Some analysts say that the current US stock market is overvalued. Others disagree. What factors are going into this decision-making? How can you decide whether a stock market is overvalued or whether it may still be a good time for investment?
Let’s take a look at some of the factors you should watch out for — it could save you thousands.
The Hallmarks of an Overvalued System
The stock market has been climbing in record amounts in 2018, which is often indication that a bubble is about to burst. Though many see record increases as a good thing, they are also indications that the market could be volatile and that it could be increasing based purely on sentiment rather than fundamentals. When a substantial market increase has been seen without any reason fort, it’s even more dangerous.
The stock market is currently overvalued by nearly every metric. There are multiple measurements that are used to determine overvaluation: P/E ratio, CAPE ratio, Div yield, Price/book, Price/sales, and Q-ratio. These are advanced algorithms that are designed to show when companies are being bought and sold for more than they are legitimately valued in terms of their economic reach.
Nearly every metric shows that the system is overvalued when compared to prior peaks. That indicates that the market is likely in a bubble, and bubbles will always burst. If you take the S&P, it has increased by about 60% in the prior 21 months. All of these gains could be potentially lost in the event that the system is currently in a bubble. A bubble tends to erase the gains of a prior period of time, but it’s also important to note that these gains are generally brought back.
Historic Overvaluations
There’s a reason why analysts tend to get nervous when a crash hasn’t occurred for a long time. In general, the market is going to continue to expand and expand until which point there is a correction. Market corrections are inevitable. Thus, historically, if there hasn’t been a crash in a long time, the likelihood of a crash occurring starts to increase.
Here are some of the notable crashes the United States has experienced in the modern era:
- 1987 – Black Monday
- 1990 – The Early 90’s Recession
- 2000 – The Dotcom Bubble
- 2008 – The Financial Crisis
- 2010 – The Flash Crash
- 2015 – The Selloff
Crashes of some degree occur every few years at minimum ,and every ten years at maximum. It’s been three years since the selloff, and it’s been nearly ten years since the flash crash, which indicates historically that another major market correction could be on the way.
Does Overvaluation Matter?
What is seldom asked during discussions of stock market overvaluation is whether it truly matters. The DJIA fell from 14,000 to 6,600 during the Financial Crisis of 2008. By the 2015 Selloff event, the DJIA had risen to 18,400, falling to a low of 17,504. In other words, even the U.S. financial crisis of 2008 was recovered from substantially by 2015.
For long-term investors, overvaluation may not matter. Even investing in the market at the height of the events leading to the financial crisis would still put an investor well ahead today. Even if the market, averaging over 25,000 in July of 2018, crashed 10,000 points — which would undoubtedly be temporary — it would still have more value than investments in 2008.
Overvaluation primarily matters to investors who are looking to make money within the next few years. These short-term investors, however, are likely making trades that will go into and come out of the market before any large crashes begin. Investors who are looking for short-term investments shouldn’t be holding positions long enough to be impacted significantly by another financial crisis.
On the other hand, there’s another reason you may want to worry about the stock market: economic strength. During a recession or crash, businesses stop investing and money tries up. If you are an entrepreneur rather than a stock trader, this could be a very real concern for you.
Is the stock market overvalued? Some investors say yes, and some say no, but ultimately it’s up to each investor to decide whether this even matters to their investment strategies. Overvaluation can have a direct impact on the amount of money you make on your investment, and waiting for a crash can be a valid strategy for investors thinking ahead. That being said, these market corrections and crashes really have minimal impact on the long-term, buy-and-hold investor, such as those inspired by the strategies and philosophies of Warren Buffet.
Regards,
Ethan Warrick
Editor
Wealth Authority
