Nobel Prize winner explains why the stock market is overvalued

Sock Market overvalued

A few days ago the Dow Jones Industrial Average reached another all time high.  This is often used as a barometer of how the overall economy is doing in the United States by commentators and pundits.  But one has to take a closer look to understand exactly what this “all time high” actually means, and whether or not one could consider the stock market overvalued.

 

So…   Is the stock market overvalued?

Stock Market overvaluedThe Dow Jones Industrial Average is a composite index that shows how 30 large publicly owned companies based in the United States have traded during a standard trading session in the stock market.  So it is less a measure of the overall economy, and more a measure of how these 30 companies future outlook of profits are bid for. Well things seem to be OK for these 30 companies, so why not invest in them?

The answer comes from Yale Professor and Nobel Prize winner Robert Shiller.  He has come up with a method of comparing earnings per share (EPS) with price performance. Using Shiller’s formula of averaging earnings over a 10-year time frame, the CAPE (also known as the “P/E 10”) is currently 25.61 — well above the historic mean of 16.52. To translate that into English, the stock market is currently more than 60% over-valued.

Using the long term values of stocks, there are only 3 times in history has this formula been so overvalued:

  • Just before Black Tuesday 1929
  • The IPO .com bubble of 2000
  • Late 2007 before the onset of the 2008 financial crisis

 

Why is this happening?

Why is there such a discrepancy between what people are willing to pay for a stock and real value?  The answer lies in where the money is coming from.

Simply put, the Federal Reserve – the central bank of the United States – is printing a money.  A lot of money.

Currently more than $60 Billion dollars a month. 

A good portion of this money ends up in the stock market where it competes for the future earnings of the most sought after companies (which is what stock prices are).  When a market is priced based not on real demand but on expectations of future price rises it is called a speculative bubble.

If history can teach us anything, this means it is time to get out.

Now.

 

And how does this relate to real estate in Playa del Carmen?

Given the relative certainty, based on every available indicator, that there will absolutely be a stock market crash in the near future, the question then arises: If I shouldn’t keep my money in the stock market, what are my options?

Are there other investments where the economic indicators show a better outcome – both long and short term?

Of course!  And in an upcoming blog post, we are going to explore some of those options.

Talk to you soon!