The presidential election is over and everyone is weighing in with their opinion of where the market is going. Some will tell you we are headed up and point to every gain occurring after a piece of vaccine news or an earnings report comes out as evidence that things will continue on as they had. Others will say that we are overdue for a true correction of the market and the 2^nd wave of COVID is going to start us on the path to at BEST a correction and at worst a recession. They will point to the pullbacks on news of the pandemic ramping numbers back up and say “See, we are going to start the cycle of February into March all over again.”

So, what is the truth and what should we look to in the markets today, what you believe is a major rally one day gives everything back the next? Drug companies soar on news of their vaccines effectiveness and then come back to Earth when people realize there is not going to be a sustained surge anytime soon as trials continue. Work from home companies rise and fall day in and day out and even some consumer defensive stocks have come under pressure. Tech remains a darling when in some cases there is nothing but rumor seeming to sustain forward momentum.

What is the truth? Buy or sit on the sidelines? FOMO (fear of missing out) or TINBA (there is no better alternative)? The even greater, “How do I explain sitting in cash to anyone right now with the historic highs we are hitting?” I caution everyone to remember this thought “…no matter how wonderful a business is, it’s not worth an infinite price.” Charlie Munger, Warren Buffet’s good friend, investment partner and Abominable No-man, said this as part of his 4 principles of investing. At the end of the day every position you take is based on a business, and none of them are worth an infinite price.

Does that mean that there are no wonderful businesses out there right now? I would say that would be false, there are always at least a handful out there, it is certainly harder now to find than they were in the past. Some will tell you that value investors these days are actually bears in disguise…”Roar” I guess. I see concerns in markets where every day seems to be pushing a new record while there is not a lot of solid evidence for their valuations, in a time where we may be watching a major shift in how work is conducted from here on out, and there is a ton of chop in the waters of the market. Any one of these would not be worrying on its own to me, but when all of these are present at once and seem to getting murkier…I sometimes find it hard to distinguish between analysis and opinion.

Does that mean there is nothing for us to do right now as investors? Not so much, I won’t harp on the time to be finding companies, doing your homework on them and preparing for them to be in our margin of safety. I will say that this might be the time to look at short term trades and low risk, good return trading. I know, I have treated trading as a dirty word before, but that is true to me only when you are using your long-term investing funds for short term trading. Trading has a place in your portfolio, but I am one who believes that it cannot be your entire strategy and you have to be strong to do this with any regularity.

You should trade in the market, but with rules and with an amount of money that will not put you in trouble if you lose it. We call it risky business or capital building funds. It is a tool, not a strategy. This is why you have to be strong to do it as well. There are times when you will find that you picked a great position which is working with your trade and you make a lot of money in a few days. This happening over and over again for a few months can make you feel invincible and lead you to think you can take larger risks for higher payoffs or the need to make up for small losses with a big payday. This mindset can lead you to over-leverage yourself and can get caught in a bad trade that wipes you out.

I say this not to scare you, but to reinforce this ONE principle. Everyone who trades should have a set of rules they follow to limit risk and you MUST stay within the rules. You may well win a few times in a row, but to me much like a casino the longer you stay and the better you do, the more likely you are to lose it all eventually. We are enticed by the high of winning and lose our logical fear of the loss.

That mindset should also apply to your investments for the long term. You are buying part of a company every time you buy a share of stock. You must ask yourself in some of these high-flying, hyper-growth stocks, what makes this company so valuable?

At some point earnings almost don’t matter because of trading at ludicrous multiples of earnings. Is it the price compared to sales every year? No, they can sell six to a hundred times less than their price would suggest they are worth. Free cash flow? Nope, some of these companies are not profitable or have only become profitable recently. The worth of the equipment and property (or book)? Nope, many don’t have physical property worth selling nearly enough to cover their debts or investment price.

It is literally people’s belief that the company will be worth much more in the future than the numbers suggest and if you don’t get in now you’ll miss the ride. I hate seeing people coming out of the woodwork and saying, “Oooh this is the next” fill in the blank FANG, “stock, you need to buy now!” This is often a company that has already gone parabolic and anyone with a trend line can see the direction of the stock.

Let me fill in my theory with an example from the past, back in 2000 the NASDAQ was trading at multiples of earnings over 200 just before the bubble burst. There is a company currently trading over 900 times earnings and just had their price target raised. Whether there is a fundamental change in the valuation of markets or not, I cannot help to feel concerned by continual up trends in markets where businesses see cyclical highs and lows.

The answer I see right now is that we need to be thinking hard about sitting out through the chop and the back and forth and wait for the opportunities to trade on other’s psychology. Watch the earnings seasons for short term trade opportunities and be wary of the companies on parabolic growth trajectories, do the research on the company and see if their current rates of growth make sense. The growth rate of some of these companies will have them worth more than the GDP of any nation on earth in the next five years…if that doesn’t make you raise an eyebrow than I wish you the best of luck, but I will be very careful in when and where I put my money in the market going forward.

Remember Robert Shiller and Alan Greenspan’s thoughts on Irrational Exuberance, the only reason the stock market is not perfectly balanced is that humans are unpredictable and that is a good thought to keep in your head as you read your business section in the morning. Till next time stay safe and this Daddicus Rex signing off.

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