Recently, the US stock market has been on the rise for consecutive months following a short-term but steep downfall in April 2025. The downfall was largely attributed to the announcement of tariffs by Donald Trump, the elected president of the United States. The announcement of tariffs on major economies, such as China, Europe, and Japan, and the like, also created panic across the stock markets of these countries. Since then, the tariffs have been either negotiated, reduced, or paused for the countries.
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Disclaimer
Before diving deeper, I would like to declare that the following materials are purely meant for educational purposes and do not constitute investment advice. The post does not encourage or discourage investing in any equities or financial instruments. The materials in this post may change in the future without any formal announcement.
Back to the topic
The US stock market crash in April 2025 created a bargain opportunity for many stocks. Since then, stock markets have been making rapid progress. Traders and investors consider each news as a positive development for the economy and the stock market. However, this enthusiasm may put stock market exchanges such as Dow Jones Industrial Average (DJI), NASDAQ (IXIC), and S&P 500 Index (SPX) at high P/E (price to earnings) levels. According to Simply Wall St, the US stock market’s total P/E is hovering around 30.9x. This might sound like the US stock market is currently overpriced, and it’s hard to find a bargain at this moment. Apparently, this has been true since the majority of large-cap and “hot” stocks are on the rise.
However, one of the most concerning factors is that the large tech stocks are highly concentrated, which has created an imbalance. For instance, Yahoo Finance sector-wise breakdown shows that around 30% investment weightage for the technology sector, of which around 60.7% constitutes the semiconductor and software infrastructure. This may represent a possible opportunity even in the technology sectors themselves. The next 15% investment weightage represents the financial sector.
The rest, 9 sectors, combine investment weightage, then become only 55% which certainly signals an imbalance. Therefore, a possible opportunity could exist within these sectors. It is also important to note that market sentiment may not change over time; therefore, patience is important for possible success and a rebound of investment in these sectors. This necessitates disentangling the price of the stock and the value of the company represented by the stock.
At times, the stock’s price levels may indicate that it is undervalued. However, industry challenges and company fundamentals are the key here. A stock can remain at lower price levels for a prolonged period, not because the company is performing poorly or its debt is high, but rather because the overall industry might be in a lower economic cycle. According to the memo written by Howard Mark, the vice chairman of OakTree, the value of the stock is determined by fundamentals, which combine to constitute its earning power and ultimately become the source of its earnings. These fundamentals include, among others:
- Earning power and how the company maintains a steady flow of earnings.
- The value of the assets.
- The competence of the management and how they can produce many new products.
- The competitive landscape in which the company is operating.
It’s pertinent to note that the company normally has two types of assets: tangible and intangible. The tangible assets may include, among others, buildings, plants, machinery, and mineral deposits. The intangible assets may include, among others, patents, trademarks, know-how, talent, and management. On top of that, some assets may have earning power in the sense that they produce operating cash flows. Whereas other assets may not have the earning power until they’re being sold to someone.
The assets with earning power can produce earnings today or in the future. The current earnings are reflected in the quarterly and annual reports. In contrast, future earnings can be determined by holding the assets and producing products in the future as the favourable environment unfolds. Therefore, assuming that the neglected 9 sectors will remain neglected is an unwise decision, as they may, at any time, see the revival of the investment as the favorable conditions unfold.
Price vs value
The price is the amount of money one pays to obtain goods. The value, on the other hand, is the estimated worth of the stock that the current price has yet to achieve (under-valued), is in the proximity (fairly valued), or has already passed beyond the value (over-valued). The value of the stocks is usually estimated from their earning power. Which ultimately boils down to the amount of cash flows a company can generate in the future.
However, the cash flow is tied to the earning potential, which leads to subjective projections (for example, the growth rate projections in the discounted cash flow model). These projections are then converted into fair prices. Therefore, the asset’s price is the consensus view of investors regarding its underlying fundamental value. This consensus view, which lies between optimism and pessimism among investors, causes the price to oscillate between the highs and lows relative to the fair value.
The value of the stock can be thought of as an attraction force, which keeps the price oscillating between highs and lows. If the price is too high, the value will pull it down toward the equilibrium, and if the price is too low, the value will cause it to move upward. Therefore, the price of the stock in the short term can move in any direction. This movement is largely due to market sentiment pertaining to developments of the company, representing the stocks, the geopolitical landscape, inflation, tariffs, and Mr. Market. As a result, those who invest appreciate the stock value, rather than price, and primarily focus on the long-term rather than the short term. It is then also important to note where the price of the assets
Interest Rates
It is also important to note where we are in terms of inflation and interest rate cuts. The Federal Fund rate is around 4.33% vs the Personal Consumption Expenditure (PCE) of 0.63 (June 2025). The PCE gauge the consumer spending, which, if it starts to rise, gives a possibility of increasing inflation, which in turn triggers the rise in interest rates and vice versa. However, given that the PCE has been on the lower side, as per the MacroMicro webpage shows, it might be likely that the interest rate would perhaps remain unchanged or go lower.
The Necessary Diversification to Avoid a Possible Trap
In the face of market uncertainty around the valuation vs price and interest rate cut speculations, one can resort to the diversification principle to reduce the risks associated with market volatility. By diversification into different sectors of the stock market, such as technology, oil, metals, finance, utilities, medical, and uncorrelated sectors, one can reduce the impact of risks on their portfolio. For example, clean energy such as solar power and coal energy, in my opinion, are negatively correlated. Clean energy has been enjoying the inflow of investment because of environmental regulations surrounding the traditional forms of energy. This causes lower returns from the traditional energy sectors. However, the recent policy shift on removing most of the regulations for the traditional form of energy may see an increase in investment in this area in the near term.
In addition to sector-wise diversification, there is also a market-wise diversification. For example, many investor would opt to diversify their investment in different countries to minimize their risks that may possibly exist in a single country.
In my view, a balanced portfolio is always better than a risk-bearing, one-sector-focused portfolio. The reason for such a view is due to the fact that every sector has a cycle, which sees its constituent stock prices go up during the rising cycle and go lower during the down cycle. However, given that not every sector rises or falls at the same time, it is beneficial to have a diversified portfolio where one can invest in the down cycle and sell in the rising cycle, when most of the stocks have deteriorated fundamentals. This can somehow relieve the pressure of timing the market, cycles, predicting the interest rate cuts, and falling into the trap of Mr. Market.
However, it is also important to wisely diversify and avoid “diworsification”. Furthermore, it is always wise to check the stock fundamentals before investing in it. For example, in my post titled, A beginner’s guide to stock picking, I have outlined the common metrics that one can use to value a stock before investing in it. Such valuation metrics, although they may not completely determine the stock as a possible investment opportunity, certainly determine the company’s past and current financial health.
