The valuations of certain stocks today have officially hit nosebleed levels, particularly in sectors such as technology. The valuations investors are now paying for cash flow streams that can, in most cases, only be hurt by a global pandemic, has boggled my mind.
Lower for much longer interest rates, spurred by global central bank stimulus measures, have changed the investing formula for many investors, making equities inherently more valuable.
Stocks tend to go up when interest rates drop to zero because the discount rate investors use to forecast the value of future cash flows is tied to government bond yields (which in turn drive borrowing rates across the board due to the government bonds being the equivalent of the “risk-free rate”).
Central banks can thus create a valuation bubble in stocks which can burst if and when interest rates are forced to ruse via inflation and higher interest rates in the future.
With most sectors, even the most defensive of sectors, seeing average valuation multiple increases, I’d caution investors to dive into stocks with valuations in the nosebleed levels for now.
Certain sectors have now breached long-term valuation multiple levels by a very wide margin, signaling we may have entered bubble-like territory for certain stocks, so sticking with more reasonably valued stocks can help cushion the blow should interest rates rise or another economic shock hit.
Invest wisely, my friends.
