Stock Stumble Isn’t a Starting Gun for Hysteria

Panicking is never a good plan when it comes to investing, but it’s particularly silly now, because nothing truly eventful has happened yet.

Sure, the Dow Jones Industrial Average was down 1,175 points on Monday — the biggest one-day drop ever, before stocks fluctuated on Tuesday. In percentage terms, it was a 4.6 percent decline. Investors may not see that every day, especially recently, but it’s happened plenty of times in the past.

And yes, the S&P 500 Index was down 7.8 percent since Jan. 26 through Monday. But it’s nowhere near a 20 percent decline that constitutes a technical bear market. It’s not yet even a correction, which is a 10 percent decline.

In fact, bulls should be as confident as ever. Their defense of the market’s rich prices is fully intact. The economy continues to grow, and no recession is in sight. Corporate earnings are expected to grow 26.7 percent in 2018 and an additional 10.4 percent in 2019. Interest rates remain low, and the current sell-off will undoubtedly make the Federal Reserve think twice about its plans to raise rates.

Just a week ago, bulls were fond of pointing out that the S&P 500’s price-to-earnings ratio was a reasonable 16.7 times based on expected earnings for 2019. That P/E ratio has since dropped to 15.4 times. If they liked stock prices then, they should love them now.

On the other hand, investors who are more circumspect about the market’s lofty levels, including me, have nothing to get excited about. Even after the recent declines, the cyclically adjusted price-to-earnings, or CAPE, ratio for U.S. stocks stands at 32 times, according to data compiled by Yale professor Robert Shiller. That’s still nearly double the long-term average of 16.8 since 1881.

To put that in perspective, the S&P 500 would have to fall to 1,380 — or an additional 52 percent — just to reach its long-term average valuation. And if that were to happen, more than likely the market would overshoot the mark. At its post-financial crisis low in March 2009, the CAPE ratio was 13.3. That translates into a price of 1,100 for the S&P 500, or a 58 percent decline from its current level.

I’m not predicting that the market is poised to return to its long-term average now or even any time soon. But let’s take a collective deep breath. Investors who weren’t worried a week ago have nothing to worry about now. And for those who were, there’s nothing remotely interesting to see yet.

Source: Bloomberg Gadfly, https://bloom.bg/2EcMKRG

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