Believe it or not, high valuations aren't what causes a stock market bust. The real cause is simple... Stock market busts begin when folks stop buying and start selling.
Editor's note: Amid the recent spell of volatility in the markets, it's hard to blame investors for being nervous about stocks right now...
And over at our corporate affiliate Stansberry Research, so does our friend Brett Eversole...
Today's essay from Brett published in the February 13 edition of his free DailyWealth e-letter. And in it, he explains why getting scared over a particular aspect of stocks right now is the wrong move...
High Valuations Won't Kill the Bull Market
By Brett Eversole, editor, Stansberry Research
Believe it or not, high valuations aren't what causes a stock market bust.
The real cause is simple... Stock market busts begin when folks stop buying and start selling.
Now, that might happen because of economic turmoil or an unexpected black-swan event. But investors never wake up en masse and say, "Wow, stocks are just too expensive... better sell."
It's true that the greatest busts began when stocks were wildly expensive... But they didn't begin because stocks were wildly expensive.
This is important today. Just about everyone knows that stock valuations are high right now. Plenty of investors are worried. But getting scared just because valuations are high is the wrong move.
Don't just take my word for it, though. Today, we'll take a walk through the 1990s boom to see what I mean...
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You could have nitpicked the 1990s boom based on valuations just about the whole way up. To see it, we'll use the cyclically adjusted price-to-earnings ("CAPE") ratio.
This measure takes the average of the past 10 years of inflation-adjusted earnings to build a price-to-earnings (P/E) ratio. That smooths out economic cycles. Plus, we have CAPE data for a century... giving us a lot of history to go on.
Stocks absolutely soared in 1995, rallying 34%. That was after more than a decade of consistent gains. Stocks only fell in two of the years between 1982 and 1995... And over that span, the total return was more than 700%.
Unsurprisingly, stocks weren't cheap after that incredible run. In fact, by 1995, the CAPE ratio showed that stocks were the second-most expensive they had ever been. Take a look...
Stocks soared for more than a decade and became fantastically expensive. By the end of 1995, the CAPE ratio stood at 25.
The previous two times that stocks neared that level were 1929 and 1966... And in both cases, major market crashes followed. So, of course, most would have thought you could pin 1995 as the market top... and that selling would have been the right call.
Except that wasn't true at all. Valuations don't cause market crashes. And they certainly didn't in the mid-1990s...
Instead of crashing in 1996, stocks soared again. The market was up 20% that year. And the CAPE ratio soared to 28 along the way.
But if that had caused you to sell, you would have made a terrible mistake... because stocks catapulted higher once more in 1997. The S&P 500 surged a massive 31%. And the CAPE ratio soared to its highest level in history, hitting 33 at the end of 1997. Take a look...
So, surely if you were going to sell because of valuations, this had to be the moment. Stocks were up nearly 10 times from their 1980s bottom. And valuations were the highest in history.
It probably felt like the most obvious sell signal of all time. But man, would you have ended up kicking yourself if you acted on it...
That's because, as I'm sure you know, the eventual peak was still years away.
Stocks jumped 27% in 1998... then another 20% in 1999. And the CAPE ratio eventually peaked at 44.
If you had bailed at the first sign of extreme valuations in 1995, you would have missed a chance to more than double your money. And that mistake would have been totally avoidable... if you had known that high valuations don't cause stock market busts.
It's crucial to remember this lesson right now. Stocks aren't cheap based on the traditional measures today. Valuations have soared since this bull market began...
The current CAPE ratio is around 38. The standard, simpler P/E ratio is around 27.
This is exactly what we saw in the 1990s. Stocks and valuations soared... eventually reaching heights that no rational person would have thought possible.
But markets aren't perfectly rational. And in a major bull market – like we're in today – they can get more and more irrational.
So don't sell just because of valuations. Stocks aren't cheap... But in the years ahead, they'll likely end up more expensive than anyone believes possible.
Good investing,
Brett Eversole Editor's note: For more insights like this from Brett, you can sign up directly for his DailyWealth e-letter. It publishes every weekday morning that the markets are open. And it's 100% free to read – just like the Chaikin PowerFeed.
Learn how to sign up for DailyWealth by clicking here.
Market View
Major Indexes and Notable Sectors
# Hld: Bullish Neutral Bearish
Dow 30
-0.33%
9
15
6
S&P 500
UNCH
86
276
136
Nasdaq
+0.42%
31
51
18
Small Caps
-0.08%
429
1027
447
Bonds
+0.53%
— According to the Chaikin Power Bar, Large Cap stocks are more than Small Cap stocks. Major indexes are mixed.
* * * *
Sector Tracker
Sector movement over the last 5 days
Information Technology
+3.07%
Communication
+2.5%
Materials
+1.77%
Energy
+1.71%
Staples
+1.59%
Utilities
+1.23%
Discretionary
+0.63%
Real Estate
+0.21%
Industrials
+0.16%
Financial
-0.04%
Health Care
-1.11%
* * * *
Industry Focus
Oil & Gas Equipment Services
0
14
17
Over the past 6 months, the Oil & Gas Equipment Services subsector (XES) has underperformed the S&P 500 by -18.77%. Its Power Bar ratio, which measures future potential, is Very Weak, with more Bearish than Bullish stocks. It is currently ranked #21 of 21 subsectors and has moved down 1 slot over the past week.
Indicative Stocks
AESI
Atlas Energy Solutio
CHX
ChampionX Corporatio
CLB
Core Laboratories In
* * * *
Top Movers
Gainers
ABNB
+14.45%
SMCI
+13.32%
WYNN
+10.38%
WST
+7.84%
DXCM
+5.92%
Losers
GDDY
-14.28%
DVA
-11.09%
AMAT
-8.18%
IR
-7.38%
LULU
-6.18%
* * * *
Earnings Report
Earnings Surprises
MMI Marcus & Millichap, Inc.
Q4
$0.22
Beat by $0.24
SWI SolarWinds Corporation
Q4
$0.51
Beat by $0.24
NMRK Newmark Group, Inc.
Q4
$0.55
Beat by $0.07
* * * *
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