Is The Stock Market Overvalued? Does it Matter?
If you spend any time watching or reading about the stock market, I’m sure you will often hear debate on whether now is a good time to invest. Some will argue that the market is overvalued and is due for a drop, while equally intelligent sounding people will argue the market is not expensive and now is a good time to invest.
We’ll they can’t both be right, can they? And does it really matter in the end whether the market goes up or down 10 or even 20% in the next few months?
Question #1: Is the stock market overvalued? We’ll focus on the USA and Canada for now.
The case for overvalued: Robert Shiller from Yale University believes the markets are overvalued because the price to earnings ratio of companies that make up the S&P 500 is very high relative to its 136 year average. His price to earnings ratio is averaged over the past 10 years to smooth out super strong and super weak years. It’s commonly called the CAPE 10.
The case for not being too overvalued (no one is really arguing stocks are cheap today): Larry Swedroe from etf.com believes that Robert Shiller’s CAPE 10 is flawed for a variety of reasons. His main argument is if you remove the horrible 2008-2010 years when earnings collapsed in the US, the numbers look a lot better. Secondly, the data that Robert Shiller uses in his historic calculations is just not that accurate. Instead Larry thinks the data used should start around 1960 instead of 1871. Using Larry’s data set, the S&P 500 is not as overvalued as Robert Shiller suggests.
In Larry’s camp is Warren Buffett who also believes the market isn’t cheap but considering how low bond interest rates are, he doesn’t see the current valuation as being that problematic.
Conclusion: Who the heck knows? Probably not cheap but your guess is as good as mine.
Question #2: Is it worth worrying about answering question #1 above?
Probably not, because a guaranteed answer is not available. If you are worried that future returns will not be the same as past returns, you could always increase your savings from 6% to 10% of income.
Secondly, in any given year, the stock market can be up or down 15 or 20%. If you have the courage to wait and then buy in a dip, you can turbo boost your returns. For example, from April 24, 2015 to January 20, 2016, the TSX was down 23%. If you were worried that stocks were too expensive last year, you could have bought them for a 23% discount a few months ago. Since the January low, stocks have rebounded and made up all their loses. Do you have to courage to buy when the world is telling you to sell?
Lastly, none of these month to month gyrations will matter much if you invest faithfully for 30 or 40 years. Far more important is sticking to a plan year after year, decade after decade, then re-balancing as required and forgetting the market noise.
I’m a department head for a high school in Toronto. I graduated from the Ivey School of Business at Western University and have been a DIY investor for over 20 years.