Even though there has been a lot of commentary around current high stock valuations against lackluster earnings growth for the S&P 500, it is “neither practical or precise” for an investor to use this as a basis for lowering their exposure to stocks or selling their portfolio. This according to Miles Johnson of the Financial Times who writes, “Warnings about irrational stock valuations fail the test of practical advice because they inherently require an unspoken reliance on market timing.”
Index investing, says Johnson, relies on both average price-earnings multiples as well as a collection of unrelated companies and industries to determine the “underlying economic reality of these assets.” He contends, however, that indices offer little information in terms of the fundamental strength of their stock components.
The columnist argues that fund managers who beat indices don’t base their decisions to buy or sell on the overall price of the market. Instead, they wait to find opportunities to invest in what they view as undervalued businesses.
“Using crude metrics such as the PE ratio of the S&P 500 to dip in and out of the market is likely to result in long-term disappointment,” says Johnson.