Bull Market Cheap Or Bear Market Cheap?

“I invested my money and my mother's in Microsoft,” a private investor told me in the late 1990s. “The company has a future, because every office needs Microsoft Office and Windows,” he was convinced. My pointing out the high valuation was met with raised eyebrows: “The company can only continue to grow.”

The stock markets were booming in those days. And in the end, we were both right. However, he and his mother had to endure some tough times, as it was not until 15 years later that Microsoft surpassed its high from back then.

The private investor was right, as the company continued to grow undeterred. In recent years, the cloud business was added, which did not even exist in 1999. And I was right to point out the valuation. Because even the best business model is not a good investment if the price for future profits is too high. 

The Tricky Nature of Valuation

In a bull market, we see the future potential of a business model. Spectacular growth, stable or even expanding margins and new market opportunities. If everything unfolds as expected, the stock is valued far too cheaply. 

All investors swim in the same river. When a full-blown mania takes hold- as it did in 1999 - it becomes challenging to resist its pull. After all, we are part of the swimming crowd being carried along. We’d have to brace ourselves against the current or get out of the river completely to look at the flood from the outside. Soberly and without emotion. That’s hard. Very hard.

Cracks of perception 

After a speculative bubble bursts, valuations fall. Investors now demand a higher return for the risk they have taken. So it seems that cheap isn’t always cheap. It depends on the environment. “Bear market cheap” is always well below “bull market cheap”. 

Rational investors always apply the same valuation yardstick. That is the counter-argument. However, I don't believe that. No one can escape the river they’re swimming in. Euphoria or fear creeps in through the cracks of perception, nudging our expectations higher or lower.

Our safeguard against the torrent of potential exaggerations on the stock market is diversification: spreading risk across business models, themes and strategies. This way, we avoid one-sided portfolios, which tend to form in bubbles. We work with discipline: this ensures a minimum level of balance in our clients' portfolios.