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Keep Calm and Invest On...
Some correction is expected but there's no reason to panic.
Panic is first and foremost on everyone’s mind when you see Red. The truth is we’re not used to negative balances and even for those of us who are (bankers!), we still don’t like it.
The last couple of weeks, towards the end of February and beginning of March 2021, has been challenging for many. Fear mongers have been going around with the notion that the stock market is about to crash. While I support no such theory, I can’t help but think when the bull run will end. The truth is the market is overvalued to a certain extent and while there is room to run for many sectors, there’s also room for correction.
The Market is Definitely Overvalued
Take a look at the S&P and the DJIA charts below, as I write this is in the second week of March 2021, you’re bound to notice two things:
They look very similar when you zoom out
We are currently trading at levels higher than we were before the Pandemic Crash
I've never been a chart aficionado. In fact, I only know the very basic indicators. But a picture paints a thousand words, hence, I decided to make things a little visual.
So now that I've stated the obvious, what about valuations. I used Professor Aswath Damodaran's NYU Website where you can download the Excel to value the S&P and play with estimates to value the market yourself. He's the expert and I agree with his model, so I don't bother building one myself. I used various rates and earnings measures, which I thought was appropriate and I came to the conclusion that ... the S&P is overvalued by a range of 8% to 31%.
So, one thing about valuations though - they are only ever as good as your assumptions. Sure, you can base your assumptions on experience or market consensus, but remember, it boils down to Garbage In, Garbage Out. But, we have to start somewhere and my estimates tell me the S&P is overvalued.
I realize that the range I've arrived at is pretty wide. But, if you ask me narrow it down I'd say we're about 20% overvalued at the moment.
But, let's get to the title of this post. Why I'm not overly worried and why I think we should carry on investing.
Why We Should Keep Calm
Demand & Supply
There's been a fundamental shift in market dynamics. We have a wave of new companies and SPACs coming to market, who are supported by a whole new subset of retail investors. While these retail investors realistically still only represent a fraction of the market, there's no doubt that there is strength in numbers. We've seen this first hand a couple of months ago with the surge in stock prices for popular names, not to mention the growth in cryptos. So the whole market has grown.
Stock Prices are Sticky
We all know by now that Tech Stocks are significantly overvalued and they will come down. But, I think prices will be stick and won't go below a certain level even if the P/E indicates otherwise. The last year has taught us important lessons about technology:
1) Life is better with technology and people won't just abandon it
2) We've explored companies that we'd have never thought to look at
3) There's real value in many of these companies that's sustainable (unlike the dot.com era).
4) These companies will eventually grow into their valuation
Interest Rates will Continue to Remain Low for Some Time
I know bond yields are rising but I don't foresee them crossing 2%+ levels in the next few months. The Fed still has good reason to keep rates low - unemployment levels are still high and the economy needs to recover. Low rates will foster a recovery environment and will fuel stock prices.
At the end of the day, how you play it will completely depend on your investment style. There still remains plenty of opportunity to make money in the market, if you play your cards right.
Happy Investing... and remember there's always a story behind the numbers.