When the NASDAQ Composite Index hit 5000 in March of 2000, jubilant investors celebrated the milestone. Shortly thereafter, however, scores of individuals lost their collective shirts. Many witnessed losses of 50%, 60% or 80% of their account values on names like Cisco, JDS Uniphase and Pets.com.
Back then, the euphoria was akin to unchecked greed. Today, the public is far more subdued. And that’s a positive sign. After all, how could we be in a “stock bubble” if we are merely revisiting the place where it all began?
(Note: Actually, we have only revisited a nominal (price-weighted) starting gate. The NASDAQ would need to rise above 7000 on an inflation-adjusted basis for the dollars to mean the same thing.)
So no, this is not the manic Willy Wonka-like balloon ride that characterized the start of the 21st century. That said, there are valid measures of value that suggest things are every bit as overpriced in March of 2015 as they were in the dot-com era. For example, the current median price/earnings (P/E) and current price/revenue (P/S) for all U.S. listed stocks is higher than in 1929, 1973, 1987, 2000 and 2007. The highest median stock P/E and P/S price tags in recorded history? Unfortunately, yes.
Surely, stock prices cannot be as insane as they were 15 years ago, can they be? Maybe not for the NASDAQ. Back in March of 2000, the index had a 64% weighting in tech stocks, mostly Internet names. Today, the index is broader. It has a much greater allocation to health care corporations that actually earn profits. What’s more, today’s NASDAQ has a 10% weighting in Apple.
My, how quickly they forget. The last time that you were able to find a negative word about Apple’s future was in the summer of 2012. Many articles about soon-to-be retirees with 100% of their retirement in Apple stock commended those investors for the foresight to bypass “over-rated” diversification. And then the roof caved in.
Similarly, the complacency about risk in stocks has been reaching extremes. For instance, the Investors Intelligence Advisory Sentiment Survey is one of the premier contrarian indicators. The most recent reading of bullishness and bearishness? Bullish optimism hit a remarkably high level of 60%, while bearish pessimism hit a startling low of 14%.That’s one of the most off-kilter sentiment extremes since the survey first started.
Overpriced markets come in many disguises. March 2000’s NASDAQ witnessed irrational exuberance in the form of the Internet’s creation of a “New Economy.” Today’s illogical rationale centers on ultra-low interest rates – zero percent, even negative percentage rates – that absolutely, positively, “must” push real estate and stock prices higher.
“Why is it illogical?” you ask. Ultra-low rates have been working their magic for more than six years, pushing savers into higher-yielding, higher appreciating investments and prodding businesses to borrow “on the cheap” before buying back their own shares. Yet low rates can only take stocks so far. Consider a neighborhood where the comparable price for a home is $450,000. One is unlikely to pay $4 million for a similar property on the sole basis that mortgage rates are marginal. By the same token, there comes a point where stock assets are severely overpriced, so much so that no amount of Federal Reserve rate manipulation can justify ownership.
In truth, it is a positive sign that investors can look past the phenomena of the NASDAQ hitting 5000 here in March of 2015. Merely taking note of the fact that the same event transpired 15 years earlier shows guarded vigilance.
And there’s more. There are no rules about when an overvalued world of assets – stocks, bonds, real estate, etc. — will crack; overvalued conditions can persist for years. That’s why I employ stop-limit loss orders, multi-asset stock hedging and trendline breaches to minimize exposure to market-based securities.
Let me shift to bond ETFs to provide perspective. Anyone who has read my commentary over the last 15 months knows that my clients have benefited immensely from owning Vanguard Extended Duration Treasury (EDV). Moreover, in my estimation, the party for overvalued long-maturity treasuries is far from finished. Still, if EDV breaks below its 100-day and hits my pre-determined stop-limit loss order near 122, I will reduce some portfolio exposure. (Note: A key will be resistance in and around 124, as well as at 122.7 at the 100-day.)
Stocks do not appear ready for a tumble. Not without a shock to the system, whether it is an unexpected move by the Fed, an unnerving geopolitical occurrence, or a sharp pain from recessionary pressures. There is little evidence of an imminent economic contraction at this moment, though deceleration poses a unique threat at a time when the Federal Reserve has been discussing an overnight lending rate hike.
Consider the fact that the U.S. economy grew at its sub-par, six-year average of 2.2% in the final three months of 2014. Meanwhile, in the first three months of 2015, exports have been waning, consumer spending has been declining and manufacturing has fallen to 13-month lows. Expect first quarter economic activity to dip markedly below its six-year average. One might also anticipate that if chairperson Janet Yellen moves ahead with a rate hike in spite of signs of economic deceleration, stocks will stumble.
I am sticking with lower volatility stock ETFs – both stateside and abroad. My largest holdings are still Vanguard High Dividend Yield (VYM) and iShares USA Minimum Volatility (USMV). Moreover, to reduce the dramatic price swings associated with a number of unhedged foreign market stock ETFs, I prefer funds like WisdomTree Europe Hedged Equity (HEDJ).