Three Reasons Why You Should Ignore the Doomsayers and Stay in the Market

The mainstream media is costing investors a fortune…

Just take a look at some recent headlines below.

• “U.S. Stock-Market Valuations Are At Dangerous Bull-Slaying Levels”—Seeking Alpha, April 19, 2014

• “Stock Valuations Flash a Warning Sign”—The Wall Street Journal, August 14, 2016

• “Stocks have only been this expensive during the crash of 1929, the tech bubble, and the financial crisis”— Business Insider, December 9, 2016

• “A record number of market pros believes stocks are too expensive”—CNBC, August 19, 2017

If these headlines (or ones like them) have scared you out of investing, you’ve missed out on some major gains.

Since that first headline appeared in April 2014…

• The S&P 500 is up 40%

• The Dow Jones Industrial Average is up 41%

• And the Nasdaq is up 60%.

And each index has reached all-time highs in 2017.

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I’m back in the office after my two-week Rust Belt Tour. During my travels, I showed you that the gloom and doom you hear from the media about the U.S. economy is overhyped.

Just like with the economy, the media is selling fear of the markets. But there’s a clear disconnect between what you hear in the financial press and what’s actually going on.

Today, I’ll share three reasons why the markets are fairly priced… And why you should ignore the gloom and doom and continue to own quality stocks.

How to Tell If a Market Is Expensive

The price-to-earnings (P/E) ratio is one of the most common ways to value stocks.

The P/E ratio is the price you’re willing pay for $1 of current earnings. Generally, a higher ratio means a more expensive stock.

Today, the market’s P/E ratio is 25.6. And that does seem more expensive than the historical average of 16.5 (see chart below).

Analysts will look at this chart and say, “The market is overvalued by 64%… Be careful.”

Here’s the problem with that line of thinking… It’s looking backwards. I want you to look forward.

Drawing the Wrong Lessons From the Past

Comparing current valuations to those before 1997 doesn’t make sense. Things are very different today than they were back then.

Since 1997, we’ve seen fast-growing tech companies join the S&P 500. And innovations like computers and the internet have made companies much more efficient than before.

Central bankers’ policies have also distorted the markets. Their permanently low interest rates and unlimited money printing have pushed more investors into stocks.

To be more forward-looking, we should break the chart above into two time frames: before 1997 and after 1997.

Here’s what the chart above shows…

• From 1907–97, the average P/E ratio of the S&P 500 was 13.7.

• From 1997 until today, the average P/E ratio of the S&P 500 is 24.6.

That means stocks today are 80% higher than they were before 1997.

On its face, that may seem expensive. However, I think the market is priced fairly. Here are three reasons why today’s valuations aren’t expensive…

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The New Normal

People often say the most expensive words in the English language are, “It’s different this time.”

Usually, that’s true. But this time it’s really different.

I don’t make claims like this lightly. So, here are the three reasons I believe stocks are fairly priced when compared to the past:

• More people own stocks now than they did before.

In 1950, only 4% of Americans owned stocks. By 1990, 20% owned stocks. Today, more than 50% own stocks. The reason is simple… More Americans are invested in Individual Retirement Accounts (IRAs) and 401(k) plans.

More people are buying and that has created more competition. In turn, more competition is driving up stock prices.

• Low interest rates.

Low interest rates reduce the gains from savings accounts and buying bonds.

In the past, you could earn a 6% (or higher) interest rate in your savings account or from a 10-year Treasury bond. Today, you’re lucky to get a 0.1% return in a savings account or a 2.5% return on a 10-year note.

Stocks have returned an average of about 10% per year (over the long run). With ultra-low interest rates, people have shifted their money from bonds to stocks.

• Corporate profits are up.

The S&P 500’s average return on sales is 40% higher after 1997 than it was before.

The faster profits grow, the more you can pay for current profits. That’s why growth companies are typically more expensive than value companies.

These three factors have catapulted stocks to new levels. Until these three trends reverse—and in a meaningful way—stock valuations will remain higher than they did in the past.

So, in our new world, the current P/E ratio of 25.6 is pretty close to the 20-year average of 24.6. Just consider it the “new normal.”

Don’t get stuck dreaming about the past. Times are different… Stay the course and continue holding your stocks.

Regards,

Nick Rokke, CFA
Analyst, The Palm Beach Daily

P.S. Have the headlines in the mainstream media scared you out of the markets? Let me know right here…

I brought up the subject of overregulation in the June 21 Daily, and the topic continues to be a source of concern for our readers…

From Jimmy S.: Hi Nick. California is a perfect example of out-of-control regulations that are harming businesses. For example, a nationwide organic food manufacturer headquartered in the city where I live needed to expand. They planned to move into a production facility that had been used by another food manufacturer. And the city tried to extort them for $34 million in water and sewer permit fees!

Instead, the company moved to a small town in Idaho and bought a shuttered Heinz plant. I had an “inside man” at the company with the real scoop. He said the move was because the cost of the Heinz plant was not that much more than the outrageous permit fees.

From Keith M.: In response to your ebullient view of the Canadian side of the border (“This Is the Biggest Threat to U.S. Industry”), I would like to offer some additional comments. In the Niagara (Canada) region, the recent unemployment rate was 7.1%. However, the labor participation rate is only 61.1%. According to the government, 9.9% of Niagara households are “food insecure.” Property values in Niagara Falls are going up only because of Toronto bubble overspill.

Once a tourist gets away from the “nice” area around Niagara Falls—with the “nice” tourist-gouging hotels and stores—the city deteriorates into what some tourists have described as “dumpy” with poor roads, weed-infested parks, and few shopping areas.

It must be noted that you compared the Canadian side to a failed liberal, Rust Belt Democrat and overly taxed New York State. Perhaps not a great comparison? I personally prefer the U.S. side.

Nick’s Reply: Thanks for the response, Keith. The comparison I wanted to make is that the overregulated city of Niagara Falls, New York, is much worse off than the less-regulated city of Niagara Falls, Canada. Regulations are destroying the U.S. city.

Note that this has nothing to do with comparing Canada to the United States as a whole. That’s a completely different conversation…

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