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If you think the stock market is overvalued and therefore ripe for a fall, you’re not paranoid. You’re most likely right.
According to a Bank of America Merrill Lynch survey of fund managers in June, a record number of investment professionals said they believe the stock market is overvalued. And that was in mid-June, when the Dow Jones industrial average was hovering at around 21,300. As I write this (Aug. 3), the average has climbed another 700 points to 22,000.
Nobel laureate and Yale University professor Robert Shiller is legendary for predicting both the dot-com and housing bubbles in a 2006 book called “Irrational Exuberance.” He developed a ratio to predict overvalued markets called the Cyclically Adjusted Price/Earnings Ratio (CAPE). What’s it saying now? From a recent CNBC article:
His Shiller PE Ratio, also known as CAPE, shows the price-earnings ratio based on average inflation-adjusted earnings from the last 10 years is over 30. The number carries significance because the only times it’s been higher was just before the Great Depression in 1929 and [the dot-com bubble of] mid-1997 to mid-2001.
There are, of course, dissenting Wall Street voices suggesting stocks aren’t overvalued, thanks to factors like low interest rates, a favorable political climate and investor sentiment. Still, in my opinion, if you’ve got a lot of your savings in stocks and you’re not a little nervous, you’re not paying attention.
So what’s an investor to do?
Why I don’t time markets
I’ve been investing in stocks for nearly 40 years, including a decade as a Wall Street investment adviser, so I’ve been both sanguine and scared more times than I can count.
It’s understandable to be concerned when the market gets overpriced like it is today, especially when you’ve experienced major setbacks in the past. It’s no fun to watch 20 or even 50 percent of your savings evaporate.
That being said, I’m not selling, at least not across the board. The reasons are simple: First, I’m not smart enough to know when a correction, even an inevitable one, will occur. Markets can remain overvalued for years. Second, even if I do sell and preserve my profits, I’m not smart enough to know when to get back in.
One recent example of why I stay invested: I was convinced that a Donald Trump presidential victory would result in a market crash. (I certainly wasn’t alone.) Nonetheless, I didn’t sell a thing. As we all now know, the experts, myself included, were spectacularly wrong. When Trump was elected, the Dow was around 18,000. Now it’s 22,000, more than 20 percent higher.
If you had $100,000 in a stock mutual fund, listened to the experts and sold the day before the election, so far you’d have left $20,000 on the table. You could retire six months earlier with that kind of money.
But refusing to sell everything doesn’t mean I’m not doing anything.
What I’m doing now and you should consider
I’m not likely to touch the money I have in the type of stock mutual funds I often recommend. I will, however, take a look at my overall picture to make sure I don’t have more exposure than I’m comfortable with.
The market has gone up more than 20 percent in less than a year, and more than 200 percent since the lows of 2009, so the savings I’ve allocated to stocks may now represent a higher percentage of my overall net worth than they should. In other words, if my plan is to keep 50 percent of my long-term savings in stocks, and paper profits have now pushed that percentage to 70, this would be the ideal time to bank some profits.
I also own shares in a bunch of individual companies. Some I’m happy with, some not so much. While the market’s high, it’s is a great time to sell shares of those I’m not as fond of, then either buy into companies I like more or, if I think they’re too rich, keep the proceeds on the sidelines until prices become more attractive.
Bottom line? Timing the market is a fool’s game. Trust me: Even when the next market move looks obvious, it isn’t. And even if you do get out at the top, down the line you’ll be faced with another, equally difficult decision: when to buy back in.
That being said, if you’re genuinely worried, or can’t stomach the thought of even small paper losses, that’s a sure sign you’re in too deep. Do something about it.
I founded Money Talks News in 1991. I am a CPA and have also earned licenses in stocks, commodities, options principal, mutual funds, life insurance, securities supervisor and real estate. If you like what you read here, sign up for our free newsletter.