Like it or not, it’s a fact: Using any historical valuation metric, the U.S. stock market is overvalued. For example, in last week’s Money and Markets column, I pointed out that the Shiller price-to-earnings ratio was well above its long-term average.
Well, here’s one more indicator that shows that stocks are in overpriced territory. And it’s one of Warren Buffett’s favorite valuation tools. It compares the total market capitalization of U.S. stocks to gross domestic product. Get this: At its current level of just above 113 percent, this valuation indicator has exceeded the level prior to the subprime crash in 2007 and is moving toward 2000 Internet-bubble extremes.
While I can make my case about excessive market valuations based on facts, theory, data, history and plain old-fashioned arithmetic, what I can’t do is change perceptions. Beliefs and perceptions are what they are. And, as such, they’re only as changeable as the minds that hold them; similar to the beliefs that were held prior to the bursting of the technology bubble, the dot-com bubble, the subprime bubble and countless other bubbles throughout history.
That’s because late in a bull market many individual investors — at the urging of Wall Street — often become convinced that the “greatest risk is being out of the market.” To paraphrase Buffett, there is nothing so disconcerting to your own beliefs as to see your neighbor who is acting foolishly get rich.
|Investors often believe what Wall Street wants them to believe.|
Unfortunately, investors who make a habit of believing what they want to believe — or what Wall Street wants them to believe — without considering the overall market environment, often end up losing a lot of money when reality comes crashing down on them in a harsh way.
Currently, we are just a few years past the 10-year mark of the Internet extreme. And the paltry 3 percent annualized returns that the S&P 500 has posted since then have been achieved only by returning to historically high valuations. What these markets need to provide as a sustainable base for future advances is good, old-fashioned economic growth.
Last week, we received encouraging news on that front when second-quarter GDP was revised upward from 2.8 percent to 3.6 percent. I am keeping my fingers crossed that this positive trend in economic growth continues. But I doubt it will because much of the change was a result of inventory adjustments, which tend to reverse in the next quarter.
For investors, the challenge remains to see things as they are, not as you want them to be. Accordingly, I urge you to hold only those investments that you would be comfortable with if the stock market were 25 percent lower than it is today. Go to Money and Markets’ Facebook page to see a couple stocks that tend to fare well in any environment.