My Comments: Dr. Doom here again. And boy, do I love this first chart. Many of my colleagues have been encouraging our clients to sit on the sidelines now for about two years or more. And we’ve been blasted because the DOW and the S&P just keeps going up.
Unless you believe the world has been reinvented, it will turn down. At least for a while. And if you have money critically placed to help you in your retirement, my suggestion is to play the odds that the market will turn against you.
There are ways to protect yourself and still make money, but that’s for another day when I change from Dr. Doom to Mr. Happy.
Steve Hunt | April 12, 2017
Since Donald Trump became the 45th president of the United States of America, the S&P 500 has jumped more than 8%. However, at least five different major financial indicators, along with a chorus of financial experts, agree: The stock market is alarmingly overvalued.
We’ve seen these historical moments before: a great boon before a great crash. President Coolidge’s era of excess in the 1920s led directly to the Great Depression. The dotcom boom in the 1990s was followed by a recession. The mortgage bubble burst us into the 21st Century’s Great Recession.
In March 2009, the S&P bottomed at 666. Today it’s trading around 2,300. This marks one of the longest bull markets in history, sparked largely by the Federal Reserve’s low interest rates. In the last decade, the Fed has shouldered a massive amount of debt to keep the economy afloat after the housing crisis, rolling out multiple rounds of quantitative easing. The national debt doubled between 2007 and 2017, from $9.2 trillion to $18.9 trillion.
Moreover, the Committee for a Responsible Federal Budget, a non-partisan group advocating for responsible government spending and debt reduction, predicts that the federal budget could increase by $5.3 trillion in the next decade, raising the deficit by as much as 25%.
Still, consumer confidence was at a 16-year high in March. Investors appear to be displaying optimism for the American economy by investing in stocks, an attitudinal response to President Trump’s rhetoric of unbounded economic expansion.
Unfortunately, the surge in the stock market does not reflect an economy grounded in reasonable economic growth. Financial strategist Michael Pento points out that historically, a recession has occurred in the U.S. about every five years and we’re long overdue.
Generally speaking, when the stock market is overvalued at the extreme levels we are seeing now, a sharp reversal occurs. The bubble bursts. The last time stocks were identified as being riskier than they are now was in 1929 and 1999.
Here are five financial indicators that show an overvalued stock market.
1. According to CAPE the Stock Market Is Overvalued By 75%
Case Shiller’s cyclically adjusted price-to-earnings (CAPE) ratio is a widely respected valuation measure of the U.S. S&P 500 equity market, originated by Nobel Prize-winning economist Robert Shiller. Though CAPE shows the stock market as overpriced since the 1990s (the 10-year CAPE average is 16, meaning that for every $1 a company makes, an investor pays $16), it hasn’t been this high since 2002 and 2007, directly before the last two crashes. For reference, the ratio was at 45 before the dotcom bubble burst in 2002. As of April 11, 2017, the ratio stood at 28.75.
Shiller recently warned against the dangerous “narrative” sparked by the Trump administration. Markets are rising based on unrealistic optimism over future prospects, despite the fact that the market bubble resembles the days leading up to the 1929 crash. Shiller warns that “something is not quite right with the supposedly strong and expanding U.S. economy.”
2. Corporate-Equities-to-GDP Ratio Is At Third-Highest Point in History
There are two primary “Warren Buffet Indicators,” named as such because the famous billionaire identified them as his favorite market valuation tools. One measures corporate equities against gross domestic product (GDP) and the other measures market-cap to GDP.
In December 2016, Wall Street jumped to 27.9 times the corporate earnings of the past 10 years, which registers as extreme on CAPE. It’s only been higher twice since 1950 – in 1999 at the height of the dotcom bubble and in late 2015. As of March 2017, the corporate-equities-to-GDP ratio was 125.3.
3. Wilshire 5000-to-GDP Ratio Is At Third-Highest Point in History
The Wilshire 5000-to-GDP is Buffet’s other favorite indicator – a market-cap weighted index of all U.S.-headquartered stocks traded on the major exchanges. A reading of 100% shows stocks valued fairly – anything over that reflects stock market overvaluation. The Wilshire index as a percentage of U.S. GDP is at 130%, much higher than the 45-year average, which stands around 75%.
4. Goldman Sachs S&P 500 Valuation Shows Stocks Overvalued By 88%
According to Goldman Sachs’ valuation of the S&P, the market is in the 88th percentile on an aggregate basis and in the 98th percentile on a median basis.
5. BofA S&P 500 Valuations Show Stocks Overvalued on 17 Out of 20
As of December 2016, Bank of America showed that the S&P is above average prices along 17 different measures, with overvaluation standing at more than 20% for nine of those.
Looking at the data across these five different metrics, it would be hard to make an evidence-based case for an accurately valued stock market. Instead, what some analysts are calling “Trump hope” seems to be spurring the rush into the rising S&P. It might be weeks, or it might be months or years, but at some point there’s a whole lot of hurt waiting to happen.
Considering the larger picture of growing consumer and national debt, paired with continuing global and civil tensions, the S&P’s performance is an incomplete picture at the very least and a red flag of looming economic collapse at the very worst. Either way, investing too heavily in rising stocks now could easily be considered a bold display of misplaced confidence