Should You Invest in Today’s Stock Market Environment?

The stock market has been good for the last 5 years—almost to the date. Really good. Since hitting its low of $676.53 on March 9, 2009, the S&P 500 has been on a tear that, as of this writing, has it sitting right around all-time highs at $1,886. Looking at the chart below, it’s been an almost straight ride up, with the exception of a few small corrections. It’s blasted past the previous high set in 2007 and is now in uncharted territory.

Stock market S&P 500 Index - March 2014

The stock market is at an all-time high. What’s your comfort level at investing at these levels?

So the question is, will it keep going? What’s going to stop it from going higher? Why should you or should you not be involved in this market?

 

What Are Your Stock Market Concerns?

Many people are concerned that the current bull market has gone on too long and too far for it to continue much longer. Others argue that bull markets in the past have stretched further than this one.

Some critics say that valuations are too high by many measures, while there are just as many bullish analysts that will point to undervalued metrics for this stock market and individual stocks in general.

In other words, nobody knows for sure what’s going to happen over the next year or two in this market (and the good news is, you don’t have to in order to be successful). The only thing you can do as an individual investor looking to maximize growth is to consider what kind of return you believe you’ll get from being in this market and investing in individual stocks—at these prices—over the long term. As a smart, educated investor, you are looking for results—not in the next year—but over the next 10 years and beyond. Getting bogged down by the noise of short-term fluctuations will only lead to headaches.

All the individual investor should be worried about is what kind of return is still possible out of this market compared to the risk he or she is taking on. Or more simply—at today’s prices, is there still enough money to be made, or is the bull market close to running its course?

 

Questions to Ask Yourself Before Buying and Selling

Here are some things to consider in determining what kind of decisions you should be making in today’s market, and if your money and time is best spent in stocks, or a different investment type.

  • Will QE (quantitative easing) continue much longer—and what will happen when it’s taken off the table?

Whatever your opinion on QE is, we all know that it won’t last forever. When it finally does go away, what will the market reaction be? What kind of reward is there still potentially left in these prices for taking on the risk of a market absent of QE?

The “Bernanke put” is a phrase for the current situation in the market that means the federal reserve won’t let the stock market drop too far without jumping in. This can’t go on forever. What will make that disappear?

 

  • Are you more worried about return of your capital—not losing the money you put in—or return on capital—making large gains on your accounts?

If you are worried big losses are possible in this market, then your risk/reward scenario doesn’t warrant buying stocks at these levels. Investors who focus first on avoiding losses—then on gains—feel that current stock prices are generally too high. If you are more concerned with missing the next bull run and can’t stomach being out, then you are probably better off in this market.

 

The Schiller PE Ratio is based on the average inflation-adjusted earnings from the past 10 years for the S&P 500 index. A high number indicates that stocks are valued in the upper range—a low number indicates stocks are valued in the lower range. It’s a highly recognized metric that garners a lot of attention in the financial world.

Look at the chart below. It’s currently at 26, which is a level only seen before in 1929 (great depression), 2000 (dot-com mania), and 2007 (housing and credit collapse). Does that mean it can’t continue going higher? Absolutely not. Look at 2000, it went all the way up to 44. However, risk/reward comes into play again here. What is the potential reward for the amount of risk you’re willing to take? What does history say about markets at this level?

Shiller PE - March 2014

The last time the Shiller PE was this high, stocks tumbled. In fact, every time the Shiller PE has been this high, stock prices ended up in disaster

  • How long will interest rates stay where they are?

Stocks generally tend to move inversely with interest rates. As rates go down, more money is available—which is good for stocks—so they tend to go up. And vice versa. With interest rates at nearly 0%, how long can that continue, could they go any lower, and what will happen to stocks when they start increasing?

 

  • There is no volatility in the market, meaning that investors as a whole are not scared. They don’t believe that this market will go down and the “fear index,” or lack of volatility proves this. Does this sort of thinking and activity worry you when these have been previous signs of market tops? Remember what Warren Buffett said about fear:

“Be fearful when others are greedy and greedy when others are fearful” In other words, buy fear and sell greed. Are we in a fearful or greedy market right now?

 

  • There are some “off-the-charts” PE ratios out there for some individual stocks (similar to 2000). Tesla at 279, Twitter at 500, Amazon at 570…the list goes on. Is this a worrisome situation?

The PE ratio doesn’t tell you everything, but it can tell you where stocks are valued historically. These levels are in the upper range, and investing in stocks with PE ratios like the ones mentioned above is similar to driving a car at 160 MPH. It can be fun and can go well for awhile, but one wrong move and a lot can go wrong very quickly. Know what you’re getting into and what the potential red flags can be.

 

  • The economy has been getting better. Is this for real, or is it because of artificially low interest rates and spending by the federal government? Will the economy continue to improve at a rate that warrants current stock prices?

The economy improving is a great thing. Unemployment is down, earnings are up, and stocks are increasing because of it. How long will this trend continue?

 

  • National debt is at an all time high and continues to climb—what does this mean for stocks going forward?

Taking this a step further, what does potentially high inflation to counter our record high debt mean for stocks in the future?

 

It’s Your Decision—Take Responsibility

So, should you invest in today’s stock market?

In the end, it’s up to you to decide what’s best for your portfolio. I can’t say a blanket yes or no for you because I don’t know your situation, opinions, and ability to tolerate market movements. These are questions and items you need to consider before investing in the stock market because successful investing ultimately comes down to managing the risk you are taking on with the potential reward—which is also related to how you’ll react when investments don’t go as planned (which happens a lot).

If you feel comfortable with these issues and can fairly decide that these current prices leave a lot of room for future growth, then you should absolutely be a purchaser of stocks. On the other hand, if you don’t feel so comfortable with the future—or at least not with the current stock prices—then you’re probably better off waiting for a correction or drop in prices. Otherwise, you won’t be able to handle it when prices do drop, and you’ll only end up giving away your gains out of fear of loss. This is not the correct way to operate in a bull market that has had a straight-up run for five years.

It’s all about how aggressive you want to be in valuing stocks. This is why everyone is different and should have a custom, personalized look at their financial blueprint. It’s up to you decide how much risk you can work with, what kind of volatility you can handle, and what your end goal really is. Once you can accurately assess those questions—only then will you be able to begin true long-term, profitable investing in your accounts.

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Kevin Tudor is the VP of Investment Training for Margin of Safety Investing, LLC. After a significant amount of time in the financial services industry, Kevin moved on to investment research and analysis to bring his expertise to the individual investor. He now resides in Scottsdale, Arizona where he conducts online webinars, writes financial newsletters, and provides various methods of investment training to show others the key strategies to successful investing.

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