After a long period of economic uncertainty, valuations for stocks and shares are depressed and it’s a good time to invest an ISA.
Should we pick companies to fill a Stocks and Shares ISA in the middle of a raging bull market, or now when uncertainty is in the air?
It’s a good question. And I have a good answer to offer.
Rising valuations
Picking stocks in a bull market will probably feel safe and exciting. The general economic outlook will likely be reassuring. And companies will be posting decent growth figures for earnings and cash flow.
But there will be a problem. Valuations will likely reflect the rosy picture. So, we’ll probably end up paying a high price for our stocks in valuation terms.
At first, that will not seem like anything to worry about. Bull markets are bull markets and shares tend to keep going higher. Not all of them, but most of them.
And in a raging bull market, it’s easy to start thinking the good times will roll on for years to come in a new paradigm.
But a corrosive force often starts to assert itself in a long-term investor’s portfolio.
In raging bull markets, valuations tend to move up. And that means company earnings tend to be rated at ever-higher multiples. So, a business that once had a price-to-earnings multiple of 10 may see it increase to 20.
And in that way, valuation up-ratings can be part of the driver behind a bull market alongside operational progress in the underlying businesses.
But up-ratings tend to come to an end. And valuations tend to revert to the mean (average).
So, what was once a catalyst for driving the progress of a portfolio switches to become a drag on its performance. And from then on, building long-term returns from stocks and shares can become hard work.
Depressed sentiment
However, after a long period of economic shocks and uncertainty, valuations can be driven down too far. After all, investors are worried and sentiment is poor with the general economic outlook often murky.
My feeling is that we might be in the doldrums like that right now.
But mean reversion will likely kick in again for company valuations at some point. So, valuations that look low may start to claw their way back up. And at some point, the economic storm clouds will part to reveal the first chinks of light.
When that happens, general investor confidence will likely grow. Businesses may start to see their earning pick up. And valuations will likely climb ever higher again as a new bull market gathers pace.
That’s a broad-brush theory and every stock opportunity must be judged on its individual merits. But the principle is the bread and butter of successful investors such as billionaire Warren Buffett and others.
He’s known for buying stocks when the outlook is uncertain and holding well into the good times that have so far always followed.
All stocks and businesses carry risks as well as opportunities and positive investment outcomes are never certain.
But I reckon we are seeing a once-in-a-decade opportunity to aim for life-changing long-term returns from stocks and shares, right now.
