<\/p>\n
Is now a good time to invest in the stock market? This is the million-dollar question to which every investor would love to have the correct answer.<\/p>\n
It seems as though we find ourselves in a complicated time for investing in the U.S. market for two reasons:<\/p>\n
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- Risk of recession<\/li>\n
- Stock far too expensive<\/li>\n<\/ul>\n
Beyond that of problems facing China<\/a>, we have already addressed the risk of a recession extensively in other articles<\/a> and in our reports<\/a>. The risk of recession in the U.S. is slim. The risk to investors, at least in the medium term, does not stem from this.\u00a0<\/p>\n
Nevertheless, a market crash could occur even without the economy entering into recession (a clear example of this would be the enormous drop in stock market prices in 1987). This is why we will attempt to respond to a second question; is the U.S. stock market overvalued? Unquestionably, since this drop and compared to the Great Recession, securities have risen a great deal in price.<\/p>\n
<\/p>\n
![\"A.72-1S&P500\"](\"https:\/\/trends.ufm.edu\/en\/wp-content\/uploads\/2016\/07\/A.72-1SP500.png\")
<\/a><\/p>\nSource: Stock Market Data Used in “Irrational Exuberance” Princeton University Press<\/sup><\/p>\n
<\/p>\n
Usually, the ratio most used when measuring the overvaluation of stocks is the Price Earnings Ratio<\/em> (the market price of a company share divided by the earnings per share of the company). In terms of historical returns, at present, the U.S. stock market undoubtedly is very expensive.<\/p>\n
<\/p>\n
![\"A.72-2StockMarketOverprice\"](\"https:\/\/trends.ufm.edu\/en\/wp-content\/uploads\/2016\/07\/A.72-2StockMarketOverprice.png\")
<\/a><\/p>\nSource: Stock Market Data Used in “Irrational Exuberance” Princeton University Press<\/sup><\/p>\n
<\/p>\n
Historically, the P\/E ratio has been at 16.7 and is currently at 26.3. This means that it would take 10 years more than average to earn on an initial investment if we buy a share today. In terms of historical yields and after discounting inflation, the U.S. market return is 7% annually. Current yields are less than 4%. This would indicate an overvaluation of stocks in the U.S. stock market.<\/p>\n
<\/p>\n
![\"A.72-3USStockMarketYield\"](\"https:\/\/trends.ufm.edu\/en\/wp-content\/uploads\/2016\/07\/A.72-3USStockMarketYield.png\")
<\/a><\/p>\nSource: Stock Market Data Used in “Irrational Exuberance” Princeton University Press<\/sup><\/p>\n
\u00a0<\/p>\n
If we take a more limited time period (from 1990), we see that the current situation is not so dramatic; historical yields are at 4.2% versus a current 3.8%.<\/p>\n
Nonetheless, in order to decide if an investment is attractive, we must compare it with its alternative, not with its own history<\/a>. In this case, the most common alternative to investing in stocks tends to be fixed income investments. For this reason we propose comparing returns on stocks with returns on long-term bonds. From this point of view, the situation changes radically.<\/p>\n
<\/p>\n
![\"A.72-4StockMarketvsBond\"](\"https:\/\/trends.ufm.edu\/en\/wp-content\/uploads\/2016\/07\/A.72-4StockMarketvsBond.png\")
<\/a><\/p>\n