As a portfolio manager, I love long term investing in the US stock market. I believe investing in stocks has historically been an effective way to grow your portfolio over the very long term. But even on the low end of the current valuation scale for U.S. stock values… investors should be very aware of their risk tolerance and amount of stocks held in their portfolio… along with expectations of continued stock market growth vs. potential for stock market and economic downturn.
Based on commonly used valuation metrics for the S&P 500 US Stock market index, the U.S. stock market is currently overvalued between (approximately) 37% and 80%. These are levels last seen prior to the Stock Market Crash of 2000-2002 (“The Tech Bust”), and just prior to the “Great Financial Crisis” recession of 2007.
(Common valuation metrics referenced here are: “12 month trailing Price to Earnings (PE) Ratio”, and the “CAPE Shiller PE Ratio”. As of May 28th the 12 Month Trailing PE Ratio is 21.97, and the CAPE Shiller PE Ratio is 28.81. With the approximate historical average ratio for both ratios at “16”, current ratio levels put the S&P 500 Index in an overvalued state by approximately 37% to 80%. Historical references ratios found at: https://www.multpl.com/shiller-peand https://www.multpl.com/s-p-500-pe-ratio.). These two Price to Earnings Ratios are used to compare earnings profitability of a company to the price of a companies’ publicly traded stock.
I am not a “perma-bear” (an investor or portfolio manager who is always thinking that the stock market will meet its demise at any moment). But there are times as history has shown that at the end of economic super cycles where investors should be highly cautious and know their investment options to help preserve their portfolios, and possibly position their portfolio to possibly take advantage of investing opportunities which may arise in times of stock market and economic uncertainty and volatility.
Why are stocks recovering so much with the global economy so bad?
From the beginning of March 2020 until the writing of this commentary, the United States Federal Reserve Bank under the leadership of Jerome Powell has infused almost 3 Trillion dollars of triage stimulus into the financial markets. As of today (May 29th, 2020), the Gross Domestic Product for the U.S. is projected to be at a rate of negative 51.2%... (-51.2%). This is a number not seen since the Great Depression era of the 1920’s and 1930’s. Yet the S&P 500 index is at levels seen just last October 2019. The unemployment rate currently holds at about 24% today as well, which is a dramatic decline in and of itself.
I feel we have not seen such a disconnect in the valuations of U.S. stock vs. U.S. economic fundamentals in the history of the U.S. stock markets.
Know history and your investing options:
Due to the overvalued state of the overall U.S. stock market, along with the historically large decline in economic growth due to the Covid-19 shutdowns…. stock market investment risk may be considered much higher than average today.
During each of the two last recessions (2001 and 2007-09) where stocks and real estate assets were considered highly overvalued, the S&P 500 dropped approximately 50% to 55%.
The average recovery time needed to gain back pre-crash value of stock market losses from the “Technology Bust” recession was 8 years, and the average recovery time for recovery from the Great Financial Crisis recession was 7 years.
I suggest anyone who owns a stock portfolio of any size to evaluate their time horizon for their investments and understand their risk exposure. In addition, take a look at historical stock market performance of the last two recession periods. (Stock Market Crash of 2000-2002 (“The Tech Bust”), and the “Great Financial Crisis” recession of 2007-2009). http://www.nbcnews.com/id/37740147/ns/business-stocks_and_economy/t/historic-bear-markets/#.XRz7hehKiUl
Periods of “irrational exuberance” of highly overvalued stock markets may continue for some time, but I feel the current highly overvalued state of the markets today has been going on for approximately 3 years now (and now the economy is showing signs of slowing). Given these factors, I recommend investors ask themselves the following questions…. How much time can I wait to recover if overvalued markets decline to meet current day depressed economic fundamentals? If so, what can I do to preserve my investments?
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Michael Raymond Bacci, CFP
History and past performance are not a guarantee of future performance. Information contained in this commentary is not the opinion of Royal Alliance Associates, Inc. or it’s affiliated companies. Any information contained within this commentary is not a solicitation to buy or sell securities or advice to buy or sell securities.
Investing involves risk including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values. Past performance is no guarantee of future results. Please note that individual situations can vary. Therefore, the information presented here should only be relied upon when coordinated with individual professional advice.
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