For value investors whose primary goal is avoiding the loss of capital, the current market environment hardly provides a margin of safety. Of course, the overall market matters less if one is able to find individual securities with a margin of safety. Even in the year 2000, during the biggest stock market bubble in US history, there were bargains as many small cap & "Old Economy" stocks were being discarded in favor of "New Economy" stocks and blue chips.
Finding bargains in the current market might be even harder than in the year 2000 as small caps trade at record valuations and dispersion in the S&P 500 is at an all time low. The lowest dispersion ever means that the difference between the most and least expensive stocks is smaller than ever. In some sense value investing has become a victim of its own success as "cheaper" stocks have been bid up. The cheapest part of the market, where value investors tend to fish, is as expensive as it has ever been.
What is a value investor to do in such an environment? This makes it much more difficult for a value investor but not impossible. I believe the most important thing is not to force investments or lower ones standards in any environment. If that means holding more cash so be it.
(As an aside I am actually quite optimistic about my portfolio for the new year, although my positions are largely not traditional value investments (ie. long common stocks). I plan to write about why I'm optimistic about my portfolio some time in the next week.)
If there is anything that I have learned having lived through two bubbles its that expensive can become more expensive. I have also learned that few who say "I will dance until the music stops" find a chair when the music ultimately comes to an abrupt halt. Unless one believes that we are in a new paradigm where cycles have been eradicated than there will be better opportunities some time in the future for value investors. Will you have cash to invest when that happens?