Investing In an Overpriced Stock Market

Financial Advisor Tim Hayes

The U.S. stock market has come a long way from its Great Recession low. That low, when the S&P 500 bottomed out at 666 on March 9, 2009, is called “the Haines’ bottom,” named after legendary CNBC anchor Mark Haines, who called the bottom of the market’s plunge on the air. (Sadly, Mark passed away in March of 2011.)[i] [ii]

Today (May 23, 2020), that index stands at 2995, an increase of some 340% from the low, almost doubling from its previous cycle high of 1576, reached on October 12, 2007.

The U.S. economy, however, is in the worst unemployment crisis since the Great Depression. Since March, the coronavirus-induced economic slump has caused 40 million Americans to lose their jobs.[iii] At one point, the U.S. stock market was down 40%.

The number of unemployed has risen, yet the stock market has recovered two-thirds of its losses and is down only 10% for the year.

How can this be?

One explanation is that the stock market is looking past the current economic troubles to better times ahead, when either a vaccine or treatments are available. Or maybe the Federal Reserve’s pumping of three trillion dollars into financial markets has, like their other attempts to boost the economy, gone more to Wall Street than Main Street.

Or maybe with interest rates at historical lows today, a 30-year treasury bond pays only 1.37% to investors, so they have no other place to invest to generate a return.

Is the U.S. stock market overpriced today?

David Tepper, famed hedge fund manager and owner of the NFL’s Carolina Panthers, thinks it is the second most overpriced stock market he has seen, just behind the tech bubble of 1999.[iv]

According to two measures of value, the answer is yes—and dangerously so. According to the CAPE ratio, the stock market is 185% overvalued. Another measure, the q ratio, has it at 80%. It has been overpriced only twice: in September 1929, right before the Great Depression, and in March 2000, at the tail-end of the dot-com bubble.[v]

However, those latter two levels of pricing were higher than they are today. Therefore, an overpriced stock market can always go higher and become more overpriced.

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What are investors supposed to do?

Let’s say you received an inheritance, or you have a lump sum sitting in the bank, you are tired of earning no interest on it, and you are frustrated to see the market go up. One strategy is to do what we call dollar-cost averaging. Instead of moving all of that money into the market today, you set up a plan to move it into the market gradually, say, over a period of 18 months.

If you have $100,000 to invest, you transfer $5,555 a month, purchasing the market at 18 prices instead of today’s one. There is no guarantee this strategy will produce a profit, and, if the market keeps going up, you might lose out on short-term gains. It would help you, though, if there were a considerable drop of, say, 57%—which happened to the market during the Great Recession.

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What if you cannot wait?

If the idea of waiting 18 months is not for you, make sure you conduct a risk-tolerance test before investing that lump sum. (You should do a risk-tolerance test even if you decide to do dollar-cost averaging.)

The online risk-tolerance reports, FinaMetrica and Riskalyze, will give you a score you and your advisor can use to allocate your lump sum. That way, you will end up with a mix of stocks, bonds, and cash, which will hopefully help you reach your goals, with a level of risk you will be comfortable with.

By doing this, maybe you can create the portfolio that allows you to stay invested by limiting how much it might go down while simultaneously yielding a return if the stock market continues to rise.

Beware of TV pundits and hot markets

The yang to the quiet, unassuming Mark Haines at CNBC was Jim Cramer, who remains with the network as the host of Mad Money, a nightly show on which he uses his near-photographic memory to opine on stocks.

Before Cramer became a TV host, he ran a hedge fund. In that role, he gave a speech in February of 2000: “The Winners of the New World.” In that speech, he pontificated on the changing nature of the stock market and laid out the stocks his fund was buying, most of which were high-flying technology/dot-com stocks.[vi]

Cramer discussed the ten stocks he was buying, many of which ended up not surviving when, only a month later, the tech-heavy NASDAQ peaked, and then ground down some 78% for the next 30 months. One of the stocks that did survive, which Cramer recommended, still dropped from $1,305 to $22 per share.

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[i] Pisani, Bob. “Mark Haines’ Legendary 2009 Call.” CNBC, March 9, 2015. http://www.cnbc.com/2015/03/09/pisani-remembers-haines-legendary-2009-call.html

[ii] Wells, Jane. “Five Years Later, ‘Still Traumatized’ by Market.” CNBC, March 10, 2014. http://www.cnbc.com/2014/03/10/mark-haines-bottom-call-five-years-later-still-traumatized-by-market.html

[iii] Ivanova, Irina, “More Than 4 Million Americans File for Jobless Aid, Bringing Pandemic Total Above 40 Million.” CBS News, May 21, 2020. https://www.cbsnews.com/news/4-million-file-unemployment-jobless-claims/

[iv] Li, Yun. “David Tepper Says This Is the Second-Most Overvalued Stock Market He’s Ever Seen, Behind Only 99.” CNBC, May 13, 2020. https://www.cnbc.com/2020/05/13/david-tepper-says-this-is-the-second-most-overvalued-stock-market-hes-ever-seen-behind-only-99.html

[v] Smithers, Andrew. “US CAPE and q Chart.” Andrew Smithers, 2017. http://www.smithers.co.uk/page.php?id=34

[vi] Cramer, Jim. “The Winners of the New World.” The Street, Feb. 29, 2000. https://www.thestreet.com/story/891820/1/the-winners-of-the-new-world.html

These are the opinions of Tim Hayes and not necessarily those of Cambridge Investment Research. They are for informational purposes only, and should not be construed or acted upon as individualized investment advice.

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