Valuations do matter. I've been following the bull-bear market thread with some interest as that is my big question right now. Still trying to answer it for myself but one thing I do know.
Valuations are central to the stock market. What is a stock? It is not just a number made by electrons creating photons on a screen. It is an ownership share in a cash generating company. To quote Peter Lynch, "on a short term basis there is an imperfect correlation between stock price and value, on a VERY long term basis there is A PERFECT CORRELATION."
So, the question becomes whether the stock market is overvalued or undervalued both now and in the next 6 months or a year as the stock market (tries) to look forward. This is where it gets tricky for me. By some measures such as the fed model which compares income generation of bonds and stocks, recently stocks have been undervalued. By the p/e versus historical norms, it is still overvalued. And remember, it is more important to answer that question for 6-12 months out than the present.
To say that valuations are arbitrary or that the importance has changed dramatically is bubble thinking. During the dotcom bubble there was all sorts of rationalizations about how things were different now. Unfortunately, revenue and profits still mattered and most dotcoms disappeared. Same with the Japanese stock market. Some of the more dangerous words in the market are "THIS TIME IT IS DIFFERENT." Whenever I hear those words, I laugh and shudder.
My viewpoint is very much that valuations very much matter. I'm still trying to decide whether valuations are now too high or too low and by how much and which way they are trending. Need to dig out some more recent numbers but right now I'm 60-40 that this is a bear market rally and not the start of a cyclical bull. IMHO.
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