Is the U.S. Stock Market Overvalued or Undervalued?
The S&P 500 is breaking all records. It’s well above 2,860 points now. Five years ago, it was just below 1,500 points, and nine years ago, at the end of January 2009, it was 820 points. In other words, the S&P 500 has risen 320% since the rock-bottom period of the 2008 market crash. There’s no doubt that the U.S. stock market is overvalued.
The Dow Jones continues to rise, giving the illusion that the markets have relentless bullish potential. That’s like discovering perpetual motion or eternal youth. Sooner or later, someone will yell the emperor has no clothes—or its market equivalent, “the stocks have no earnings.”
In fairness, some do have earnings, but there is a euphoria that has prompted investors to be overly bullish. Perhaps the phenomenon has worsened; investors have thrown all caution to the wind. In a month, Netflix, Inc. (NASDAQ:NFLX) stock went from about $187.00 to $272.00. That’s an almost 50% increase.
It’s a fact that Netflix reported a significant increase in the number of subscribers. However, earnings released on January 22 met analysts’ expectations; they did not beat expectations of $0.41 per share. That said, the stock is trading at an astounding 260 times earnings! (Source: “Investors in Netflix, Inc. Stock Need to Walk Away From the Table,” InvestorPlace, January 26, 2018.)
Another darling of investors, especially Millennials and idealist do-gooders with big wallets, is Tesla Inc (NASDAQ:TSLA). It moves higher, despite almost daily announcements from its CEO, Elon “worried about too many high-risk businesses to focus” Musk. Granted, Tesla’s products have much curb appeal, and many covet owning one. But it needs to get the cars to the dealers in order to collect revenues and earnings.
Tesla continues to struggle getting the “Model 3” out the door. That’s supposed to be its bread and butter model, but problems with battery production (and quality) are slowing everything down. Tesla has scaled down production estimates from 10,000 to 2,500 cars a week. (Source: “Tesla Model 3 delays persist, reportedly due to Gigafactory problems,” The Verge, January 25, 2018.)
Yet Tesla stock is trading at about $340.00 per share, sporting an uninviting earnings-per-share achievement of about -9.00. Its price-to-earnings (P/E) ratio is best described as N/A; if you prefer, it means it’s losing money—and quite a lot of it—every day.
Bob Lutz, automotive legend and former CEO of companies like General Motors Company (NYSE:GM) to Bayerische Motoren Werke AG (ETR:BMW), says Tesla may have a good car in the “Model S,” but it may not have, “a good automobile company.” (Source: “Bob Lutz And Tesla: The Difference Between The Old Economy And The New,” Forbes, January 23, 2018.)
Tesla has earned its place among car manufacturers, showing the world that electric cars can be exciting (for some). However, Elon Musk is running Tesla like a mission, in the strictest religious sense of the term. In other words, such details as earnings, revenues, and production costs aren’t as important as getting drivers to give up the internal combustion engine in favor of a battery on wheels. There’s nothing wrong with that.
Musk is free to pursue this goal with the messianic zeal of St. John the Baptist. But investors should be aware of the difference between General Motors—which has a Model 3 competitor (in showrooms and ready to go) in the form of the “Chevrolet Bolt”—and Tesla. General Motors sells about 10 million cars per year, while GM stock is trading at $43.29 per share and has a P/E ratio of 22.55, which is well within the industry normal.
Why Is the U.S. Stock Market Overbought?
I’ve singled out Tesla and Netflix because they offer some the most “in your face” examples that the U.S. stock market is overpriced. Consider that Tesla stock, despite the company posting some downright embarrassing production figures in view of expectations, has gained about 35% in the past year. GM stock, by comparison, after the company posted good financials and actual earnings, gained about 15%.
The numbers and common sense should have inspired more investors to go for GM, but the razzle and dazzle of Tesla product announcements captures the imagination. It makes grown men feel like children again, and the younger ones dream. But investors should think with their wallets. Big words and even bigger promises are lovely to the ear, but dangerous for your savings. Therefore, if you had wondered why the U.S. stock market is overvalued, you have your answer.
The Tesla and Netflix stock examples are not unique. There are many stocks–especially in the tech sector–that should have you do a double-take, and then walk away. Some stocks have legitimate valuations and bullish prospects, but many of the ones getting attention do not. Need I bring up the example of Snap Inc (NYSE:SNAP) stock, better known as “Snapchat.” It’s trading well below half its IPO price.
How to Determine the Market Is Overvalued
Indeed, looking at the multiples and the expectations surrounding some stocks, it’s worth entertaining a few doubts before buying. It’s legitimate to have them, and as the Romans said, “caveat emptor,” Latin for “let the buyer beware.”
Many stocks are trading at prices that are too high relative to the value of their assets. If that doesn’t cause alarm, remember that’s what caused the subprime financial disaster. Not surprisingly, the current P/E values have not seen such high values as in the period that came just before the biggest recession of the 21st century. Some say it sparked a depression deeper than the one that afflicted the world in the 1930s.
With stock values as high as they are, and so many unjustified by their earnings, equities on Wall Street might well be the most overvalued of them all. The question you may be asking, and which many are afraid to admit: as a result of which economic or financial principles does Wall Street remain so bullish?
No doubt, there’s some of the good, old-fashioned spirit that spurred on the gold rush. It’s the same temptation that makes perfectly rational people buy a lottery ticket, or makes that same person visit a Las Vegas casino and “invest” a few hundred dollars on the slight chance that certain ideal numbers come up. With the P/E ratios and market sentiment where it is, choosing stocks based on the way their letters form certain patterns in the light seems sensible.
Certainly, it’s no stranger than picking stocks based on what your Uber driver heard from his second cousin at a bar once. Still, the Las Vegas “school of investing” that’s producing so many graduates these days received some aiding and abetting from the very top. President Donald Trump’s corporate tax cut from 35% to 20% can take much of the blame (or credit) to explain how the market has taken off so rapidly and sharply.
Ask a Simple Question
Given that the tax cuts are the main driver of bullish sentiment, you can evaluate whether the market is overvalued or not by asking a simple question: would stock A or B have gone up this much if Trump had left corporate taxes as they were?
You would have to go back to January 2017, or even November 2016, for a thorough analysis. The tax cuts were one of the main points of Trump’s election campaign. Its bull market mechanism came into play the moment Trump delivered his acceptance speech.
Those investors who want to hang on to the belief they are prudent and disciplined while still betting on one of the many overrated horses–I mean, stocks–have a good excuse. They can carefully explain that the lower taxes will have a positive effect on earnings per share.
However, many stocks were already overvalued in 2016 or 2015. Whatever effect the tax cuts will have on P/E will already have been canceled out by the disproportionate rise in value. Again, I’m thinking of Netflix and Tesla, as explained earlier.
Others may point out that Trump’s tax cuts have made America into the new fiscal paradise. There’s no need for Americans to play hide and seek games with the IRS or open-numbered bank accounts in Switzerland, the Cayman Islands, or the Isle of Man. The new U.S. fiscal regime makes it worthwhile to repatriate holdings.
The idea is that companies are fundamentally “good” and that they act for the public good. Under this optimistic philosophy, companies will invest the sizeable sums they bring back in the economy, creating new jobs. Surely (sarcasm alert) if there’s anything that corporations have proven over the decades is their dedication to their fellow man. At no point have companies put those earnings to work in buyback plans, which will further inflate the market. When the companies that do boost the market when they play the buyback game, the overvalued ones may finally start falling, triggering a correction or a crash.
It so happens that Wall Street-listed companies have already been playing buybacks. They may have invested over trillions in buybacks before the tax cuts. (Source: “Stock Buybacks Are Nothing But Margin Speculation,” The Epoch Times, January 11, 2018.)