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Writer's pictureJohn Gibson, CFA

The Boy Who Cried "Bubble"



2024: “The Buffett Indicator is indicating US stocks might be overvalued.” - Business Insider

2023: “The Stock Market Is Wildly Overvalued, Interest Rates Show: JPMorgan" - Markets Insider

2022: "Is the Stock Market Still Overvalued?" - MarketWatch.

2021: "Experts Warn Stock Market is Overvalued" - CNBC.

2020: "Markets Enter 2020 Overvalued, Analysts Say" - Bloomberg.

2019: "U.S. Stocks Remain Overvalued: Analysts Caution" - Financial Times.

2018: "Market Overvaluation Concerns Mount as Stocks Climb" - Reuters.

2017: "Are Stock Markets Overvalued? Analysts Weigh In" - Forbes.

2016: "Markets Overvalued? Experts Say Yes" - Wall Street Journal.

2015: "Stock Market Overvaluation Hits Record Levels" - The Economist.

2014: "Investors Worry About Overvalued Markets" - Barron's.

2013: "Stocks Overvalued, Warn Economists" - Business Insider.

2012: "Market Overvaluation: Time to Worry?" - Financial Times.

2011: "Stock Market Overvalued, Analysts Suggest" - Reuters.

2010: "Overvaluation Fears in Stock Market" - Bloomberg.

2009: "Stocks Look Overvalued: Market Analysts" - CNBC.

2008: "Market Overvaluation Worries Grow Amidst Crisis" - Wall Street Journal.

2007: "Warning: Stock Markets Overvalued" - The Economist.

2006: "Analysts Warn of Overvalued Stock Market" - BusinessWeek.

2005: "Are Markets Overvalued? Analysts Say Yes" - Reuters.

2004: "Stock Market Overvaluation Concerns" - Forbes.

2003: "Is the Stock Market Overvalued? The Data Says Yes!" - Liberated Stock Trader

2002: "Stock Market Overvaluation Remains a Concern" - Bloomberg

2001: "Overvalued Markets Pose Risks for Investors" - Financial Times

 

No matter what year you look, you can always find analysts and market researchers that presume that the stock market is overvalued. Given that value is relative, there is some truth to the notion that the stock market has become more overvalued compared to the past.


Indeed, according to the CAPE (cyclically adjusted price to earnings) ratio, the market has seemed overvalued for much of the 2000s. In the world of stocks, the CAPE ratio helps us understand if a stock market is a good deal or not by looking at how much money companies make compared to the price of the stocks. If the CAPE ratio is high, it might mean the stock market is expensive compared to how much money the companies are making. If it’s low, it might be a better deal.


The average CAPE (Cyclically Adjusted Price-to-Earnings) ratio of the S&P 500 from 1900 to 1989 was 14.15. In contrast, the average CAPE from 1990 to 2023 increased to 26.33. Currently, the CAPE ratio for the S&P 500 stands at 35.49. As illustrated in the chart below, the CAPE ratio has fluctuated around a stable average for 90 years before rising to create a new benchmark.

Does a higher CAPE ratio indicate that it's time to sell and seek investments elsewhere? Historically, making such a judgment could have led you to abjectly miss out on significant market returns over the past three decades. Moreover, even in seemingly "overvalued" markets, there are always undervalued investment opportunities, albeit they may require more diligent searching.


Additionally, I believe that today's markets merit a higher valuation compared to those of the past for several compelling reasons.


1.      Economic Growth: The U.S. economy has grown significantly since the 1980s. Strong GDP growth, increased consumer spending, and higher corporate profits have contributed to rising stock prices.

2.      Technological Advancements: Technological innovations have driven productivity and profitability for many companies. The rise of tech giants like Apple, Microsoft, and Google has boosted the index's value.

3.      Financial Market Efficiency: Advances in financial technology and market infrastructure have improved trading efficiency and liquidity. High-frequency trading, algorithmic trading, and better access to financial information have all played a role. Trades are now virtually zero-cost.

4.      Increased Corporate Profitability: Companies have become more profitable due to improved management practices, globalization, and advancements in technology. This is somewhat restricted to the advanced economies of the world. For example, the average net profit margin of S&P 500 companies has increased from around 5-6% in the 1980s to approximately 10-12% in recent years.

5.      Inflation and Interest Rates: Lower interest rates and inflation have generally increased the attractiveness of equities compared to other investment options, driving up stock prices.

6.      Globalization: Increased global trade and investment have benefited U.S. companies, many of which operate internationally and generate significant revenue from abroad. China’s manufacturing capabilities changed the world starting in 1994.

7.      Demographic Changes: The growth of investment funds, including retirement accounts like 401(k)s and IRAs, has led to more capital being invested in the stock market, driving up the index’s value. More demand will increase prices.

8.      Regulatory Changes: Deregulation and changes in financial regulations have sometimes led to more efficient markets and increased investment opportunities. Increased regulations have restricted public market supply. Companies stay private for longer these days. Less supply = higher prices.

9.      Investor Behavior: Changes in investor behavior and the rise of passive investing strategies, such as index funds and ETFs, have increased demand for S&P 500 stocks.

10.  Less Pirates: There are less pirates in the world today. In the early 19th century, the United States faced threats from the Barbary States. These states were allowed piracy of U.S. and European trading vessels. After gaining independence, the United States no longer had the protection of the British Navy, making American merchant ships vulnerable to piracy. The Barbary pirates demanded tribute, which the U.S. initially paid but later refused, leading to the First Barbary War. The most notable event involving the Marines was the Battle of Derna in 1805. Led by First Lieutenant Presley O’Bannon, a small force of U.S. Marines and mercenaries marched across the desert from Egypt to capture the Tripolitan city of Derna. This campaign is famously associated with the Marine Corps hymn line “to the shores of Tripoli.” The successful capture of Derna and other military actions pressured the Pasha of Tripoli to negotiate peace, ending the war and reducing the tribute payments. The U.S. military forces have helped cut down piracy and protect global trade ever since.

 

Sorry #10 was so long. I like the story. There are several other direct and indirect, market and non-market related reasons that I could list, but we don’t have all day and I prefer a 10 item list.


When considering investment opportunities, it is crucial to take valuation into account. However, it's equally important to recognize that value is relative and must be understood within its historical and fundamental context. Are the stocks and markets of today truly comparable to those from 50 or 100 years ago? The landscape of the market has evolved significantly over the past century, driven by advancements in technology, globalization, and changes in consumer behavior. Today's companies often operate in dynamic, fast-paced environments and leverage innovative business models that were nonexistent in the past. In conclusion, while valuation remains a key factor in investment decisions, it is essential to evaluate it in the broader context of market evolution and the specific characteristics of contemporary companies.


Lastly, it is important to diversify investments in different asset classes according to your risk preferences and financial goals. BrightHaven Financial Advisors can help you with this.

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