Many analysts claim that current stock valuations are similar to the dot-com era. You can see it visually on CurrentMarketValuation.com. Some highlights …
The classic “Buffett Indicator” certainly seems to be in the area of the nosebleeds. Note that valuations were also high in 1966, the beginning of a long-term bear market.
Then there is the always popular Price-performance ratio. By doing this, note that the 1966 ratings were not stretched too far. Nevertheless, a 17-year bear market followed, measured from the peak to the beginning.
The next is unusual: Score measured by mean inversion. Mean inversion is the fairly straightforward concept that “what goes up has to come down”.
While the daily movements of the market are chaotic, long-term stock market returns tend to follow somewhat predictable upward trends. But they can also deviate from the trend for years or even decades.
This is not a trading strategy. But it’s still a useful indicator of overall market valuation compared to the past.
What’s different now?
This isn’t your father’s or grandfather’s overvalued market (if he was still alive in 1929).
There are two main differences …
First, in the dot-com era, the Federal Reserve let loose the dogs of loose monetary policy for 2000. That was reasonable given the uncertainty, but it clearly helped drive already overvalued markets to extremes.
We’ve had day traders piling up in what looked like an internet stock, speculation, really easy money, and so on. After January 1st passed uneventfully, Greenspan appropriately reversed the Fed’s monetary policy. Oops.
And now we have huge incentives for the federal government, which in less than a year will soon be about 25% of GDP. The money ends up somewhere, but its effects are still unclear. There is no historical parallel to consider.
Overrated … but maybe not overpriced
Jerome Powell is not Alan Greenspan.
Powell and his colleagues have made it very clear that they will keep monetary policy loose and keep rates low for a very long time. Inflation is way down on their list of concerns. Their main concern is unemployment, which is indeed a real problem.
The Fed is telling us that inflation will rise to 3% or more. They look at average inflation over time, which means they can justify doing whatever they want.
What they want is low interest rates even as they overheat the economy until unemployment is back to where it was before the pandemic.
If they really mean it, then we will have low rates for a very long time because unemployment is a bigger problem than most people think.
It also means that no coincidence may make it easier for the US Treasury Department to refinance a widening federal deficit.
Persistently low interest rates could, however, mean that stock market valuations are actually in the range of the fair value.
Check out this graph that shows the S&P 500 value versus interest rates. The interest rates are 1.6 standard deviations below the trend line.
This suggests that the S&P 500 might not be that overpriced.
While the valuations say nothing about short-term market moves, they are actually pretty good for longer-term returns.
That being said, some smart people I follow see undervaluation in more than a few places (at least when compared to the US). If you are looking for value, you might want to start there.
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