The FTSE 250 delivered a total return of 25% in 2019. The STOXX Europe 600 index delivered a return of 29%. The MSCI China A I returned 35%. Japan’s Nikkei 225 returned 21%. And the S&P 500 delivered a more than 30% total return last year.
Looking at all the double digit returns across all major indices, one can see that 2019 has been a great year for the markets. Anyone could have easily turned each pound into a pound and 25 cents at a minimum within the past year simply by buying the above indices, all without knowing anything about finance, accounting, business or management.
On the face of it, this appears like great news. And it is great news for some, like those investors who will not add a penny to the markets going forward. On the other hand, 2019 can be seen as a very bad year for investors still in the accumulation phase of their lifecycle whom still has years ahead of them in the markets. This is due to stock market valuations rising across the board. Hefty valuation has gotten heftier.
The majority of gains achieved by markets in 2019 are thought to be from liquidity injections as opposed to better business performance. In short, it means stocks have simply gotten more expensive.
Look at the following excerpt from Lindsell Train Asset Management
Students of financial markets know that over longer time horizons the impact of this valuation nudge tends to be much more muted. For example, over the past two decades the MSCI World achieved averaged earnings per share growth of c.5% pa with a c.2.5% dividend yield. Summing these figures gets you reasonably close to the index’s historical return over the same period of 6.2% pa with only a (much more modest) -1-2% valuation headwind needed to bridge the gap. With this historical perspective we can also point to the market’s 22.7% return as being unusually robust. But financial scholars also know that over shorter time periods such swings are perfectly possible. Denying this can spell disaster. There have been many individual years in which the valuation contribution has become a dominant component of returns, and in 2019 this clearly happened for both the market and the Fund. The MSCI’s price to earnings ratio rose by roughly 30% in 2019! Such dislocations tend to even out in the long run, but in the short-term can be wild. This time round the boost benefited investors, but these moves are influenced by shifting sentiment and cannot be counted on.
So valuations have risen across the board. Stocks have become more expensive. This is is bad news for investors like myself whom are still buying shares and building up a portfolio.
Think about it this way, if your favourite shoes went up in price, would you jump up in joy at the fact that they got more expensive or would you moan and be unhappy that you now have to pay more for them?
If I had to fathom a guess that you would do the latter. You would prefer that your favourite shoes fell in price instead of rising.
Same thing applies to stocks, you should jump for joy when you are able to buy stocks in your favourite company for cheaper, provided the fundamentals are still in tact.
All this is to say that perspective is important. If you had a stellar year last year, pat yourself on the back. But don’t lose focus on the goal. Don’t get bummed out if your portfolio goes sideways for a while waiting for earnings to catch up. And if it falls (without detriment to business performance), be glad at the fact that stocks are on sale and you can buy shares in quality companies at a cheaper price.