The rally continues against all odds at present. The oddest part of it is that the lower the quality, the higher the gains year to date. The Russell 2000 index (an unmanaged index of 2000 small companies) is now up 22% through September. The price to earnings ratio for the index, according to the Wall Street Journal Market Data Center, is……………………………NIL!!! The 2000 stocks combine to have a loss, so……no ratio of price to earnings as there are no earnings. Forward looking estimates for the next year give the Russell 2000 a price to earnings ratio of over 44. So, if things go really well you will have a net earnings return of just over 2% on your investment for the next year. Do you want to invest in a basket of risky stocks so that you can hopefully earn a bit over 2% if things go well? This is not to say that these stocks can’t get more overpriced in the next year, giving you a terrific return. They can. It is just that the odds are not with you, they are against you.

On the other side of the coin, let’s consider the SPDR Global Titans ETF, made up of the largest multinational companies. It is up just over 16% year to date through September . Nothing to sneeze at, but a far lower return than the Russell 2000. This investment, made up of the highest quality companies from both the United States and other countires, has a price to earnings ratio of just over 15 and a dividend of over 3.5%. So, this investment is priced around historic norms, has a nice dividend return, and is filled with companies who are well poised to survive (and possibly thrive) potential economic problems should they arise.

As a rational investor (investing in often irrational markets), I can’t help but think that the odds are overwhelming from here. You should buy the highest quality, most reasonably priced investments you can find. You may suffer in the short term but should be fine longer term. At the same time, you should be considering taking profits and possibly shorting in the lowest quality parts of your portfolio. Warren Buffet famously said “it is not until the tide goes out that you know who is swimming without trunks.” The tide is likely to go out. It may be very soon or it may be much later. Don’t get caught again.

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