Investing in an Overpriced Stock Market

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.[1] [2] (Sadly, Mark passed away in March of 2011.)

Today (Oct 31, 2021), that index stands at 4587, an increase of some 588% from that low, and almost tripling from its previous cycle high of 1576, reached on October 12, 2007.

How Overpriced Is the U.S. Stock Market Today?

According to three measures of value, the answer is very—and dangerously so. The CAPE ratio has the stock market as 240% overvalued. Another measure, the q ratio, has it at 330%. The market cap to GDP ratio supposedly famed investor Warren Buffett’s favorite is at 200%, eclipsing the previous high of 140% in 2000.[3]

Jeremy Grantham, famed money manager and founder of GMO, a Boston-based asset manager with over $60 billion of assets under management, thinks this market is comparable to the 1600s tulip bubble and the 1929 and 2000 stock market bubbles.

But Didn’t the Stock Market Go Down 40% During Covid?

 It did, but not for long, nor did it get cheap. Looking back, that 40% drop looks more like the 1987 stock market crash. A quick significant reduction followed by a recovery and then new highs. But not a grinding lower like what happened in 2000 and 2008.

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 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. Of course, 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. However, it would help you if there were a considerable drop of, say, 57%—which happened to the market during the Great Recession.

Read More: What Is a Reasonable Rate of Return After Retirement?

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 a 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.

Are Any Markets Undervalued?

Emerging markets have underperformed the U.S. stock market in the last ten years. And have significantly underperformed the more growth types of stocks that many of your funds invest in.

With many financial assets priced to perfection, the more you can diversify, especially into emerging markets that may be undervalued, the better.

Beware of TV Pundits and Hot Markets

The yang to the quiet, unassuming Mark Haines at CNBC was Jim Cramer. He 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.[4]

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.

Notes

[1] 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

[2] 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

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

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

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