Investing in an Overpriced Stock Market

by | Wealth Management

The U.S. stock market has come a long way from its Great Recession low. That low, at which the S&P 500 bottomed out at 666 on March 9, 2009, is what has been 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.)

Mark Haines’ Legendary 2009 Call

Today (July 3) that index stands at 2423, an increase of some 200% from the low, recovering all plus some from its previous cycle high of 1576, reached on October 12, 2007.

Is the U.S. Stock Market Overpriced Today?

According to two measures of value, the answer is yes—and dangerously so. According to the CAPE ratio, the stock market is 113% overvalued. Another measure, the q ratio, has it at 79% overvalued. It has been overpriced only two other times: in September 1929, right before the Great Depression, and in March 2000, at the tail-end of the dot-com bubble.[3]

U.S. CAPE and q Chart

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

What Are Investors Supposed to Do?

Say you received an inheritance, or you have a lump sum sitting in the bank, are tired of earning no interest on it, and 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 gradually into the market, say, over a period of 18 months.

So, if you have $100,000 to invest, you transfer $5,555 a month, purchasing the market at 18 prices instead of today’s one price. There is no guarantee that 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 huge 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, then 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 that 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 hopefully will 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 but simultaneously yields you a return if the stock market continues to go up.

Beware of T.V. 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.[4]

The Winners of the New World

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

[4]   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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