As I write this, Amazon’s (AMZN) stock was up close to 78% on the year1, Apple (AAPL) was up by 69%2, and Netflix (NFLX) was up by 49%.3 Alphabet (GOOG), the parent company of Google, was up by a meager 18%.4 Come on, Google, get with the program. Note, that was said in my sarcastic tone. Being up by 18% while we’re only in August is more than respectable. But none of those high-flying stocks have remotely returned the 375% return on Tesla.5
It’s been a long time since the internet bubble of the late ‘90’s, but I’m starting to note similarities. Like those heady days, more people seem to be following the market and looking for stock tips instead of steadily dropping money into index funds. Part of this might be due to the popularity of next generation brokerages like Robinhood, which feature commission free trading and only a hint of financial and investing advice, most of it canned.
I’m leery of buying stocks solely because of the fear of missing out. I hope you will be, too. By the time a stock becomes frothy enough to generate returns like Amazon, Apple and especially Tesla, there’s a good chance the stock price has more to do with the behavior of crowds than the value of the company. Many people do trade according to stock momentum and beliefs about the supply and demand for a company’s shares, but I need to be confident about the company and the value of the shares.
No one can say for certain the market is “overvalued” because stocks’ underlying value depends on forecasts, estimates and value judgments. It very well might be the market’s latest run makes perfect sense given the progress in vaccines and employment trends, which remain lousy but maybe less lousy than the Street feared.
But there’s some evidence the market might be frothier than a cappuccino party. One indicator I’m fond of is the Cyclically Adjusted Price to Earnings Ratio, otherwise known as the Shiller PE Ratio, or simply PE10. The CAPE ratio is the level of the S&P 500 divided by the average of the past ten years’ inflation adjusted earnings6. The low for that ratio was estimated to be 4.78 in December 1920 and the high was 44.19 in December, 19997. The average has been between 15 to 17, depending on which average you use. On Friday, August 21 the CAPE Ratio stood at 31.257, which is close to twice the historic average. That could make sense if we were seeing profits skyrocketing for most of the companies in the S&P 500, but it seems a bit optimistic given that we might be only halfway through a global pandemic.
As I’ve said before, I try not to overreact to any one data point. I won’t short the market in all my clients’ portfolios, because as much as I might suspect the market is overvalued, it can stay overvalued for an astoundingly long time. But I won’t be surprised when the market decides this rally has run its course.
Evan R. Guido is the Founder of Aksala Wealth Advisors LLC, a 2018 Forbes Next-Gen Advisors List Member, and Financial Professional at Avantax Investment ServicesSM. Evan heads a team of retirement transition strategists for clients who consider themselves the “Millionaire Next Door.” He can be reached at 941-500-5122 or email@example.com. Read more of his insights at https://finance.heraldtribune.com/category/ask-guido/. Securities offered through Avantax Investment ServicesSM, Member FINRA, SIPC. Investment advisory services offered through Avantax Advisory ServicesSM, Insurance services offered through an Avantax affiliated insurance agency. 8225 Natures Way Suite 119, Lakewood Ranch, FL 34202. The views and opinions presented in this article are those of Evan R. Guido and not of Avantax Wealth ManagementSM or its subsidiaries. Past performance does not guarantee future results. The S&P 500® Index is an unmanaged index of 500 selected common stocks, most of which are listed on the New York Stock Exchange. The Index is adjusted for dividends, weighted toward stocks with large market capitalizations and represents approximately two-thirds of the total market value of all domestic common stocks. Investments cannot be made directly in an index.