Don't Fear The 'Overpriced' Market

Richard Robinson's picture

Tuesday, January 17, 2017 - 11:30am

by Richard Robinson

If you Google the phrase, "is the stock market overpriced," you'll get more than 600,000 hits on how the market is ready to fall off a cliff. That search will find you article after article comparing today's market to 1999 and even 1929.

Several articles try convincing their readers that the market is as much as 80% overvalued -- as if that statement has any real meaning.

Others say prudent investors should stay away from the stock market after it hits a new high. They reason that the market must revert to some mean level before it can sustain a move higher.

On that, I call BS.

Here's why...

It turns out that, historically, the best time to buy stocks is after a new 12-month high as opposed to a new 12-month low. Now this may seem illogical or counterintuitive. After all, you'd think the market would have more upside potential after hitting a new low than a new high. But I have 90-years of data to prove that hypothesis incorrect.

You see, the historical record going back to 1928 shows that stocks perform 160% better after hitting an all-time new high. Take a look at the chart below. The data shows that the 12-month return after hitting a new high is 7.3% versus the 12-month return of just 2.8% after a new low.

And the data wasn't cherry-picked to make the point. I looked at all 12-month periods after a new high or new low since 1928.

Better yet, the numbers above represent actual returns in the market. They aren't influenced by dividends, but if they did the total return would be even higher.

What this means is that investors shouldn't be afraid of buying stocks after the market hits a new all-time high. On the other hand, investors should be afraid to buy stocks after a new 12-month low.

So this begs the question...
 
Can Stocks Go Higher In 2017?
The answer is yes. Let me explain...
 
Most times, the main driver of stock prices is earnings. In fact, there's an old saying that as earnings go, so go stock prices. It's a truth burned into most investors' minds.

But it isn't always true.

Now don't get me wrong, earnings are the most important driver of stock prices... most of the time. The problem here is that earnings over the past several years haven't grown in real terms. Rather, they've been manipulated to a large extent by stock buybacks.

By buying back its stock, a company reports its earnings per share over a reduced share count. By doing that, they make it appear their earnings are rising -- when in fact they're level, or quite possibly in decline.

It's a neat trick if your shareholders aren't paying attention. But it hides the fact that a company isn't growing its earnings. And in a normal market, that should cause stock prices to fall.

But if earnings haven't been the main driver of stock prices in recent years, what has driven the market to the highs we see today?

It's simple. The main driver has been ultra-low interest rates.

What Does This Mean?
To understand if stocks can go higher from current levels, investors must consider whether stocks are a good deal relative to interest rates. In other words, investors must consider both stock valuations AND interest rates when making investment decisions.
 
Now, short term interest rates have risen since late last year. Some of that is from the Fed's actions. But the Trump rally has done a fair share of pushing rates higher based on the expectation of future higher inflation.

But despite the recent rise, interest rates remain incredibly low by any historical measure. And with the prospect of higher inflation, investors aren't likely to be lured to the higher coupons of bonds. The yields just don't justify the inflation risk.

That means stocks will continue to be favored over income-producing assets through 2017.

But There's Another Reason...
Investors make a mistake when they focus on the overall market.

The idea of an overvalued market is meaningless. You see, unless you own stock indices, such as the SPDR S&P 500 ETF (SPY), you don't own the market.

You own stocks, like General Motors (NYSE: GM) or Apple (Nasdaq: AAPL).

Of course, every company is different. Their earnings are growing or declining. They're in cyclical businesses that are expanding or contracting. They have wide moats and narrow moats, mega trends or no trends.

In other words, each stock is its own entity. You can believe that the market is overvalued, but that doesn't tell you anything about the current valuation of Coca Cola (NYSE: KO) or any other stock.

So, it's an abstraction to say the market is overvalued. The "market" as an entity that can be valued only exists in some ethereal sense. It isn't real.
 
That's why the analysts at Street Authority focus on the valuations of individual stocks and not the valuation of the market as a whole. We concentrate on the underlying businesses.

That's how we've become one of the preeminent stock advisory services in the country.

Risks To Consider: While using terms like "the market is overvalued" is meaningless in and of themselves, that doesn't mean that stocks aren't greatly influenced by economic conditions. Stock prices can fall if interest rates rise significantly from current levels or if inflation becomes a problem under Trump's spending plans.

Action To Take: Keep up with the latest research and analysis from StreetAuthority to be the first to hear about value plays and market-beating income opportunities on individual stocks.

Editor's Note: From proven blue-chips to breakthrough players, these 10 top stocks are rock solid "must-have" material for any portfolio. To find out how you can accelerate your retirement schedule by up to a decade, check out the report here...

does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.