Yes, COVID, it seems, is making a comeback with the new variant Omicron, but the markets may not reflect the situation or include higher inflation numbers. But regardless, investors still seem excited by the markets despite these issues. And that could be cause for you to be concerned.
It seemed as though the US was finally emerging from the more severe effects of COVID, and then last month, Omicron emerged and renewed fears. But that has only temporarily seemed to have affected the markets, as in 2021, there have been over two dozen records associated with the market. And interest in the markets has increased with smaller investors due to an influx of stimulus funding and investment apps such as Robinhood and placing billions in the market. And as always, I will not go into any of the effects of and funding placed in cryptocurrencies.
The current market is excellent for those who can and follow the adage of “buy low and sell high.” So, what is the issue with investors and the current markets? People are buying high or simply not selling and letting their position run. This is fine, provided that if and when the market goes bearish, you do not panic and sell when prices are low and lock in those losses. Remember, over the long term; the market does one thing: it goes up. It may take some positions longer than others to get back to your purchase price point, but chances are if you are patient, they will reach that level again and once again start the process of going beyond that point. The key here is to never sell in a panic when prices are depressed unless there is an actual reason to exit a position, such as the fundamentals of the business have changed. A general bear market is not a reason to sell, and that is the perfect buying opportunity, not a selling one.
So, while many investors are excited about the state of the current market, others who may be more experienced are somewhat nervous as some indicators might suggest something other than good times are ahead.
Shiller Price-to-Earnings Ratio
On December 17, 2021, this ratio was 38.76, and the S&P 500 price-to-earnings stood at 29.1. Why the difference? The S&P 500 P/E is simply the ratio at which people are willing to pay for a company’s earnings. In the case of the S&P, as of December 17, 2021, people were willing to pay $29.10 for each $1 in earnings. Not an all-time high but higher than the historical mean of 15.96. That means in the current market, and people are willing to pay over twice the historical mean of the S&P 500
So, why the difference between the two P/E ratios? The Shiller is based on the previous decade, not just at a single point in time. And except for the brief bear market in the spring of 2020 at the onset of COVID, the markets have been on an extended bull market since the recovery from the Great Recession in 2009. That is why investors right now are willing to pay $38.76 for each $1 of earnings in the S&P 500.
So yes, no matter which ratio you use right now, many of the companies in the S&P 500 are overpriced compared to historical averages. But that does not mean there are no buying opportunities if you are patient and do your research before buying. But buying blind may not end well for you if you panic when the market reverts to the mean and sell at the wrong time.
For more information on the Shiller price-to-earnings ratio, see https://www.multpl.com/shiller-pe/faq.
Price-to-Sales
On December 17, 2021, this ratio stood at 3.16, near an all-time high. Yes, not all companies boast record profits or profits of any sort in many cases. But the profitable businesses now appear to be extremely profitable despite the effects of COVID, and we will see the effects of inflation when many report their next earnings for the current quarter. And while not all investors or companies are worried about the price-to-earnings ratio, companies focused on expansion may decide to use price to sales instead, a measure of how expensive a stock is for every $1 of revenue that the company generates.
The market today is even more expensive measured against sales rather than earnings. While the price-to-sales data does not go back near as far as the price-to-earnings data, it indicates that during the dot.com bubble, it stood only about 2 where we are at 3.16 as of last Friday. For more information on price-to-sales, go to https://www.investopedia.com/terms/p/price-to-salesratio.asp.
Investor Sentiment
This measure is based on a group of investors surveyed on how they feel about the market in general. As of December 15, 2021, only 25.2% were bullish, 35.4% stated they were neutral, and 39.3% were bearish. This survey was conducted by the American Association of Individual Investors or AAII, and they have been conducting it since 1987. For more information on AAII, go to https://www.aaii.com/.
Margin of Debt
Buying stocks with borrowed money is nothing new, but currently, we are near all-time highs on margin debt, standing at almost $934 billion as of December 3, 2021. This concept and practice are the riskiest of all investment options for the average investor. As long as the market goes up, you can experience some truly outstanding rewards and profits. But when it turns, you are in a position to lose far more than your original investment. One of the major reasons the stock market crash of 1929 was exacerbated was people had purchased so much of their portfolios on margin.
FINRA, which tracks the use of margin and is the brokerage industry’s self-regulator, sees that when greed is prevalent, its use rises, and when fear is apparent, its use falls. To put this in context, in March of 2021, FINRA stated we hit an all-time high in the use of margin at $823 billion, which is well below where we are at today. And as a reference, in the spring of 2020, with the introduction of COVID and its restrictions, the use of margin volume dropped to $479 billion. Before 2018, the level of margin debt had never climbed over $700 billion.
For more information on the use of margins, visit https://www.finra.org/rules-guidance/rulebooks/finra-rules/4210.
Put-Call Ratio
This reading as of December 17, 2021, was 0.59. This measure is more or less indicative of more sophisticated investors than a typical one. It involves a more in-depth strategy and understanding of the markets and is measured by the Equity Put-Call Ratio. The Chicago Board of Options Exchange calculates the ratio, and it compares the volume of bearish bets versus the volume of bullish bets at any given time.
A low number indicates optimism; generally, 0.50 or lower, and a higher number such as 1.0 suggests that investors are fearful. One firm that tracks this ratio stated that over the past two decades, it had averaged 0.65.
Based on my research, the put-call ratio on December 3, 2021, reached 0.74 and for December averaged 0.56, which is in line with the December 17, 2021 ratio. But when you look at the average for 2021, it is a bit more bullish at 0.47. This trend leads one to believe that the markets may be overvalued, and a correction is in order.
If you have any questions or need additional clarification, don’t hesitate to contact me directly. Though located in Nashville, Tennessee, we can assist you no matter where you are located in the US if you cannot reach out to another fee-only Registered Financial Consultant to get assistance.
