The stock market rebounded from the COVID-19-fueled sell-off in record time. But the rapid ascent of the S&P 500, Nasdaq, and Dow Jones Industrial Average has many asking if stocks are overvalued.
Especially in light of the fact that the U.S. is in a recession, the coronavirus pandemic has left millions of Americans and Canadian unemployed, and corporate profits have taken a nosedive. On top of that, coronavirus numbers are picking up again.
So, Are Stocks Overvalued?
Are stocks overvalued or is just the bears ruining the party? According to the two most trusted stock market valuation indicators, the Case Shiller P/E Ratio and the Warren Buffett Indicators, the stock market is seriously overvalued.
First things first. The stock market has recovered all of the losses associated with the coronavirus pandemic. This past spring, the Dow Jones Industrial Average and S&P 500 cratered approximately 35% within a short six-week span. It was the fastest ever collapse from record levels to a bear market.
Since then though, the Dow Jones, S&P 500, and Nasdaq have all rallied at an unprecedented rate. The S&P 500 hit a new record in just 126 trading days. That’s significantly shorter than the six-year average it takes for the S&P 500 to return to record levels. The Nasdaq returned to record levels after approximately 75 trading days and the Dow Jones is less than 5% away from its pre-pandemic record.
This rapid increase has pushed stock valuations into the stratosphere.
According to the Case Schiller CAPE/PE Ratio, the S&P 500 is overvalued by around 95%. The index is currently sitting at 31.35, the historical average is 16. That means that for every $1.00 of earnings a company makes, investors are happy to shell out $31.35. The index has only been higher once: in 2000. That also means stock valuations are higher than they were back in 1929, 1987, and 2007.
Admittedly, it’s impossible to time a stock market crash, but when the stock market is this overvalued, it never ends well. In fact, in all of these cases, overvalued stocks plunged in a stock market crash.
The second indicator that suggest the stock market is overvalued is the Market Cap to GDP Ratio, which compares the total price of all publicly traded companies to gross domestic product (GDP). Warren Buffett once said that this metric is “the best single measure of where valuations stand at any given moment.”
A reading of 100% suggests U.S. stocks are fairly valued. The higher the ratio is over 100%, the more overvalued the stock market. Conversely, the lower the ratio is under 100% the more stocks are undervalued. The current reading of 179%; a historic high.
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Even with the recent sell-off in stocks, the stock market is significantly overvalued. How long will stock valuations remain this high? It’s impossible to tell, but history shows that a correction is coming. Instead of running for the exits though, the trading professionals at Learn-To-Trade.com can teach investors how to make money when the markets are going up, down, or sideways.
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