B. Riley Advisor Talking Points: The Stock Market Is Overvalued. This Is A Healthy, Normal Correction.
Year-to-date, the S&P 500 Index is up 6.07%, and for the past year, it is now up 16.65%. The tech-heavy NASDAQ Index is up year-to-date 26.09%, and it is currently up 41.82% for the past year.
S&P 500 & NASDAQ Indexes Hit All-Time Highs Early Last Week and Then Started To Decline
After the S&P 500 Index and the NASDAQ Index both hit historic highs earlier last week, the S&P 500 Index dropped -4.3%, and the NASDAQ Index dropped -6.17% on Thursday and Friday. That was roughly the level both indexes hit two weeks ago.
As we take a look at the current state of the overall underlying U.S. economy, we can see from this week’s ECRI Weekly Leading Index of leading economic indicators that the economy is still growing and expanding.
The chart below shows the ECRI Weekly Index of Leading Indicators going back to the 1960s. On the far right, you will see that the current ECRI Weekly Index of Leading Economic Indicators is now back to where it was the week before the Coronavirus lockdown began in mid-March.
The U.S. Economy Is Still Growing And Expanding
Last week, the U.S. economy added a better than expected 1.4 million jobs in August, sending the unemployment rate from 10.2% down to 8.4%. The good news is that many of those new jobs came in sectors that have been hit hardest by the pandemic. The economy saw job gains in retail, leisure, and hospitality—mostly in restaurants, bars, and other food establishments. We also saw job growth in education and health services.
Another good sign for the economy was that national factory manufacturing increased to its highest level since January 2019, after three months of solid growth. Home sales were also up dramatically.
Still, on the negative side, 190,000 are dead from the Coronavirus since February, and 29 million people are receiving some form of unemployment benefits.
Why Is The Stock Market Declining Now?
According to Factset, the forward 12-month Price Earnings Ratio (P/E) for the S&P 500 Index was 22.3 at the beginning of last week. That P/E ratio is above the 5-year average of 17 and above the 10-year average of 15.3. That means the S&P 500 Index could be overvalued by more than 26% compared to the 5-year P/E average of 17.
I have warned that investors should not be surprised to see a 10% or more pull-back or correction from current prices over the next few months. This would be the start of a normal, healthy reversion to the stock market’s long-term trend of between a 15 and 17 P/E ratio.
That doesn’t mean we won’t see more declines and volatility before the election—we likely will—but because the stock market is overvalued, this is an entirely normal and healthy correction. Sometimes the markets get ahead of themselves, and then they adjust. That is what is happening now.
The good news is that one of the first things economists learn in “Economics 101” is that over the long-term, the U.S. stock market always follows the directional trend of the underlying U.S. economy. If the U.S. economy is growing and expanding, in the long-term, the U.S. stock market will go up. If the U.S. economy is plateauing or going sideways, the U.S. stock market, in the long-term, will go sideways. And, if the U.S. economy is contracting and declining, the stock market, in the long-term, will decline with it.
Right now, the underlying U.S. economy is continuing to grow and expand. I believe this will continue through 2021 and 2022, and growth will accelerate if we finally get a safe and effective vaccine.
How Should An Investor React?
Stay invested in the stock market! If you looked at the historical stock market performance charts when there were similar fears over the SARS virus and the MERS virus, they were all short-lived, and investors were rewarded for staying in the stock market.
Despite this current market correction, the U.S. economy is still growing and expanding.
Once the stock market pulls back to a more reasonable valuation, it can resume its growth in a more sustainable valuation.
As the British always say, “Remain Calm and Carry On.”
NOTE: This report is authorized for distribution to clients
Paul Dietrich, Chief Investment Strategist, B. Riley Wealth Management
Paul Dietrich is focused on managing investments for private investors, retirement funds, and private institutions throughout the United States. He also serves as a frequent on-air commentator. He regularly contributes market analysis to business and financial media, including CNBC, Fox Business, Bloomberg TV, CNN, The Wall Street Journal, Yahoo! Finance, Reuters, and The Washington Post.
Information and opinions herein are for general use; are not unbiased/impartial; are current at the publication date, subject to change; may be from third parties, and may not be accurate or complete. Past performance is not indicative of future results. This is not a research report or solicitation or recommendation to buy/sell any securities. B. Riley Wealth Management is not engaged in rendering legal, accounting, or tax preparation services. Opinions are the Author’s and do not necessarily reflect those of B. Riley Wealth Management or its affiliates. Investment factors are not fully addressed herein. For important disclosure information, please visit www.brileywealth.com/legal-disclosures.