Game of Trades: This Only Just Got Started
While investors can get a sense for the market from the big-picture data, looking at the charts can also show the current trend and where things are likely to move.
Ideally, investors should buy stocks during periods of low inflation and low market valuations. That’s because companies can grow fairly well without having to deal with persistent changes in prices. And because low valuations can lead to higher valuations as companies grow.
At the opposite end of the spectrum, investing in high valued stocks during periods of high inflation is problematic. That’s because rapidly-changing prices make it difficult for a company to grow, and they’re already overvalued.
That’s the situation investors were in at the start of 2022, when the stock market peaked on January 3. The rest of the year was a fight to bring down inflation, and high market valuations came down as well.
Investors can get an idea of how stocks are valued adjusted for inflation. How? By looking at the forward price-to-earnings ratio of the market combined with CPI inflation data.
At present, that valuation metric suggests that valuations hit the level of the dotcom bubble. And at the end of the year, the valuation was off its extremes, but well off its highs.
Those valuations indicate that there’s likely more pain ahead for investors. And that those who bought at the highs will likely take years to recover.