Just How Expensive is the Stock Market Right Now?

Hey guys and welcome back to the channel. So I wanted to make this video to try and provide a balanced insight into the current state of the stock market. Because no doubt it can be hard to get a grip on what the hell is going on at a high level if you're new to investing. So in this video, I really want to try and provide some context as to where the market currently sits so that you can be better informed for your own investing.

So with that said, let's get started. [Music] This video is brought to you by Sharesight. Seek the tracking of your performance manually; track capital gains, dividends, and currency fluctuations easily. And when it comes to tax time, have everything you need ready to go with just a click of a button. Try Sharesight for free or use the referral link in the description to get four months free when you sign up to an annual plan.

So in this video, I'm going to focus on the US market and specifically we'll be looking at the S&P 500. Now, that is the grouping of the 500 largest companies in America. Now currently, the S&P 500 sits at 4,372 points. That is pretty much the highest value it has ever sat at, but that in itself doesn't mean the market is expensive. What the investing world does, of course, is we compare price to performance because, of course, you'd be willing to pay a higher price for exceptional performance, right? Conversely, if the S&P 500 was performing poorly and was just getting worse, you wouldn't want to pay very much for it, right?

Now a good measure of price versus performance for the US market is a metric called the Shiller PE that compares the price of the S&P 500 to the average inflation-adjusted earnings of the S&P 500 over the past 10 years. So if the Shiller PE is, say, 20, that means investors buying the S&P 500 through ETFs and index funds would be paying 20 times the average earnings of the past 10 years as a share price. Historically, this Shiller PE number has sat at 16.84; however, in recent years it spiked up dramatically. Now it's up to 38, and this comes down to two potential factors.

It means that, one, the average inflation-adjusted earnings of the S&P 500 over the past 10 years have been poor, and/or the price has just risen to crazy levels. And it looks like a little bit of both in this case. The annual inflation-adjusted earnings of the S&P 500 since the start of 2011 had risen roughly 50 percent up to the start of 2020. That's about 4.9 percent growth per year. However, of course, with all that's happened in the past year and a half, it now looks as though the S&P 500 earnings have only grown 2.4 percent over 10 years or 0.24 per year.

Now surely eventually the earnings will climb back over time, but the question is over how much time. Then the second factor is, of course, the price rising, and the S&P 500 has certainly experienced that. The price has risen 228 percent over the last 10 years. So those two factors give us that extreme Shiller PE we currently see. However, even if we assume the earnings of the S&P 500 were back to pre-lockdown levels, we'd still get a Shiller PE of 33.5, roughly double the price that investors would typically pay to own the market.

So by looking at that, the conclusion is that yes, versus the historical average, the market definitely seems high. Even if you forget about the lockdown and assume it had no effect on company earnings, that's what it looks like at face value. However, next we have to consider the world of the big money, the big money managers that manage, you know, billions and billions of other people's dollars. Generally, they have to stay mostly invested at all times; it's generally a rule of the funds they work for.

So for them, it's not actually a question right now of, you know, selling down or staying out of a really expensive market; it's simply a question of where do we park our money? What asset class offers the best deal right now? And usually this battle comes down to stocks and bonds. Now a massive factor in determining whether stocks or bonds look more attractive or less attractive is the current interest rate, which is set by the Federal Reserve.

In a very low interest rate environment—that's what we're in right now—bonds look rather unenticing, leaving money flowing into stocks. Then, in a high interest rate environment, we see the opposite. Now right now, the Federal Reserve has kept rates low to help people and businesses access money cheaply in these times. So for the big money, stocks look more enticing right now despite being overvalued, because the alternative, bonds, looks very unattractive.

Ray Dalio brought up this example in a recent talk, so I want to play a quick clip of him explaining this idea. "So for example, let's say if we were to take the bond yields. The bond yields are extremely low levels, and so say think about bonds as having a multiple. The multiples of bonds are, you know, like 75 times earnings or something depending on what bond market you're operating in. And so when stocks compete with bonds, they're competing with low returns. And so it's not unreasonable to think that the stock market could have a multiple of 50 times if bonds have a 75-time multiple, why can't stocks? And that means a low return."

So that's a good point. To the big money managers, they're happy to invest in stocks right now despite extreme valuations because the alternative isn't as good. So this keeps money flooding into the stock market, and that's the reason why currently, despite every metric saying, you know, the stock market is overvalued, the market keeps going up because huge sums of money keep flowing into stocks, which raises prices. This is Warren Buffet talking to this point: "Interest rates, you know, basically are to the value of assets what gravity is to matter, you know, essentially. And so you've had this incredible reduction in the so-called super risk-free group, the short-term Treasury bill, and that is the yardstick against which other values are measured. So you've had this incredible change in the valuation of everything that produces money because the risk-free rate produces really short enough, right now nothing. If you discount it back and you're discounting at present interest rates, stocks are very, very cheap."

Now the question is what interest rates do over time? So in a nutshell, that is the current state of the stock market. As individual investors, we are all saying, “Wow, that seems quite extreme,” but to the big money, it's all relative to what they can get in the bond market, and that hinges on interest rates.

Interestingly, that's also why you might have heard in the news lately that people are very much paying attention to inflation and also the Federal Reserve at the moment. Because inflation is rising, and the way that the Federal Reserve controls inflation is by raising interest rates, which wouldn't be great for the stock market. Because as interest rates rise, new bonds become more enticing to the big money managers, and they increasingly shift their buying from stocks to bonds.

Now the only other factor that I'll mention is that back on the topic of inflation, we've also seen a remarkable amount of money printing—digital money printing—by the Federal Reserve. Last year alone, the Federal Reserve printed around three trillion US dollars, and in fact, there are now about 25 percent more US dollars that exist today versus February 2020. So with all this money dilution happening, investors both small and large generally aren't keen to hold cash. So what do they do? They funnel their money into the stock market trying to outpace this inflation. So that's another reason why markets continue surging up.

But with all of that said, how should we be going about investing in this strange time? Well, in my opinion, we have two options. And for those that are new to my channel, one thing to know about me is that I do not cover any sort of short-term risky gambling type investment strategies. So what I really mean is how should we as long-term investors focused on building our wealth while minimizing our risk, how should we be going about investing in this strange time?

Well, as I always say, the first option is to invest passively and simply to dollar-cost average. This is just where you save up and invest across the whole market on a regular schedule. So you might come back every three months or so and invest again, buying only market tracking ETFs or index funds. And the trick here is you invest the same amount at the same time interval no matter what the market is doing. Because with passive investing, all you're doing is participating in the stock market over the long term; the market averages out to about seven percent annually. So that's all you're trying to get: average out to the long-term market return.

Despite the market seeming high, that is still a very valid strategy to start right now if you plan on being in the market for an extended period of time. You know, in 20 years, what you did today won't mean much in terms of your overall return, but ensuring you start on that path today will mean a lot. So passive investing is definitely an option in any weather; that's the whole idea.

But what if you want to invest for the long term in some individual companies? Well no doubt that is a much harder game to play right now. And the reason for that is part of the risk minimization process is that we never pay too much for the shares of a company; we only buy when we get discounts. And that is hard to do right now because of what we were talking about before: almost every company is expensive, particularly if it's a high-quality business with a, you know, big fat economic moat, managed well with little exposure to the possibility of bankruptcy.

So what do we do? Do we settle for, you know, buying great companies at expensive prices? No, we stick to the strategy. The most important thing right now is patience, and I know this is hard, particularly if you're new to investing. You know, you see your friends gamble with bitcoin or they buy into the latest SPAC and they seem to be making huge amounts of money every week. But trust me on this one, the way to make money in the stock market is to stick to a proven long-term investment strategy and never deviate from it.

Those gamblers, yes, they're making money now, but they'll lose it all eventually; all gamblers do. For us, we follow the best investors in the world, what they're saying, what they're doing right now. They aren't saying much; they aren't doing much; they aren't buying much. They're biding their time, they're staying patient. They aren't getting sucked in; everybody else seems to be getting sucked in—not them and not us. We keep researching, we keep exploring, we expand our circle of competence, and we wait until we find that great business that hasn't been bid up to the moon.

And that will happen because remember, not all stocks are sky high. If you look at, say, Apple or Google or Tesla, all of those are definitely expensive. But once you start digging into the depths of your own circle of competence, then you will find a lesser-known company that fits the bill and isn't sky high. And when that happens, by all means, you know, go ahead. You certainly don't want to avoid investing in a great company at a discount because you're nervous about the market itself being high; that's definitely a trap you'd want to get into.

But even if you don't find anything, seriously don't stress. Don't feel like you have to get into the market right now. You know, watch the market get more and more speculative and just consider missed short-term gains as, you know, the tax you pay to avoid being caught up in a disaster where you lose everything. Because, you know, if you wind up just buying really expensive stocks, that is a very real possibility.

Anyway guys, that is hopefully a fairly reasonable explanation and opinion as to where we are—or where the stock market is right now—and you know what we should kind of be doing about it. Yes, to us the market seems overvalued, but there are reasons why it's currently like that. Don't get me wrong; there are reasons those reasons may prop the market up for some time. Of course, we don't know what the future holds, but for long-term investors, regardless of what the stock market looks like, we stick to our proven long-term strategies. You know, either dollar-cost average and never stop, or we continue to look into companies within our circle of competence until we find one that fits the bill. And if it doesn't fit, just let it fly on through to the keeper.

Just remember, patience is the key to great investing. You don't make money when you buy; you don't make money when you sell; you make money while you wait. So anyway guys, hopefully that video helps out. Hopefully, it gives you some insight into where the market is, why it's like that, and what we should be doing about it.

So of course, you know, let me know. Everybody's investing strategy is different, so let me know what you're up to down in the comment section below. I’d be really interested to hear, you know, are you finding anything in your own circle of competence that's on sale? Is it pretty much a no-go zone no matter where you look? I'd love to hear from you guys, so let me know what you're thinking down in the comment section below. Leave a like on the video if you did enjoy it or if you found it useful; I’d really appreciate it. It helps out the video a lot in the algorithm.

And if you're interested, consider subscribing. Of course, completely free to do so if you want to see more videos about the stock market. But that will just about do us for today, guys. Thank you very much for watching; that's always the number one thing I appreciate— you guys watching through to the end.

If you're interested in how I go about my investing strategies, either passive investing or active investing, you want just a full walkthrough of both of those strategies, feel free to check out Profitful. Links are down in the description below; that will take you over to the business that I started. We've got two in-depth investing courses over there depending on what strategy you're interested in.

But guys, that'll do me for today. Thank you very much for watching and I'll see you all in the next video. Thanks again to Sharesight for sponsoring this video. So recently, I finally decided to stop being lazy, and I imported all of my stock portfolios across into Sharesight. Finally! I should have done that a hell of a lot sooner.

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So at least sign up for the free plan; it will make your life easier. But that's it for today guys. Thanks very much to Sharesight for sponsoring this content, and I'll see you guys next time. [Music]