Stocks in 2015 - Instant Sticker Shock or Still Good Value?
Today I'd like to talk about something that gives most investors nightmares -- overheated stock valuations.
One example: A mobile food company called Grilled Cheese Truck Inc. recently started trading over the counter at around six dollars a share.
Grilled Cheese Truck Inc. looks like it has a good product. After all, who doesn't love a gourmet grilled cheese sandwich? Yet the company is essentially just four mobile food trucks. They also reported a net loss of $900,000 in the third quarter of last year, on sales of $1 million.
So not exactly a cash cow poised to take over the restaurant industry, right?
Yet this company had a valuation of roughly $108 million on Feb. 5. This astonishing valuation drew national media attention. It was hailed as another sign that irrational exuberance has returned.
And it was just one more example of what some observers claim are overpriced equity markets.
So what does that mean for you and your nest egg? Should you tilt away from stocks? Keep your foot on the gas? Adopt a wait and see attitude?
Let's find out.
Why you might be paying top dollar for stocks
If you're a value skeptic, there's certainly plenty of data to support your view. By at least one measure from investment strategist Jim Paulsen, U.S. stocks are at their most expensive since World War II. That's enough to scare even the most starry-eyed market optimist.
There are plenty of other negative tea leaves to read. The price-to-earnings ratio for the S&P 500 is the traditional yardstick for stock value. This determines whether corporate earnings justify present valuation.
With a PE ratio of 18, we are three points ahead of the historic average. Other tried-and-true indicators are bearish. At least six show that equities are more overvalued now than they've been for as many as 89-percent of the last century's bull market tops.
These indicators aren't infallible. Yet they have a strong record of predictive accuracy. If you believe these ratios ultimately tell the real story, then you might want to consider getting less aggressive with regard to equities.
Why you might still be getting relative bargains
There is certainly a case to be made on behalf of current values. The U.S. economy is providing significant tailwind. Despite slumps across the globe, U.S. corporate growth and earnings have been strong.
Unemployment is down. GDP is up. The macro trends certainly look capable of supporting sustained growth -- provided we avoid natural disasters and major policy mistakes.
Unfortunately for those who crave certainty, one such policy adjustment is looming.
There's no getting around it -- action (or continued inaction) by the Federal Reserve could ultimately play a huge role. If the Fed moves too quickly or too forcefully to raise rates, stocks could be seriously affected.
Nobody knows what kind of effect the end of historically low interest rates will have. It might not matter much at all, or it might act as a major growth inhibitor. We just won't know until we cross that bridge.
Pessimists believe rates have been so low for so long that even slight a slight bump could trigger a bear market.
There's also the question of time. Six years in, how much further can this historic bull market run?
We believe the finish line is still out of sight. If there isn't a recession lurking around the corner -- and there's no underlying evidence to support that notion -- then a bear market should be a distant concern. A strong economy means more corporate growth -- and higher stock prices.
That's not to say there aren't some ludicrous valuations out there -- they certainly exist. Yet the market as a whole seems capable of outrunning underlying indicators -- at least for another year.
Are you a long-term wealth builder with a sneaking suspicion we're in for a correction? Then it might be time to sit on the sidelines. If action from the Federal Reserve triggers a slowdown, you'll be in prime position to scour the market for devalued bargains.
Are you still feeling good about stock valuations? Then we'd suggest tilting toward companies of the highest pedigree and quality. The market is full of debt-laden, uncompetitive companies with sky high P/E ratios. Avoid them. If you're going to overpay, pay for high quality.
If overvaluation is a widespread trend, you're better off throwing your lot in with companies that are proven winners.