How to value markets now
It’s very hot outside today.
So, let’s stay in the cool and check if stock-markets might be overheated now too.
And let’s use one of the most powerful tools you’ll find.
The US stock market is the world’s largest – and it’s often said that when they sneeze, we catch a cold.
So it’s worth having a some kind of tool for valuing that market.
Having a basic idea about market value can can help you to . . .Avoid being caught with all your money in the markets at the wrong time.Click To Tweet
It can also help you to gain the confidence to commit some funds to the markets when others are running scared.
Unfortunately, not all advisers will offer you this sort of information.
The best will, of course, but many won’t because they take the view that markets are correctly valued at all times.
We’ll explore this belief another time but one thing’s worth noting here. Advisers who follow this view do not tend to adjust their investment advice at different market valuations.
And whilst that simplifies their business model, it presents additional investment risks to you.
So stay tuned!
Now, when markets take a nosedive, you’re likely to hear some of these reassuring words:
“don’t worry . . . it’s just another little correction… …it’s all perfectly normal….
…prices will march upwards again shortly.”
Yes, and some media commentators will also suggest that you buy more shares at those times.
At what ‘they’ might describe as cheaper levels.
Buy more on the dips
You must have heard that phrase
And when you think about it – it’s really quite curious isn’t it?
I mean, how can markets become ‘cheap’ if you believe they’re correctly valued at all times?
And how useful (or dangerous) are recommendations that you should ‘buy on the dips’ from newspaper articles or blogs anyway.
You see the thing is . . . that these writers have absolutely NO idea:
- How much you’ve invested already
- About your personal attitude to risk or – most importantly
- Your capacity to take on risk at all
They know NOTHING about your personal financial situation – or that of your wider family.
So, they should NOT be advising you on any investment matters – as I pointed out here.
Okay so are there any rules of thumb?
No, none at all.
All we can say is that the “buy on the dips” idea might be sensible for some people . . . some of the time!
But then only when your chosen market is at reasonable or ‘fair’ value.
Right, so where might we get some clues as to ‘value’?
Well, take a look at this chart which I’ve just updated to June 2017
It uses CAPE data from Nobel Prize winning economist, Professor Robert Shiller. So the data is robust!
And it covers the period from 1880 to Summer 2017.
So it gives great long term perspective.
Okay but does CAPE stand for?
Well, the CAPE (aka Shiller PE) stands for Cyclically Adjusted Price to Earnings.
And you can (Learn more about it here if you’re interested)
The key point here is that this red line (the CAPE) is accepted by many investment experts as a useful indicator of market value.
And what happens to that red line – over time – is what matters.
See how, when markets are overvalued (as the US market seems to be at the time of writing) a “little correction” often turns into something much worse.
And notice howthe US market (by this measure) has only been up at these current levels on two previous occasions in the past 130 years.Click To Tweet
Those years were 1929 and 2000
And both occasions were followed by a crash!
Oh dear . . . so am I predicting a crash?
Well no, no one in their right mind would predict one of those!
That said I’m not predicting that there won’t be one either 😉
The truth is that no one can predict the direction of markets. So do NOT believe anyone who says they can.
You might as well read your tea leaves!
All I’m saying here is that this CAPE measure can help us to see when stock markets might have gone haywire.
It gives us a clue as to when valuations have reached ‘wackily cheap’ or ‘super expensive’ levels – at least relative to their long-term history.
Yes, it’s rough and ready and does NOT promise precision but it’s useful.
And it’s a LOT more useful than being told by an overzealous sales person that markets are fairly priced at all times eh?
Now, if you’re old enough – and British – you may remember a family TV programme called ‘The price is right’ – with Bruce Forsyth.
That was a great name for a fun TV show – but it’s NOT a good maxim for thinking about your stock market investments.
Clearly market prices are not right all the time – anyone can see that.
If they were always right, then they would not reverse direction as violently as we see above.
So the lesson here is to take account of market value when investing your wealth.
And yes, I do think the US and UK stock-markets are pricey right now.
They could race up again to the extraordinary levels reached at the start of the millennium.
Then again, they could, quite clearly, fall a lot from here.
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