July 2017 Update

Equity markets are at their highest valuation in history by some measures. The S&P 500 is selling at 25 times earnings compared to a long term average of 15, a level only exceeded in 1929 and 2000. Warren Buffett’s favourite valuation measure, total US stock market capitalization divided by GDP, is at an all-time high of 145, compared to a long term average of 100. In the past when valuations were this high, subsequent ten year returns have been single digits or negative.

Investors seem to believe there’s no price too high for the largest US stocks, responsible for driving most of the rally this year. These FAANG stocks (Facebook, Amazon, Apple, Netflix, Google) are trading at over 30 years worth of current earnings. They have performed well, but given their valuations, are they safe investments?

Few seem to care about the answer to that question. Over a trillion dollars are now deployed into passive investment funds, of which the FAANG stocks make up an increasing percentage of holdings. By definition, the passive investment philosophy ignores company valuation, buying instead on the basis of popularity: buy more of what’s popular, and sell what’s unpopular. If that sounds like the opposite of buy low, sell high, it is. It should concern investors that over one trillion is now invested in this way, with no attention paid to analysis or valuation.

After years of low interest rates, investors have been encouraged to view this excess risk taking as normal, and even welcomed. Hand in hand, the amount of leverage deployed in stocks, bonds and real estate shows there is more worry today about being under-invested than being over-invested. When so many are willing and excited to bear excess risk, we do the opposite.

Portfolio construction and company-specific notes are available for clients only.

Interesting links:

Uninsured mortgages in Canada pose a risk http://business.financialpost.com/personal-finance/mortgages-real-estate/uninsured-mortgages-are-greatest-risk-for-canadian-financial-institutions-dbrs-report-says/wcm/4c169bd0-473a-46e0-966e-dec0f678aaa5

The effects of Indexing on the market https://www.bloomberg.com/view/articles/2017-07-06/the-stock-market-has-entered-bizarro-world


Ben W. Kizemchuk

Portfolio Manager & Investment Advisor
Welling-Altus Private Wealth
(416) 369-3024

55 Yonge Street, Suite 1100
Toronto, Ontario
M5E 1J4