My son flunked his driving test at the DMV last month. According to the DMV officer, Carlton (16) ran over the curb as he drove out of the parking lot. Needless to say, his mother was less than impressed with Carlton’s performance and we all enjoyed teasing him to no end when he got home that day. There had been quite a bit of build-up associated with his appointment with the DMV. First, we’d made it clear that Carlton wouldn’t be allowed to get his driver’s license until he had completed his Eagle Scout project. As you might imagine, Carlton waited until his sixteenth birthday was right around the corner to get started on his project and then he wanted to get it done immediately. He soon realized that building a kiosk for the mountain bike trails at Huntersville Elementary was not going to happen overnight. But he kept the pressure on me. “Dad, take me to Lowe’s to buy wood,” and, “Can you pick up eight 80-lb bags of concrete at Home Depot after work?” and, “Will you help me cut the rafters on Saturday?” or, “Can you drive me to the school to work on the project this afternoon?” This fall became quite the fire drill for me as Carlton pushed to complete his project before his birthday. Finally, it was done.
Dad sighed with relief but Mom quickly found herself in the hot seat as Carlton pestered her to take him to the DMV. It was no small task to get the appointment and it fell right in the middle of the busy Christmas holiday season. Alice and Carlton assembled the necessary documents including his learner’s permit, her driver’s license, his log of hours driven, his passport, the registration for the car, his social security card, two pints of blood and my left arm. They arrived at the DMV at 7:45 am and Alice breathed a sigh of relief as Carlton climbed into the car with the instructor. Finally, he’d have his license and this mad scramble would be behind us. Wishful thinking. Little did she know but she’d be right back two weeks later (he did pass on the second try).
Carlton blamed the curb incident on his having to take the driving test in his mother’s Chevy Suburban. “If I didn’t have to drive that big tank, I wouldn’t have run over the curb,” he said. He added, “And that lady was completely unreasonable. It was just one little curb. That’s no reason to flunk me…completely unreasonable.”
Speaking of unreasonable, several commonly used measures of US market valuations currently show that stocks are priced unreasonably high relative to historical norms. Two examples in charts are at the bottom of this page.
Why the exuberance? Are things different this time? We would suggest not. In a properly functioning market, the current value of a corporation (today’s price) is simply the discounted value of all cash flows expected in the future. So what is the market telling us today with the high multiple assigned to most stocks? Here are a few answers that might be helpful.
In addition to the direct impact a tax cut will have on corporate earnings, there is the follow-on effect of the lower tax rate. Investors are optimistic that a lower rate will make the US more attractive for business. If more companies choose the US for their headquarters or for the location of their operations, this logically will increase economic activity, which means more jobs and growing earnings. And this takes us all the way back to Point Number 1.
We’ve laid out some possible explanations for today’s seemingly high valuations. Even as we’ve done so, we admittedly scratch our heads a bit as we observe the optimism and the duration of this rally. Valuations don’t appear as unreasonable as Carlton’s DMV instructor but they are a bit hard to understand. Markets don’t run forever. Corrections are normal and we think it makes sense to own a portfolio that is appropriate given your need for liquidity and your need for return. As stocks have outrun bonds, we’ve been trimming stocks at the margin and adding to bonds to maintain the balance called for in your investment plan.
On behalf of the team at Bragg, thank you for the opportunity to serve you. We wish you the best in the New Year!