Is the U.S. Stock Market Overvalued?

I always make the effort to be very straightforward about how I approach a person’s finances.  This way my client and I will have no concerns as to where we are along our journey.

So, when I read the many Wall Street articles on this question, I found many misconceptions about our stock market today.  I wanted to write this article to clear up some of them and hopefully give you my insights on how to protect your investments the way successful investors do.

It begins with a strategy that outlines where a person is today in their financial health as well as where they are going.  Some people are at the very beginning of their financial health and need to tweak their fastest pathway to cash, while others are looking for their investments to grow.

We hear people talk about success in investing but most don’t talk about failures.   However, both are present.  Most people love to talk about the bull (stock markets moving up) versus the bear (stock markets moving down).  Today’s bull market began in 2009.  And for the past 5 years, it has been in an upward tear.  In fact, in 2012, the stock market (S&P 500) rose over 16% and a year later, in 2013, it rose over 30%.

So it doesn't surprise me when people worry about the stock market being overvalued.  At some point, this bull market will reverse and turn into a bear market.  Today’s 5-year bull market preceded our 2008 bear market where the stock market (S&P 500) dropped 37%.

The math will explain why a double digit fall can be so devastating.  As an investor, if you have a $100,000 investment account and it drops 37% ($37,000), you feel that.  And it doesn't feel good.

Ever start a hike walking downhill before having to turn around an hour later and walk back up the hill?  Walking up the hill is much harder and not nearly as fun.  That is the reality.  And this is the fear—because you would need more than a 60% return just to bring you back to your starting point of $100,000.

So, is our stock market (S&P 500) overvalued today?  In my opinion, it is.  But that isn't the question an investor should be asking.

As an investor, it is important to have a clear investment strategy—one that recognizes where you are today, what your needs may be over the next year and in the future, and how to best get you there while allowing you to sleep soundly at night.

This strategy is important no matter what our stock market is doing.  That doesn't mean you can’t invest a portion of your investment to protect you from a 37% decline.  That doesn't mean you can’t invest in the stock market.  It simply means having several strategies in place.

You could include a strategy that will reduce the downside exposure in the U.S. stock market during a severe bear market.  And add a global asset allocation strategy in addition.  There are many options.

The idea that you can’t time the stock market is nonsense.  However, most are looking for perfection—and that isn't a strategy.  This is no different than trying to correctly time which is the right lane to be driving in during severe traffic congestion.  You should focus instead on how to reach your destination safely.

It doesn't matter if you are person who breaks at every red light or if you floor the gas pedal when the traffic
light goes from green to yellow.   Knowing the risk in all cases and having a strategy to get you home safely is what is important.  Stock markets fluctuate.  This is expected if you are an investor.  Having an investment strategy in place to handle these fluctuations should be a requirement for every sound investment plan.

But the question at hand is, “should I be heading for the exit?”  At this point, I can only talk from a blind position, meaning one without a strategy in place.  But as of today, no, I wouldn't recommend heading for the exit.  Even though I believe the market is severely overvalued, I also believe it can still move higher.  I believe we will have a good 2014 and possible even a good 2015 in the S&P 500.

My advice is to develop a sound strategy that matches your temperament as a long-term investor.  In my experience, finding the next greatest hit is harder than market timing and usually the hit doesn't last forever. 

If you need help putting a strategy into place, we would love to be of service to you. Please schedule an appointment with us.

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