing from the assessment, however, is the logic behind choosing more stock exposure. Bonds are terrible so, by default, stocks are terrific? The Fed all but guarantees stock gains? Fundamental value folks typically cringe at the idea of trailing 12-month P/Es of 18.1 on the S&P 500. Even Forward P/Es of 15.3 may not accurately reflect the likelihood of sub-par earnings growth. And yet, there are very few naysayers on adding more stock.
Is the NASDAQ 100’s 1.5% yield and 20.5 P/E worthwhile? Is its Forward P/E of 17.3 under-priced? More likely, the PowerShares NASDAQ 100 (QQQ) primarily represents irrational excitement for quantitative easing (QE).
In practice, there’s nothing wrong with riding the QE jet plane higher. You simply need an unemotional discipline for stepping aside; you need to know the circumstances under which you would protect yourself from extreme harm. In other words, foolish folks may be ignoring signals (e.g., valuation, economic weakness, etc.) as they chase Fed-fueled performance, but you require a plan to gracefully leave the rodeo before the stampede. Stop-limit loss orders, trendlines, hedges, put options — whatever your method, make sure that you have a concrete exit strategy.