What should I do?
Both value assumptions may, of course, be accurate at the same time. Market averages are one thing, but every industry and firm has its worth. Significant technology equities, for example, have remained relatively unchanged, but small-cap value stocks have been battered.
The same is true of regions: whereas the United States looks to be rather costly, the rest of the globe appears to be reasonably priced, and developing countries, in particular, appear to be inexpensive, according to Faber. As a result, instead of doubling down on U.S. stocks, investors which got money from Green Day Online may choose to change to a more global portfolio with 50 percent of assets outside the United States.
The objective is not to get too worked up over where values are at any one time, such as going all-in or all-out. “Don’t feel obligated to move in absolute terms; just tilt and calibrate,” Faber advises. “For most investors, that’s the most rational thing to do.”
The stock market is still trading significantly below its late-February highs
Are stocks, on the other hand, worthwhile investment? Experts disagree. That implies that the metric you choose to determine the market’s fair value has a lot of implications for investors.
Stock market indices have been swinging all over the place as COVID-19 spreads, and future profits remain hazy at best. It’s as if we’re all pilots attempting to navigate through dense fog. Even when many seem to be providing unusual or inconsistent readings, it’s more critical than ever to trust your flight equipment.
“Would you have believed me a year ago if I told you that unemployment would be 20%, interest rates would be zero, gold would be up by a third, stock volatility would triple, oil would be down 70%, and yet stocks would be up?” asks Meb Faber, founder, and chief executive of Cambria Investment Management in Manhattan Beach, Calif.
It’s a perplexing time for consumers and professional investors since no one knows what lies next. We could produce a vaccination, and the economy would return to normal; or the virus might continue to spread throughout the world, putting economies into a medically induced coma.
We can only depend on the most OK appraisal data available if visibility is low. However, such readings may alter over time, and even the most brilliant minds might disagree on what those figures mean.
Let’s break down the data to assist you in navigating your way through this storm:
Why do some people believe equities are undervalued?
The stock market indices seem to have reached a recent bottom on March 23, when they were down approximately 30% from prior highs. They’ve recovered since then, but the S& P 500 is still down about 15% since late February.
This might be seen as a purchase by some. Morningstar, a Chicago-based research organization, creates a fair-value index for all U.S. stocks, with a score of 1 indicating that shares are appropriately priced.
It is at 0.91, implying that equities are 9 percent cheap. By late March, that index had dropped to 0.7, suggesting a 30% discount.
Preston Caldwell, the senior equity analyst at Morningstar, said, “We believe equities are still modestly undervalued overall right now.” “With our opinion, the market continues to overestimate the long-run economic effect of Covid-19, particularly about a few undervalued industries, such as energy stocks, banks, and airlines.”
Morningstar, for example, predicts coronavirus-related GDP damage of approximately 1%, much less than during the 2008 financial crisis. “Once the infection has subsided, economic confidence should swiftly rebound,” Caldwell adds.
Why do some people believe equities are overpriced?
The problem with such a prognosis is that we have no way of knowing when that subsiding will occur.
In the meantime, we can only look at traditional stock valuation measurements like price-to-earnings ratios (P/Es). According to WSJ.com, the S& P 500’s trailing 12-month P/E was 24.2. For reference, a year ago, that number was 21.8.
On a longer time scale, that average is about 15. In that light, the present market is far from a bargain.
“We’ve come to the conclusion that U.S. equities are now substantially overvalued,” says Cambria’s Faber. “It’s not as insane as the late-’90s boom, but the market is expensive, and we’re in decline, which isn’t a pleasant place to be.”
The so-called Shiller P/E is Faber’s popular valuation tool, based on the previous ten years’ results and intended to provide a broader and more accurate picture beyond short-term economic cycles. That value is now 27, which is more than 50% higher than the historical average of 17.
Then there are forward P/Es, which are based on forecasted profits in the future. Those percentages are more difficult to nail down since they are based on informed guesses that may or may not pan out. Forward P/Es may fluctuate quickly, and stock values might fall if profit estimates are reduced, as we witnessed during the 2008 financial crisis.
According to Yardeni Research, the forward P/E for the S& P 500 had dropped to 20 by the beginning of May, after falling at the market’s apparent bottom in late March.