World Capital Management

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1 World Capital Management Equity & Wealth Management World Capital Management, 2018 Tel: WorldCapitalManagement.org Is the stock market 100% overvalued? & Are you prepared for the next market crash? Recently, some investment professionals have warned that the market is extremely overbought, that a number of respected indicators are flashing warning signs, and that stocks are greatly overvalued. Their concerns stem from the current market rally which some prognosticators fear might be getting ahead of itself. In just 8 years, the market averages have risen 360% and some market gurus argue that a major correction is well overdue 1 (Table 1). Table 1 Current 8-year, 360% market rally ( ) 1

2 A history of market crashes. While the stock market has had a history of bear markets, there have been 2 occasions in the past 140 years when the S&P 500 index has declined more than 50%. The first occurred with the 1929 collapse and the second, better known as the Dotcom Bubble, started in 2000 and ended 8 years later after the real estate collapse. (Table 2). Table 2 Over the past 140 years there have been 2 market declines of over 50%. Is there an intrinsic value to the stock market? The notion that stock markets might have an intrinsic value first gained credibility with Yale Professor Robert Shiller s groundbreaking 1983 study using 140 years of S&P 500 price history 2. Shiller s index is calculated on the S&P 500 s inflation-adjusted earnings average from the previous 10 years. Shiller s CAPE ratios showed a strong correlation between the present and future stock values 3 (Table 3). Table 3 Prof. Robert Shiller, Yale University, won the Nobel-Prize in 2013 after showing the relationship between historical cyclical price-earnings (CAPE) ratios and future stock prices. 2

3 Is there a way to foretell market crashes? Historically, very high Shiller CAPE ratios have appeared before major market crashes. The Shiller CAPE ratio reached a height of 32.8 before the 1929 crash. The market decline that followed was 86%. The Shiller CAPE ratio set an all-time high of 48 at the height of Dotcom boom which was then followed by a 60% market pull-back. (Table 4). Table 4 Market crashes generally occur when Shiller CAPE Ratios trade at over twice their historical average. High Shiller CAPE ratios indicate that there is an overabundance of liquidity in the economy. Excess liquidity is often associated with inflated stock values. Historically, when Shiller CAPE ratio values exceed twice their historical average the market has been followed by major market corrections. Is today s stock market overvalued? Based on Professor Shiller s research is the stock market overvalued today? The Shiller CAPE ratio is currently at a level of 32.8, which is 16.6 points higher than its long-term average of This high level has only exceeded twice in the past, from Aug-1929 to Sep-1929 and from Jun-1997 to Jan According to Shiller s analysis, today s market value is 100% higher than the historical market average. Is this a time to be concerned about my investment portfolio? The answer is yes. However, you might want to first consider the following before taking action. Those who believe the market is going higher point to several factors. 3

4 Low-Interest Rates & Little Inflation: An important reason against exiting today s stock market is the historically low-interest rate environment the economy is enjoying. As long as inflation is subdued and businesses can borrow at low-interest rates, the likelihood of a major market reversal is fairly low. No Foreseeable Recession: Heavy market sell-offs often coincide with major recessions. Presently, world markets are relatively stable, economies are growing at a steady rate, and most countries are enjoying low-interest rates and little inflation. These economic conditions are generally not associated with either major market declines or recessions. This is not to rule out something unexpected happening to the economy but a major market sell-off seems unlikely at the present time. The Previous Peak: In 1997, when the Shiller s CAPE ratio hit its previous 1929 high of 32.8, it took another 2 years before the market finally reached a Dotcom Bubble peak. If you sold at the previous CAPE 1929 market high, you would miss another 40% appreciation in your portfolio. Selling now might turn out to be premature. Overvalued stocks, bear markets & recessions. A bear market is a condition in which securities prices fall and widespread pessimism causes the stock market's downward spiral to be self-sustaining. Investors anticipate losses as pessimism and selling increases. Although figures vary, a downturn of 20% or more from a peak in multiple broad market indexes, such as the Standard & Poor's 500 Index (S&P 500), over a two-month period is considered an entry into a bear market. The yellow shading to the right of the Overvalued indicator in Table 5 tracks the subsequent market performance after CAPE ratios reached levels of 22 or greater. High Shiller CAPE ratios appear to be a consistent indicator of excess market value. However, during the 2000 Dotcom run-up, the CAPE indicator prematurely signed a market high by about 2 years. Table 5 Market performance and recessions after CAPE ratios reached >22 during the past 140 years. Should I be invested if we are close to a market top? Let your profits run is a strategy that would have significantly increased profits leading up to the top of the 2000 market bubble. That same strategy might also be appropriate for today s market. If you currently 4

5 hold stocks you may want to either use an exit strategy and sell your positions or use investments that hedge you from a major market correction. What can I do to protect myself? Most investors fail to realize when the markets are overvalued due to the buying frenzy near market tops. As markets rise to new highs investors succumb to emotion rather than rational thought. As frequently observed, the strongest emotion driving investor behavior is either greed or fear. At World Capital Management 4, we help our clients protect their stock and bond portfolios from major market swings. For example, instead of selling your stock positions and incurring sizable capital gains, we incorporate strategies to hedge the market to protect from both downside losses and a significant tax exposure 5. Ideally, we like to minimize changes to your current portfolio when possible. But to be able to help you we would need to talk to you first. So, if you are concerned about today s market and want to take steps to protect against the next major market sell-off, please give us a call. It s better to be proactive today before the next major market correction. By then, it may be too late. Please call us today at so we can discuss a strategy that fits your investment objectives. Most Sincerely, Peter Walker CEO/World Capital Management info@worldcapitalmanagement.org Updated 1/4/18, Subject To Revision 1 Warren Buffett's Favorite Market Indicator Says Stocks Are in Trouble- 2 Robert James Shiller is an American Nobel Laureate, economist, academic, and best-selling author. He currently serves as a Sterling Professor of Economics at Yale University and is a fellow at the Yale School of Management's International Center for Finance. 3 Market studies showing a relationship between Shiller CAPE ratios and future prices use indexes such as the S&P 500 and similar large world indexes. 4 World Capital Management, is a subsidiary of Money Manager Review, a 30-year old financial provider of unbiased, in-depth analysis of hundreds of the world's leading investment managers. Both WCM and MMR are FINRA registered investment advisors. 5 The information provided is for informational purposes only. None of the material should be considered legal or financial advice. Facts presented is believed to be accurate but is not guaranteed. Past performance is not a guarantee of future return. The material provided is subject to revision at any time. 5